Introduction
The purpose of the essay report is providing a critical assessment of the primary factors that caused the Eurozone crisis and the policy response from the European Union. According to Visvizi (2012, p. 13) the Eurozone crisis attracted the attention of the world because of the prolonged period and the emergency that required addressing to avoid further damages to the economic zones. The Eurozone crisis revealed serious weaknesses in the structure of the institutions established by the Economic and Monetary Union (EMU). Additionally, the predicament highlighted limitations the EU and its member states face when required to act efficiently, comprehensively, and swiftly to address instantaneous problems. The inability to act effectively reflected the various challenges present in the way the functioning of the European Union was designed. The observable problem was poor governance structure that acted as a stimulant to other issues resulting in economic and political developments that were unwelcome in the Eurozone and beyond. According to Csaba (2012, p.77), it is common to see in literature a connection between the Eurozone crisis and the financial global crisis of between 2007 and 2008. However, while the global crisis had a substantial influence the euro area, it exposed the problems pre-existing in the European economies in addition to the weaknesses of the EMU. Nonetheless, EMU was not a failure in totality considering it was resistant to various external shocks after inception. Additionally, EMU delivered its promises including stability in prices. According to (Baldwin et al., 2015, p. 1) the crisis that the EU faced were amplified by failure to have a last resort lender. Consequently, the features of EMU have been regarded to be the roots of the crisis.
The present essay has been organized into two major sections, factors that primarily caused the Eurozone crisis and the policy response from EU.
Causes of the Eurozone crisis
Macroeconomic divergence
Adopting a single monetary policy is a difficult task especially when multiple countries are involved and happen to be highly differentiated in nature. Therefore, the initial challenge that EMU encountered which was similar to what other currency unions face was that the member states had dissimilar macroeconomics. Specifically, there was macroeconomic divergence among peripheral European countries and Northern nations where the latter countries experienced slow growth compared to the former nations whose economy grew rapidly with prices and wages rising (Harari, 2014, p. 2). Despite the divergences that were evident, the European Central Bank (ECB) had the responsibility of ensuring that single monetary was implemented. To achieve balance between the Southern and Northern countries, ECB resulted in adopting a monetary policy that attempted to achieve a middle ground. Before the crisis, the interest rate that the ECB was setting ranged at approximately 3%. As a result, the peripheral countries interest rates were low in comparison to the national inflation. According to Copelovitch, Frieden, and Walter (2016, p. 12) the low, sometimes negative interest rates meant that some households in places such as Spain accumulated strong incentives for borrowing while investors in the North accessed high incentives that they could use for lending purposes. According to Copelovitch, Frieden, and Walter (2016, p. 12) in a country like Germany, the rate of savings increased, the trade surplus was highly accumulated amid having an aging population.
What followed was enormous flow of funds from areas with surplus in particular Northern Europe to deficit locations. The flow of capital whose origin was from the North to the South would reinforce the gaps present in the macroeconomics within the monetary union. Consequently, the single monetary policy by the ECB led to unbalanced pattern of how capital was flowing between the member countries. After the crisis, the imbalances had an immediate reflection in balance of payments between the North and South European states. According to Copelovitch, et al. (2016, p. 13) the deficit to GDP of Spain and Germany in 1998 was around one percent while Ireland and Italy ran surpluses. Nonetheless, the World Bank (2014) reported that by the year 2008, the account surplus in Germany had pitched to 6 percent of the Gross Domestic Product (GDP) while Italy, Ireland, and Spain recorded a deficit of 3%, 6%, and 10% respectively. In simple terms, the surpluses with the Northern European countries in particular those from Germany were being used to finance the deficits of the Eurozone periphery. The flows of capital between the countries in the North and South had played a role in accelerating the divergences in the economies within the Eurozone area that further causes an increase in growth and prices within the periphery particularly in the housing sector. As the housing prices experienced a rise, the inducements available for lending and borrowing increased even more and deficits and surpluses between the North and South grew further apart. The various leaders in the Northern nations found it difficult discouraging willing investors to take advantage of the opportunities to make profits from the lending business while those in the Southern countries were unable to prevent people from accessing more loans due to the circumstances (Copelovitch, et al. 2016, p. 14). The busting of the bubble turned the boom into a huge crisis. Thus, unsurprisingly, the severity of the damages causes by the euro crisis was dependent on the amount of account deficit (Johnston, Hancké, and Pant 2014, p. 1771; Wihlborg, Willett, and Zhang 2010, p. 4).

