What Happened
The eurozone crisis began in 2010 when Greece acknowledged it had misrepresented its deficit figures. Greek 10-year yields rose from 5% to 30%. The contagion spread: Ireland required a bailout in November 2010, Portugal in May 2011. By mid-2011 Italy and Spain — too large to bail — were under attack.
The structural flaw was clear: eurozone members shared a currency but not a fiscal union. There was no mechanism for transferring resources from surplus to deficit countries (as exists within the US between states). When Greece was in crisis, Germany could not simply provide fiscal transfers. The result was austerity imposed from outside, which deepened recessions and made the debt burden worse.
Mario Draghi’s July 26, 2012 speech — "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough" — ended the speculative attack. The ECB had never committed to unlimited bond purchases. This commitment, without ever buying a single bond, was sufficient to remove the speculative opportunity.
The Mechanism
Monetary union without fiscal union — the design flawThe euro eliminated the exchange rate adjustment mechanism between member states. When Greece became uncompetitive relative to Germany, it could not devalue its currency. The only adjustment mechanism was internal devaluation — cutting wages and prices — which causes recessions. The ECB had no mandate to act as lender of last resort to sovereign governments (only to banks), creating a self-fulfilling crisis mechanism: rising yields made debt unsustainable, making yields rise further.
What the Consensus Believed
The prevailing view before the reckoning
The euro was irreversible. No country would leave because the costs were too high. The ECB would find a way to support member governments. Austerity would restore competitiveness and market confidence. The political commitment to European integration would outlast any economic pressure.
What the Record Shows
Currency unions require fiscal unions
The eurozone crisis confirmed what economists like Milton Friedman predicted in 1997: a currency union without political and fiscal integration is unstable. The internal adjustment mechanism is too painful to sustain.
Central bank communication is policy
Draghi never bought a sovereign bond under the OMT program. The commitment alone was sufficient to end the crisis. This demonstrated the power of credible central bank communication.
Austerity is self-defeating in a demand collapse
The IMF later acknowledged that the fiscal multiplier was higher than assumed — cutting government spending in a recession deepens the recession and makes debt-to-GDP worse, not better.
Contagion follows the weakest link
The crisis spread from Greece to Ireland to Portugal to Spain to Italy. Each country was different but all were vulnerable to the same mechanism: rising yields creating self-fulfilling insolvency.
↑ Cognitive pattern: Institutional Anchoring — Political commitment as substitute for economic design
Key Voices
Called It Right
Mario Draghi
ECB President
“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
July 26, 2012 Ended the crisis
Martin Feldstein
Harvard
“The euro has a fatal flaw. You cannot have monetary union without fiscal union. This will end in crisis.”
May 2010 Right
Paul Krugman
Princeton
“The austerity imposed on Greece is both economically and morally wrong. It will deepen the recession without solving the debt.”
February 2012 Right on austerity
Wrong
Various officials
EU/IMF troika
“Austerity will restore market confidence and growth will follow fiscal consolidation.”
2010–2012 Multipliers higher than assumed
Market consensus
Multiple voices
“Greece will leave the euro within weeks. The debt is unpayable and the political will for austerity does not exist.”
May 2012 Euro survived