Uneven Debt Levels Complicate Eurozone Monetary Policy

Former British Prime Minister Winston Churchill once remarked that Americans could always be counted on to do the right thing after having tried everything else.  The same could be said of the European Central Bank (ECB) for what it did over the past decade in the aftermath of the financial crisis. 

While the U.S. Federal Reserve (Fed) and the Bank of England (BOE) swiftly lowered interest rates to near zero in late 2008 as the crisis unfolded and initiated quantitative easing (QE) in early 2009, the ECB took a different approach.  It didn’t lower its refinancing rate all the way to zero in 2009, and was tightening monetary policy by 2011 (Figure 1).  The result was a disaster.  Yields on non-German debt soared (Figure 2), bringing Greece, Ireland, Italy, Portugal and Spain to the brink of financial collapse while the eurozone experienced a double-dip recession that the U.K. and U.S. avoided (Figure 3). After 2012, when ECB President Mario Draghi indicated that the ECB will backstop eurozone sovereign debt markets and began cutting rates in earnest, yield-spreads narrowed and the eurozone economy recovered (Figure 4).

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