Not having a coordinating fiscal policy
The imbalances faced by countries emanating from macroeconomic divergences and high capital flows that appeared exaggerated could have been mitigated if member states governments collaborated to develop a single counteract measure through fiscal policies. For instance, creation of fiscal policies that were restrictive would have enabled nations such as Spain restrain demand, consequently monitor, and control the incoming account deficits and foreign capital inflows. On the other hand, a nation like Germany could have created fiscal policies that were expansionary in nature stimulating the domestic demand in addition to restraining the outflows in capital to (Copelovitch, et al. 2016, p 14).
Nonetheless, there are numerous reasons that provide an explanation of why policymakers in Europe were unable to coordinate fiscal policies for purposes of addressing the imbalances that grew in the Eurozone areas. One of the reasons was that when a nation joins a monetary union, the autonomy they have on monetary policy is given up. Nonetheless, the efficiency and effectiveness of the fiscal policy becomes improved. In addition, having low rates of borrowing before the EMU provided an opportunity for creation of incentives that were used in accessing loans from the financial markets (Bernoth, Von Hagen, and Schuknecht 2012, p. 975). While the states from the Eurozone shared the same central bank, their fiscal policies were independent, and this applied to other regulatory and economic policies. The founders of EMU were well aware of the underlying challenges that informed the creation of the SGP (Stability and Growth Pact) for purposes of achieving fiscal discipline within the Eurozone. However, the particular provision was inadequate contributing to the lack of coordination in the fiscal policies. The rules were merely enforced specifically after Germany and France which are among the largest member states were in violation of the guidelines before five years had elapsed since establishing the monetary union (Copelovitch, et al. 2016, p. 15). Apart from these developments, the fiscal risks in many of the peripheral nations had an association with the high capital inflows and were not reflected in the public deficit and debt figures (Copelovitch, et al. 2016, p 15). The attributing factor was that many of the capital inflows were directed to the private sector resulting into its boom and recording enhanced fiscal revenues that made the fiscal policies in the respective countries appear effective years before the crisis happened. For case in point, both Spain and Ireland, nations that had been strongly affected during the Eurozone crisis were recording fiscal surpluses prior to the crisis (Johnston et al., 2014, p. 1772).
Fragmented financial regulation
While efforts were made to have the Eurozone become a single financial market that was integrated, regulations related to management of finances remained decentralized in regulatory and national central banks hands. As a result, there was a leeway for regulatory arbitrage where respective financial institutions took advantage of the gaps present in the regulatory environment to achieve high risk and higher yield loans (Copelovitch, et al. 2016, p 16). Additionally, the fragmentation of the regulatory environment developed increased uncertainty on who would bear the responsibility of the banking problems. These developments also meant that regulators at the national level were incapable of internalizing possible systematic flow outcomes in the finances within the European member states. Despite this, national regulators, policymakers, and financial institutions became resistant on attempts that would centralize or harmonize financial regulation, as they feared it would affect the competitive advantage of their domestic firms adversely. What resulted were financial institutions taking risks that were greater than what the national regulators expected which led to systematic risks that were not monitored. After the global financial crisis exposed the banking sector, the risks were more apparent. In addition, the global crisis in 2007/2008 depicted that the European financial markets were largely interconnected an aspect that influenced creation of sizeable contagion risks turning smaller economies like Greece into critical actors (Copelovitch, et al. 2016, p 17).
Deficiency in commitment to no-bailout
The fourth factor that contributed to the euro crisis was that many countries had the anticipation that if one of the member states experienced financial difficulties, the rest would swiftly bail it. While national authorities and Eurozone made attempts to insist that bailouts would not happen, there was high expectations among the member states. According to regional and international experience, a critical financial meltdown in one of the states in the Eurozone could cause a stability problem in the entire area. Nonetheless, while the expectations of having a bailout were widespread, the participants in the market were not to worry about the risks emanating from weaknesses in the financial system of a single Eurozone nation (Bernoth and Erdogan, 2012, p. 639). After the Euro was introduced, there was a decline on borrowing by governments and households in all the nations in the Eurozone and it was low before the crisis happened (Chang and Leblond 2014, p. 1; Ghosh, Ostry, and Qureshi 2013, p. 131). For the countries in Southern Eurozone, the international borrowing costs fell to levels that had not been recorded historically, an aspect that encouraged these economies to borrow further. If markets were accountable to the risks that the loans accrued, the global capital flow levels could have been little while the imbalances within the countries in the Eurozone would have reduced. Nonetheless, the market had the believe that if one of the member states experienced a crisis a bail out would be triggered naturally because of the single currency and market. While there were protests from the policy makers, they failed to agree on reasonable preparations to deal with such a crisis. Consequently, borrowing countries continued to accumulate debt while creditors were exposed to widespread default.
