The Euro Crisis and Government Debt - dummies

By Julian Knight

The future of the Euro is intrinsically linked to whether or not the government debt of member states gets under control. If the investors feel that levels of debt are being tackled, then they will be willing to continue to buy future debt. If they feel that government debt is not being well-managed, then they will stop lending money out of fear that the government will default.

In a bid to reduce the amount they are borrowing, governments across the Eurozone and Britain have been taking often painful economic measures. These include:

  • Cuts in public spending. Across the Eurozone, major public works projects have been cut back in a bid to reduce expenditures (and therefore, borrowing). This though has a negative effect on jobs and growth.

  • Laying off public sector workers. Greece, Portugal, and Ireland have been reducing the numbers of people employed by the state — again in an effort to help push down on expenditures and debt. This is also bad for jobs and growth.

  • Fixing the state pension. Europe’s population is aging fast, which means that the costs of funding state pensions are soaring. As a result, governments’ are telling their people that they will have to wait longer before they can collect their state pension.

  • Increasing taxes. Some of the debts are so large that it takes more than budget cuts to reduce the shortfall. Governments across the Eurozone have been increasing taxes.

Not all of the measures to reduce debt are bad for your personal finances. Low interest rates, for instance, are good for businesses looking to borrow and for people with mortgage debt.

This plan to reduce government debt in Europe is called austerity, and it is a finely balanced operation. Cut too deep and it could send the economy into recession — which has happened in Greece and Ireland — which in turn reduces income from taxes and can mean more, not less, borrowing in the short term.

The size of government debt is always expressed as a percentage of the nation’s gross domestic product (GDP). So for example, in 2011, Greece borrowed the equivalent of 9 percent of its GDP. This means that for every Euro produced by the Greek economy, 9 cents was borrowed from investors by the government.