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Wednesday, September 12, 2012

The Eurozone Crisis: Overview and Issues for Congress

Rebecca M. Nelson, Coordinator
Analyst in International Trade and Finance

Paul Belkin
Analyst in European Affairs

Derek E. Mix
Analyst in European Affairs

Martin A. Weiss
Specialist in International Trade and Finance

Crisis Overview 

What started as a debt crisis in Greece in late 2009 has evolved into a broader economic and political crisis in the Eurozone and European Union (EU). The Eurozone faces four major, and related, economic challenges: (1) high debt levels and public deficits in some Eurozone countries; (2) weaknesses in the European banking system; (3) economic recession and high unemployment in some Eurozone countries; and (4) persistent trade imbalances within the Eurozone.

Additionally, the Eurozone is facing a political crisis. Disagreements among key policymakers over the appropriate crisis response and a slow, complex EU policy-making process are seen as having exacerbated anxiety in markets. Governments in several European countries have fallen as a direct or indirect result of the crisis. 

Recent Developments & Outlook 

Market pressure against several Eurozone countries has increased in the second quarter of 2012. The crisis response has focused on preventing contagion of the crisis from Greece, Ireland, and Portugal, three relatively small economies, to Italy and Spain, the third- and fourth-largest economies in the Eurozone. However, European authorities announced a major bank recapitalization plan for Spanish banks in June 2012, and there is speculation about whether Spain’s government will also require financial assistance. Amid increasing market pressures, European leaders announced a new set of crisis response measures at an EU summit on June 28- 29, 2012, and in August the president of the European Central Bank (ECB) stated that the ECB would do “whatever it takes” to save the euro. However, pressures continue to build in Greece, with the Greek prime minister appealing to German and French leaders for more time to implement budget cuts and economic reforms. Some economists are forecasting that Greece could require additional aid to avoid defaulting on its debt.

Despite unprecedented policy response measures by European leaders and institutions, many of the fundamental challenges in the Eurozone remain, including lack of economic growth, high unemployment, and internal trade imbalances. The recent market pressure has raised questions about the Eurozone’s future. More economists and policymakers are openly questioning whether Greece will remain in the currency union, and asking what other countries may follow if Greece exits. Others are optimistic that ultimately European leaders and institutions will do whatever is necessary to keep the Eurozone intact, and that the EU could emerge from the crisis stronger and more integrated. 

Issues for Congress

Impact on the U.S. Economy:
The United States has strong economic ties to Europe, and many analysts view the Eurozone crisis as the biggest potential threat to the U.S. economic recovery. U.S. Treasury officials have emphasized that U.S. exposure to the Eurozone countries under the most market pressure is small but that U.S. exposure to Europe as a whole is significant. Recently, the euro has fallen against the dollar; a weaker euro against the U.S. dollar could cause the U.S. trade deficit with the EU to widen. Uncertainty in the Eurozone is creating a “flight to safety,” causing U.S. Treasury yields to fall, and volatility in the U.S. stock market.

IMF Involvement:
In response to the crisis, some countries have pledged additional funds to the International Monetary Fund (IMF). The United States has not pledged any new funds to the IMF as part of this initiative. Members of Congress may want to consider how to guarantee that the IMF has the resources it needs to ensure stability in the international economy while also exercising oversight over the exposure of the IMF to the Eurozone. 

U.S.-European Cooperation:
The United States looks to Europe for partnership in addressing a wide range of global challenges. Some analysts and policymakers have expressed concern that the crisis could keep much of the EU’s focus turned inward and exacerbate a long-standing downward trend in European defense spending.

Date of Report: August 29, 2012
Number of Pages: 26
Order Number: R42377
Price: $29.95

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