The ultimate outcome of the four named problems was the collapse of the Eurozone. As the 2007/08 financial global crisis accelerated, the bubble that was building within the Eurozone burst. Financial institutions in nations in the Eurozone found themselves clasping trillions of Euros worth of assets that were questionable. Peripheral governments were compelled to bailing out banks that had become insolvent or illiquid at high expenses. The environment created the debt crisis in the Eurozone where the loans provided by the Northern European creditors could not be serviced by the peripheral nations. The hitting of the crisis led to immediate bitter conflicts of how the distribution of the current account imbalances and adjusting accumulated debts would be done (Frieden 2015, p. 4). The economics of the ‘lop-sidedness of adjustment burden’ meant that the nations that were under deficit had to make mandatory adjustments while those with surplus bared no similar pressure. The structuring of the response was highly politicized. Both the deficit and surplus countries developed their own measures that they wanted to be implemented. Predictably, the political conflict on how to distribute the adjustment burden was not only experienced amongst nations, but also inside the countries. In the nations with debts, citizens conflicted on who would sacrifice to restore or maintain the debt service: financial institutions, taxpayers, public program beneficiaries, employees in the public sector or other stakeholders (Frieden 2015, p. 4). Similarly, in the nations with surplus, there were debates on how to support financial institutions that were struggling with non-payment of the loans. Due to these conflicts, creation of an effective policy towards solving the crisis took longer than expected. Thus, the euro crisis was made much worse by poor management of the underlying problems. While mistakes were done, the architecture of the Eurozone lacked any substantial institutional structure or policy that would have dealt with a challenge of such magnitude (Frieden 2016).
European Union Policy Response
As a response to the crisis that was deteriorating, the member states of the Eurozone unanimously agreed to create the European Financial Stability Facility (EFSF) in May 2010. The EFSF objective is ensuring that there is financial stability within the Eurozone that is preserved through provision of a lending source to the member states that are not in the sovereign bond markets (McDonnell, 2012, p. 8). The intention was that EFSF was to be replaced by a permanent solution referred to as the ESM abbreviations for European Stability Mechanism. The goals of the ESM will be similar to those of the EFSF. According to (Shambaugh, 2012, p. 1), in the interest to achieve further decrease on the yields pressure of the sovereign bond, the ECB bought approximately 200 billion Euros of sovereign debt using the Securities Market Program.
A response to the competitiveness imbalances in the Eurozone was encouraging an internal devaluation process in addition to structural reform within the member states that are less competitive. Nonetheless, the attempt of having the internal devaluation restore competitiveness was not balanced through complementary measures that would stimulate demand while generating revaluation internally in core nations. Ironically, the burden to achieve competitiveness adjustment was bestowed on the weaker economies within the Eurozone periphery (McDonnell, 2012, p. 8). In addition, the EU gave little attention to the high unemployment and reducing economic growth in the countries faced with huge debts at least in terms of developing tangible policies. According to the Eurostat (2012), countries that experienced severe unemployment crisis were Greece and Spain. The unemployment in Greece increased to 21.7% from 14.7% from 2011 January to 2012 the same month. In Spain, the unemployment rose to 24.1% from 20.8% within the same time. The youth unemployment in Greece and Spain by 2012 January was 51.2% and 50.3% respectively (Eurostat 2012).
