Readers Question: Hello! I was just wondering in the midst of the European crisis when all economically strong countries have been downgraded?
Many countries in the Eurozone have seen a downgrading in their credit rating for Government debt.
- The economic crisis saw a sharp rise in levels of government debt to GDP. In a recession, countries like Spain and Ireland saw a big fall in tax revenues. E.g. with collapse in property markets, the tax revenue from stamp duty (tax on house sales) fell. This meant tax revenue fell. Also with rise in unemployment, the government have to spend more on unemployment benefits.
- Secondly, the Eurozone crisis has led to poorer prospects for economic growth. Europe’s economy has been stagnating because economies have pursued austerity measures (spending cuts and tax increases). With lower GDP, it is hard for countries to gain any more tax revenue. They are facing a deflationary debt spiral.
- Thirdly, being in the Euro has made countries more vulnerable to liquidity shortages. Because there was no Central Bank willing to act as lender of last resort and print money, markets were nervous about buying Eurozone debt. (this has been reduced somewhat in 2012, with ECB being more active in maintaining liquidity.
There’s a bit more detail on Eurozone crisis.