There is a serious risk of a sequel to the Euro Crisis that ran from roughly 2010 to 2015. The likelihood of such a crisis is hotly debated and depends on one’s views of a number of factors that are summarized in this paper. My own base case continues to be for some version of Euro Crisis 2.0 over the next two years, but recent positive developments may cause me to lower that probability somewhat below 50 percent.

This version of the crisis could begin at any time, since the underlying weaknesses exist and there are many potential triggers. The crisis would likely proceed more quickly than last time, given what has been learned from the first crisis and the economic and political tools that have been created. That said, it could still be a multi-year process.

What would this mean? Economic and financial conditions in Europe would be substantially more volatile and financial institutions could face major challenges, including the potential for a full-blown financial crisis in one or more countries. The effects would be smaller beyond Europe’s borders, but the economies of trading partners would be impacted, as would financial exposures of foreign institutions to Europe. There might also be opportunities for some of the big US banks to acquire European institutions that have been off-limits in normal times, not to mention opportunities to pick up market share through organic growth in Europe.

THE BIG PICTURE

Views about a potential new Euro Crisis depend primarily on how one weighs the positives and negatives of the Eurozone’s situation. I’ve broken the key points down into reasons for concern, reasons for hope, and the crucial questions that could tip the balance. For the "Euro Crisis 2.0" PDF version, please click here.

My own base case is that we have a Euro Crisis 2.0 that lasts for a couple of years, but that Europe once again works through it without a breakup of the Eurozone or other extreme outcomes. That would not make the crisis costless, though. Crises can pack a lot of pain into two years and there are likely to be at least mini-financial crises in one or more Eurozone member states if we do have the sovereign debt crisis.

There is a plausible scenario that is more optimistic, in which actions of the European Central Bank (ECB), national governments, and European institutions are sufficient to weather the storm without a real crisis. I may even elevate this to be my base case, if recent positive developments continue. Sadly, there is also a plausible scenario in which the Eurozone is badly shaken and one or more member states restructure their sovereign debt, with associated financial crises in the most affected nations.

These scenarios are somewhat correlated with pandemic scenarios, since worse health outcomes that lead to a deeper and longer recession would increase the pressures considerably. However, there are many European-specific factors that are not directly driven by the pandemic.