European Union officials agreed deal at a summit in Brussels in the early hours Friday morning that they hope will save the euro.
Thursday’s developments: All EU nations but Britain agree to consider a new treaty that would impose much tougher controls over national budgets in an attempt to overcome a crippling debt crisis. Britain’s refusal created a political rift.
Market reaction: Stocks and the euro rose, while bonds were steady.
What’s next: Investors will watch the European Central Bank for any hint that the summit’s deal will encourage it to step up its support for eurozone bond markets. They will also look for signs that the nine non-euro countries that had agreed to consider the new treaty might decide to not join it.
Q: How did Europe get into this mess?
A: The creation of the euro currency in 1999 made it easier to do business across borders and made the continent a potent economic bloc. Yet the experiment was flawed. Seventeen countries have agreed to use one interest rate policy, set by the European Central Bank, despite having different economies and cultures and each managing their own state finances. As long as prosperity reigned, banks were happy to lend at low rates even to weaker countries like Greece. Greece and others exploited that by borrowing heavily. But once the Great Recession hit, their debts proved crushing. Because they remain in the euro, they cannot let their currencies depreciate, which would make their economies more competitive.
Q: Why is a solution so hard?
A: The ECB and Germany resisted aggressive action, arguing countries should first get their budgets under control. Many economists want the central bank to buy much more of the debt of struggling countries like Italy. That would push down their borrowing costs and give them the time to reform their economies. The ECB has bought Italian and Spanish bonds. But it’s loath to do so in a big way, noting that its mandate is to control inflation, not be a lender of last resort to governments. Germany opposes another idea — creating joint bonds backed by the whole eurozone — because it fears its own borrowing costs would surge if it had to borrow jointly with weaker countries. Greece and other heavily indebted countries have suffered political and social upheaval as taxpayers, unions and political parties balk at accepting painful austerity measures like pensions cuts and tax increases.
Q: What big solutions are European officials pursuing?
A: All EU nations but Britain agreed to consider a new treaty that would place strong controls over their spending policies and enforce automatic sanctions on rule-breakers. The hope is that will improve confidence in the eurozone’s long-term ability to pay its debts and will avoid a repeat of the current crisis.
Q: Why the urgency now?
A: Earlier efforts, like bailouts of Greece, Portugal and Ireland, haven’t convinced investors that European policymakers can resolve the crisis, which is now over two years old. Jittery investors are demanding that European governments pay ever-higher interest rates on their bonds.
Q: Why are higher interest rates such a problem?
A: They make it harder for governments to pay debts and they slow growth. Tax revenue then falls. The cost of unemployment benefits and other social programs rise. If countries as big as Italy can’t repay their debts they face default, which would cause massive havoc on world financial markets.
Italy has seen its borrowing rates jump above 7 percent recently. That’s considered unsustainable.