Is Another Crisis in the Eurozone Coming?

The crisis in the Eurozone was one of the landmark events in the first part of the 2010s. The economic and financial problems encountered by Greece, Ireland, Italy, Portugal, and Spain threatened to undermine the whole Eurozone and the future of the euro.

Apart from the consequences for the well-being of many millions of people, the Eurozone crisis was of great interest to students of international monetary economics, since its formation represented the first significant experiment with an advanced form of monetary integration in which countries gave up their own national currencies in favor of a newly-created regional one.

Have the markets fallen back asleep? Bird and his co-authors ask.

In an article just published in World Economics, Graham Bird, clinical professor in the Department of Economic Sciences and co-director of the Claremont Institute for Economic Policy Studies (CIEPS), along with CIEPS research associate Eric Pentecost of Loughborough University in the UK and CGU alum Wenti Du, now a professor at Akita International University in Japan, raises the question as to whether another crisis in the Eurozone is coming.

They empirically examine a number of indicators of vulnerability including indebtedness, fiscal deficits, balance of payments deficits, and domestic financial fragility. The authors go on to argue that, while it is difficult to make firm predictions, a further crisis is becoming a significant probability–a probability that has been increased by the ramifications of the COVID-19 pandemic, the Ukraine war, and rising U.S. interest rates.

Going beyond this, Bird and his co-authors also examine whether financial markets have appropriately taken the chances of a further crisis into account in their calculation of risk and risk premia. As Bird points out, “the markets did not see the first Eurozone crisis coming.” He goes on to explain that the crisis represented a “wake up call.”

An interesting question raised by this article is whether the markets have gone back to sleep. In discussing this, the authors argue that financial markets are not only influenced by economic fundamentals but also by important behavioral characteristics.

Although some economists continue to believe that financial markets are “efficient,” market psychology and sentiment may play a crucial role in determining what happens in the months ahead and whether or not another Eurozone crisis materializes.

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