Inspecting the Mechanism: Leverage and the Great Recession in the Eurozone

We provide a comprehensive account of the dynamics of eurozone countries from 2000 to 2012.We analyze private leverage, fiscal policy, labor costs and spreads, and we propose a modeland an identification strategy to separate the impact of credit cycles, excessive governmentspending, and sudden stops. We then ask how periphery countries would have fared withdifferent policies. We find that countries could have stabilized their employment if they hadfollowed more conservative fiscal policies during the boom. Macro-prudential policies and anearly intervention by the central bank to prevent market segmentation and reduce fiscal austeritywould also have significantly reduced the recession