Geopolitics Review - 30th June 2025

European Monetary Policy, Fiscal Policy, and Sovereign Debt

Dylan Muggleton

Jun 30, 2025

Contents

Introduction
Monetary Policy In Europe
Fiscal Policy In Europe
Sovereign Debt In Europe
Concluding Remarks

Bitesize Edition

In a change of pace, I’ll leave the Middle East behind for now and return to Europe in today’s post. Specifically, we’ll explore the European Union and the Eurozone, and who is responsible for monetary policy, fiscal policy, and sovereign debt. Although for those with an interest in the Middle East, or any other developments in geopolitics over the past week, scroll to the bottom of this post, where you’ll find my “Other News In Geopolitics This Week” section.
Monetary policy is how a country, or in this case, a group of countries, control the supply of money and interest rates to influence the economy. The goals are to control inflation, stabilise the currency, support economic growth, and maintain employment.
Fiscal policy is how governments raise and spend money to influence the economy. The goals here are to manage economic cycles, fund public services, support jobs and investment, and reduce inequality or debt.
Finally, sovereign debt is the money a government owes to domestic and foreign creditors. This typically comes from issuing bonds, where investors lend money to governments in exchange for a return at a later date. Debt-to-GDP and credit ratings can measure a country’s sovereign debt risk. If they have high debt levels, it can lead to rising interest rates and distrust in their bonds. In the worst cases, it leads to debt crises or defaults.
These three concepts are all vital in any country, but in Europe, where the Eurozone and the European Union are incredibly ambitious projects, this is even more vital. So, how do these aspects work within Europe, and how can they be improved? I’ll break it down today.

Introduction

One of the most important distinctions to note in the European project is the difference between the European Union and the Eurozone. The European Union is a political and economic union of 27 European countries that have agreed to integrate trade, law, and climate, as well as other elements on a lesser scale, such as foreign policy and security policy.

The Eurozone is the monetary union of 20 EU member states that have adopted the Euro as currency, and as a result, they share a common monetary policy of the European Central Bank. Back in 1989, the Delors Report presented a single currency as a potential facilitator of the free movement of goods, capital, services, and labour, and that’s what we see in reality today.

This difference between the European Union and the Eurozone ensures differences in the countries of Europe that are a part of none, one, or both of these groups.

So today, I’m going to dive into these differences and whether they place Europe in an advantageous or disadvantageous position based on monetary policy, fiscal policy, and sovereign debt. Let’s dive in.

Monetary Policy In Europe

The 20 countries that use the euro share monetary policy through the European Central Bank. (ECB). The ECB sets interest rates, manages inflation, and controls the money supply for the Eurozone. 7 EU countries, including Poland, Hungary, and Sweden, retain their own currencies and central banks, and as a result, control their own monetary policy and interest rates.

The tension that this creates in the Eurozone is that monetary policy doesn’t fit the different economic conditions that differ across the Eurozone member states. More tools are necessary to ensure individual member states can manage their national economies according to their own incentives and interests. For example, what Greece needs is different from what Germany needs, because fiscal policy and sovereign debt characteristics differ. But the tools are lacking.

Allowing different monetary policies for Eurozone members is difficult because they all use the euro as currency. But what connected mechanisms could give them more options in times of an individual nation struggling?

Longer-Term Refinancing - Offer cheaper loans to banks under strain in an attempt to incite economic growth. This could also be connected to banks in nations with high unemployment or weak credit growth.
Different Collateral Frameworks - Allow national central banks to accept a wider range of assets in weaker economies as collateral for repayments, which could stimulate local credit. However, this could increase credit risk and would hence require strict control from the ECB.

bridge during night time — Photo by Léonard Cotte on Unsplash

Regional Quantitative Easing - The Pandemic Emergency Purchase Programme (PEPP) did this as it rerouted capital to help Italy and Spain in the event where bond spreads were widening between nations in the Eurozone. This could become a permanent part of ECB policy during shocks. Importantly, QE is typically long-term monetary easing attempting to incite liquidity and hence lead to more spending and economic growth. The PEPP was an emergency response in March 2020, and it was phased out in March 2022. Also, the PEPP was highly flexible, whereas typical quantitative easing follows strict limits based on a country’s share in European Central Bank capital.
Decentralised Credit Frameworks - National central banks could promote lending from banks or private investors to innovative projects using tailored incentives or risk-sharing instruments. This would encourage innovation without currency fragmentation.
Crisis Coordination Mechanisms - The national central banks could be given authority to take temporary, localised action in regional crises with European Central Bank approval, such as emergency liquidity or temporary credit easing.

There is also the status of the euro as a reserve currency asset. As of Q1 2025, IMF data had the euro making up between 19% and 20% of global foreign exchange reserves. This makes the euro the second most held reserve currency in the world.

This is largely because of the size of the Eurozone, with 340 million people using the euro. Also, the EU and ECB are seen as stable and credible, and many Eurozone government bonds are widely traded and trusted. Countries surrounding Europe, especially in the Balkans, have adopted the euro as legal tender because it is more stable than their currencies. This is seen in Bosnia and Herzegovina and Montenegro, among others.

time-lapse photography of vehicle at the road in between the building at nighttime aerial photography — Photo by Stephan Widua on Unsplash

Moving forward, if the Eurozone could address some of the fragmentation within wider monetary policy via the strategies above, some tension within the Eurozone could be reduced.

But one way that the Eurozone remains incredibly fragmented by design is in fiscal policy.

Fiscal Policy In Europe

National governments in Europe control spending, taxation, and borrowing on an individual country basis, with some EU-level coordination existing. The Stability and Growth Pact aims to keep deficits under 3% of GDP and debt under 60% of GDP for each country, but these rules are outdated, rigid, and enforced weakly.