On the other hand, response to the crisis facing the banks was via recapitalizing the weakest financial institutions with an aim of forestalling insolvencies; prevent the financial system from having a contagion and having the real economy start receiving lending. Recapitalization was done through funding support from the national level which for instance in Ireland it undermined the sovereign government solvency. Apart from the bailouts provided from the national level, the ECB availed to the financial sector cheap liquidity using the LTROs (Long Term Refinancing Operations) (McDonnell 2012, p. 9-10). At the same time, the financial institution’s capital requirement ratio increased while the stress tests for banks were done. The prevailing narrative that crisis in the Eurozone was trigged by challenges associated with fiscal indiscipline of the periphery nations resulted to designing of new measures known as the “Six Pack (McDonnell 2012, p. 9-10).” The Six Pack was established to ensure the Stability and Growth Pact rules were toughened through increasing surveillance, and easing the procedure of initiating proceedings against a member state. Additionally, the Six Pack introduced mitigating measures against certain macroeconomic indicators like asset prices. The ultimate goal of the measures is early identification of macroeconomic imbalances to allow implementation of preventive steps (McDonnell 2012, p. 9-10). The narrative of the fiscal indiscipline led to the introduction of TSCG (Treaty on Stability, Coordination and Governance) also known as the Fiscal Compact. Both the TSCG and the Six Pack were created with the intention of strengthening the economic governance in the European Union by having more fiscal oversight (McDonnell 2012, p. 9-10).
While the negotiations in establishment of the Fiscal Compact were swift, many complications emerged with the impetus provided by Angela Merkel, the German chancellor. Merkel’s concern was that formation of a new treaty would be a reassurance to the German public that the bailout mechanism adopted by the EU would have adequate measures that would prevent crisis in the future requiring contributions from the taxpayers (Glencross 2013, p. 8). In dealing with the immediate matters, the Fiscal Compact accommodates gradual moves that allow a banking union to resolve the issues that contributed to the Eurozone crisis in particular bad debts. The ‘stress tests’ that were conducted by the European Commission on EU banks were meant to determine if they had enough assets that could cope with bad debts. From the year 2010, the European Banking Authority was given this responsibility. Using the independent agency, the bank’s capital requirements were increased from 2011 a strategy that was introduced to restore and improve the lending between banks (Glencross 2013, p. 10). Additionally, the EU in the December of 2012 agreed that the ECB would have the power to make supervisions of the banks within the Eurozone to prevent business models that were unsustainable and risky lending practices. The introduction of the particular provision was a critical step that would break the link between sovereign problems of liquidity and bank losses of the kind that required bailouts in Ireland and Portugal. The provision of these bailouts was vital in preventing a pattern of defaults. Moreover, other policy responses reduced the possibility of related circumstances unfolding. While the ECB has been criticized heavily in terms of how it responded to the crisis, through a number of liquidity supports, the institution played an important role in ensuring that the European financial system did not face a complete seize up. Nevertheless, the continued wrangles between the member states meant that the developed policy responses were either incomplete or problematic and hence insufficient to address all the aspects that led to the crisis (Glencross 2013, p. 11).
Conclusion
There exists a controversy on how the European Union dealt with the financial crisis aftermath and it does not entirely revolve on money. The problem facing the EU at the time of the Eurozone crisis was not only the capability to make meaningful decisions but the ability to achieve democratic approval for choices that were tough in nature. The EU’s democratic governance has been subject of debate with critics stating that the institution lacks fundamental democratic principles. The debt crisis exposed the weakness to high levels. The interplay of the EU and national politics played a critical role in development of responses as politicians attempted to achieve a balance between the two. For instance, In Germany, the government lead by Merkel was well aware that the public was against providing Greece with emergency loans. As a result, the Chancellor wanted to reach a bailout deal that would be convincing to the national voters on the commitment that the EU had on reforming how nations managed their own economies. At the same time, there was concern that the German Constitutional Court would rule against giving Greece and other countries the financial support they needed. Thus, the domestic preferences in Germany became central on how Merkel approached the issue of solving the crisis.
The Eurozone crisis depicts a complicated set of weaknesses within EU’s micro-economic and macro-economic environment. The weaknesses largely contributed to the growth, banking, and sovereign debt crisis. The presence of the political crisis makes the list further complicated. These crises translate into the challenges that the EU faces including incapability to put up a banking union, competitiveness union, fiscal and a political union. The member states within the Eurozone should increase the speed in establishing common policies that steer economic growth. Strong economies will be decisive in ensuring that future crisis are identified in advance and appropriate measures be implemented.

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