The eurozone crisis unfolded primarily as a sovereign-debt crisis mostly on its southern periphery, with interest rates on sovereign bonds at times reaching 6-7% for Italy and Spain, and even higher for other countries.

And, because eurozone banks hold a substantial part of their assets in the form of eurozone sovereign bonds, the sovereign-debt crisis became a potential banking crisis, worsened by banks’ other losses, owing, for example, to the collapse of housing prices in Spain. So a key challenge in resolving the eurozone crisis is to reduce the southern countries’ debt burdens. The change in a country’s debt burden reflects the size of its primary budget balance (the balance minus interest payments) as a share of GDP, as well as the difference between its borrowing costs and its GDP growth rate. When the difference between borrowing costs and growth becomes too large, the primary-budget surpluses required to stop debt from increasing become impossible to achieve. Indeed, growth in southern Europe is expected to be close to zero or negative for the next two years, and is not expected to exceed 2%-3% even in the longer term.

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