Instead, Europe could focus on innovation, not arbitrary numbers. Europe is also deemed to have a productivity problem, which I’ll discuss in more detail over the coming weeks. Investment in positively returning projects can return positive growth and boost productivity.

In vital areas such as defence, digital innovation, and energy, spending is included within these fiscal rules. But, if they were exempt from fiscal rules, could this start to encourage Europe to escape this productivity trap?

The NextGenerationEU marked another step towards shared fiscal power. This was a temporary recovery instrument created by the European Union to respond to COVID-19. It was aiming to support reforms and investment in the states hit hardest by COVID-19 via methods such as digital transformation, health systems and crisis preparedness, and economic resilience. This is the first time the EU borrowed on scale on financial markets on a collective approach for all 27 member states, and thus it was marked as a paradigm shift towards potential shared fiscal policy in Europe.

people walking near canopies in front of buildings during daytime — Photo by Severinus Dewantara on Unsplash

The European Stability Mechanism also exists, which is a shared bailout fund specifically for Eurozone members.

But until there is a shared Eurozone treasury, there is no true fiscal union. So, in summary, all fiscal decisions occur on a national level within Europe, but Eurozone countries are subject to these extra rules.

Fiscal policy reform is one of the most critical reforms that could make the European project more resilient in the face of crises. A centralised fiscal authority could collect common taxes, such as a carbon or digital tax, they could issue joint debt or redistribute funds during crises with more ease.

This change could encourage fiscal policy that aligns with the short-term debt cycle, where Europe could spend in recessions to improve the negative growth environment, while saving during periods of economic boom. It would give Europe more options. Europe can’t rely on others forever, as Trump’s first few months in office have proven.

However, further challenges still remain, with fiscally conservative countries such as Germany likely having to step up for those in less favourable fiscal situations. This is where sovereign debt enters the picture.

Sovereign Debt In Europe

Even though Eurozone countries share the euro and follow monetary policy set by the European Central Bank, each country still borrows money on its own by issuing bonds to investors, such as German Bunds and Italian Buoni del Tesoro Poliennali.

However, European Union debt instruments are jointly backed, such as the NextGenerationEU recovery bonds discussed above. But this was in exceptional circumstances. Discussions around Eurobonds in general have met resistance, especially from Northern Europe, who typically have more developed debt markets. The different levels of trust and debt sustainability in individual countries have left European debt markets fragmented. More frugal nations worry that if debt were mutual, nations with more debt wouldn’t be incentivised to maintain fiscal discipline because other nations would be forced to bail them out. In this case, shared debt could increase the risk of borrowing for frugal nations and negatively affect their fiscal policy.

brown and white concrete building under blue sky during daytime — Photo by Andreas Fischinger on Unsplash

But there are solutions here also. Most importantly, even Germany supports centralised fiscal power, but they want it to occur cautiously and in small increments. It cannot occur overnight. There are other nuanced strategies that Europe could pursue outside of a slow, cautious approach.

Eurobonds wouldn’t need to be a singular collective. Blue bonds could be safe EU bonds from frugal nations, while red bonds could include nations whose debt is seen as riskier. This could be calculated as simply as via credit ratings of individual countries in the EU, as provided by Fitch, S&P, and Moody’s. This would lower the risk during debt crises for European states in better debt positions, while also lowering borrowing costs for weaker economies in a carefully created bond structure. There likely isn’t a “one bond fits all” solution here, but a layered solution could offer broader benefits across a wider number of states.

A layered solution could even be targeted towards sectors within the wider European Union. For example, in the defence industry, introducing EU defence bonds, especially as the Europeans are seeking rearmament, could be a way that sovereign debt becomes more shared in the Eurozone.

Also, rhetoric and risk around US treasuries are rising. For investors who want a risk-free asset from the EU, risk spread over the European Union states could be a very attractive asset. This could also raise the status of the euro as a reserve currency. The dollar won’t be uprooted overnight, but the trend of de-dollarisation began when they confiscated Russian FX reserves held in dollars. The Euro could benefit here through greater issuance of debt on a continent-wide level.

white palace during daytime — Photo by Leyre on Unsplash

Concluding Remarks

A final approach that Europe could take here is a deeper, psychological pivot. China typically takes a long-term view of multiple elements of domestic policy decisions. The Europeans usually follow the same method as the United States, where short-term pursuits attempt to fix issues as they arise. The strategy of the United States is a reactive policy, and generally, it is indicative of a declining geopolitical power. The Chinese incorporate a preparation policy, and in the long term, this places them in good stead to better weather challenges and crises as they arise. It’s not guaranteed that they weather all storms, but through longer-term planning, they’re better aware of the worst cases that could emerge before they do. It gives them options.

As our geopolitical world is realigned under Trump’s power-based world order, Europe has an opportunity to realign and focus on the long term. Based on today’s discussion, this could involve multi-year fiscal plans that are tied to the EU’s longer-term strategic goals. Or it could be a long-term roadmap to European bonds.

As the United States and the European Union undergo a redrawing of relations, Europe has a chance to forge its own path and to make it one that is successful; the longer-term the plan, the better.

On Thursday, I’ll return to the Global Questions Series. The global hierarchy of our geopolitical world is aligned in a vertical structure. In incredibly simplified terms, leaders sit at the top with the governmental structure below them, eventually leading down to you and me. This vertical structure led me to question: What could a horizontal structure look like? Come back on Thursday for this and much more.

Other News In Geopolitics This Week:

Africa

Former CEO of Nigeria’s State Oil Firm Arrested Over Alleged $7B Fraud

Asia

Europe

Middle East

North America

South America

Other

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