Thursday, December 29, 2011

Did Excessive Government Debt Cause The Eurozone Crisis?

Many believe that the current problems in the eurozone are the result of excessive government debt in southern economies. This graph (via Paul Krugman) shows the composite debt to GDP ratios of Greece, Ireland, Portugal, Italy and Spain since 1999. Their composite debt was falling until 2007. Things changed dramatically in 2007 when the financial crisis hit Europe and the US. The soaring debt to GDP ratios appear to be the result of the financial crisis which slowed growth and caused GDP to fall along with tax revenues. The resulting budget deficits, combined with lower GDP, caused the higher debt to GDP ratios to become unsustainable. The weakest economies in the eurozone were the most vulnerable to the recession. Ireland and Spain, in particular, benefited most from housing bubbles, and suffered most from the bursting of the bubbles.

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