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Wednesday, April 3, 2013

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 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.

The economic crisis also turned into a political crisis. A combination of deep cuts in public spending, rising unemployment, and economic recession has provoked large-scale protests in several Eurozone countries, and several governments have fallen as a direct or indirect result of the crisis. Additionally, disagreements among key policymakers over the appropriate crisis response and a complex EU policy-making process are seen as having exacerbated the crisis. 

Recent Developments and Outlook 

Market pressure against the Eurozone eased considerably in the fourth quarter of 2012 and the start of 2013, but uncertainty increased in February and March 2013, particularly driven by developments in Cyprus. The sentiment that the crisis had “turned a corner” at the end of 2012 was largely driven by the European Central Bank (ECB) and its new bond-buying program. Announced in September 2012, the program has not yet been triggered but is viewed by many as successful in restoring market confidence, particularly in Italy and Spain, the third and fourth largest economies in the Eurozone. Other developments helped calm markets, including debt restructuring in Greece and Ireland and progress towards creating a Eurozone “banking union.”

The crisis flared in February and March 2013, highlighting the continuing challenges facing the Eurozone. The February 2013 election in Italy failed to produce a clear winner, raising concerns that political instability could heighten investor unease about the country’s fiscal position. In March 2013, Cyprus’s banking crisis came to the forefront. A tentative assistance package that included taxing depositors was rejected by the Cypriot parliament. After a week of tense negotiations, a new agreement was reached that does not tax small depositors. Although the new agreement is broadly expected to be finalized without problems, concerns persist about potential contagion to other Eurozone countries.

More broadly, fundamental challenges in the Eurozone remain, including lack of economic growth, high unemployment, and internal trade imbalances. Analysts disagree about the likely outcome of the crisis. Some analysts argue that the Eurozone will be able to “muddle through,” making incremental changes without changing the structure of the Eurozone. Others argue that European leaders and institutions will reform, and that the EU could emerge from the crisis stronger and more integrated. Others still have not ruled out some countries, particularly Greece, exiting the Eurozone, although improved market sentiment has limited discussions about a potential Eurozone breakup. 

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 one of the biggest potential threats to the U.S. economic recovery. Additionally, the crisis has bolstered interest in U.S.-EU trade and investment

liberalization, to bolster both economies. In February 2013, the Administration and EU officials announced plans to launch talks on a Transatlantic Trade and Investment Partnership (TTIP). 

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 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 international economic stability and to exercise 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 range of global challenges. Some analysts and policymakers express 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: March 25, 2013
Number of Pages: 23
Order Number: R42377
Price: $29.95

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