Euro Zone Crisis : A macroeconomic study
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Transcript of Euro Zone Crisis : A macroeconomic study
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2013
12/18/2013
THE EUROZONE CRISIS:
A Macroeconomic Perspective
Prepared By:
ANAND ODEDRA (B13132)
AMITABH VAJPAYEE (B13131)
ANIRBAN CHAKRABORTY (B13134)
ANUPAM MAITY (B13183)
ASHUTOSH SINGH (B13138)
Macroeconomic Theory and Policy
XLRI, Jamshedpur
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INDEX
THE EUROPEAN UNION ..2
PRELUDE TO THE EUROZONE CRISIS .3
A CHRONOLOGY OF THE MAIN EVENTS .5
CAUSES OF THE CRISISPICTORIAL REPRESENTATION ..6
CAUSES FOR THE EUROZONE CRISIS .6
POLICY MEASURES .11
EUROPEAN CENTRAL BANK .14
ECONOMIC REFORMS AND RECOVERY PROPOSALS .15
LESS AUSTERITY, MORE INVESTMENT .15
INCREASE COMPETITIVENESS 16
ADDRESS CURRENT ACCOUNT IMBALANCES .17
WHAT IS THE WAY OUT? .18
PROPOSED LONG TERM SOLUTIONS .. 19
CONCLUDING REMARKS .. 22
REFERENCES .24
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THE EUROPEAN UNION
The European Union (EU) is quite unique in the international system. The original goal behind
the integration of Europe was to prevent the recurrence of the devastating wars of the first half
of the twentieth century. The seeds of a united Europe were laid post WW 1. Presently 28
countries are part of the EU. There are various bodies that govern specific functions of the EU.
Here we shall focus on the relevant points for the later part of the discussion.
Convergence Criteria are the necessities that an individual country has to meet so as to become
a part of the Union. It has been observed that the countries have fulfilled the criteria at the
time of joining, however, they have violated these rules time once they become members. The
salient features of the Maastricht Treaty that the country has to comply by are as follows:
Inflation Rate :
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from countries within the EU which meant that this was recorded as a deficit in the balance
sheets of the other Eurozone countries.
PRELUDE TO THE EUROZONE CRISIS
The Eurozone crisis has several features in common with other similar financial-stress drivenepisodes in the history of Economy. To start with, it demonstrated some of the characters that
are common to such crisis. The parallels that can be drawn are as follows:
Preceded by a comparatively long period of swift credit growth, Copious availability of liquidity Low risk premiums Strong leveraging Soaring asset prices Development of bubbles in the real estate sector.
The collapse of the banking systems and the subsequent crisis that precipitated in the year of
2007 was brought about by a chain of events. These events were to an extent chronological.
The analysis of this can be broken down into several steps which may or may not overlap to a
certain extent. There are sub reasons for these events as well but here we focus on the main
It was believed that the European economy, unlike that of the USA, would be largely immune tothis financial turbulence. This was based on the belief that the real economy, though slowing, was
thriving on strong fundamentals such as rapid export growth and sound financial positions ofhouseholds and businesses
This tuned out to be an illusion of sorts because the major part of international trade that wasbeing done was between the countries of the EU; thereby making it seem that one country was
accumulating a trade surplus. In reality there was little if any growth occuring.
The interbank market virtually closed and risk premiums on interbank loans soared tounprecedented heights. Banks faced a serious liquidity problem, as they experienced major
difficulties to rollover their short-term debt.Policymakers still perceived the crisis primarily as a liquidity problem. This was one of the majorblunders and mistakes made. Concerns over the solvency of individual financial institutions also
emerged, but systemic collapse was even then deemed unlikely.
When the crisis came to be in 2007, uncertainty among banks about the creditworthiness of theircounterparts evaporated as they had heavily invested in often very complex and opaque and
overpriced financial products
This led to the deteriorating loan performance and disturbances in the wholesale funding markets.
Such episodes have happened before. The examples area bundant (e.g. Japan and the Nordic
countries inthe early 1990s, the Asian crisis in the late-1990s). However, the key differencebetween these earlier occurences and the Eurozone crisis was its global dimension.
The presence of stretched leveraged positions as well as maturity mismatches made financialinstitutions in the European Union highly vulnerable to any corrections in asset market.
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reasons leading up to the crisis. The following Info graphic summarizes the chain of events
leading up to the economic crisis:
As it can be seen, there
was an overestimation of
the trade taking place
between the countries of
the European Union. The
trade surplus that
Germany, the forerunner
of the EU as far as size and
strength of Economy is
concerned, was also
attributable to the nations
of the EU to a large extent.
The nations that it tradedwith were showing deficits
in their balance sheets.
Moreover there was the
ever looming threat of
internal collapse of the
economy. These points and others will be covered in more detail in the rest of the report.
Confidence of both consumers and businesses fell to unprecedented lows.This set chain of events setthe scene for the deepest recession in Europe since the 1930s
The downturn in asset markets snowballed rapidly across the world. As trade credit became scarceand expensive, world trade plummeted and industrial firms saw their sales drop and inventories pile
up.
The crisis thus began to feed ontoitself, with banks forced to restrain credit, economic activityplummeting, loan books deteriorating, banks cutting down credit further, and so on.
Panic broke in stock markets, market valuations of financial institutions evaporated,investors rushedfor the few safe havens that were seen to be left (e.g. sovereign bonds), andcomplete meltdown of
the financial system became a genuine threat
Bankruptcy of Lehman Brothers and fears of the insurance giantAIG (which was eventually bailed out)taking down major US and EU financial institutions in itswake
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A CHRONOLOGY OF THE MAIN EVENTS
The beginning of the crisis is a debatable event however the first clear-cut signs of it came
when in 2007 BNP Paribas froze the redemptions for three major investment funds. The reason
cited was its incapability to value structured products. As a result of this, the confidence of
consumers as well as businesses fell to all-time lows.
The direct repercussion of this was that there was a dramatic increase in the counterparty risk
between banks. This was reflected in the soaring rates of lending charged by banks to each
other for their short-term loans. This indirectly led to an increase in the credit default swaps
and the insurance premium on banks' portfolios. People were also complacent regarding the
onset of a crisis. Most observers were not even alerted that the systemic crisis would be a
threat.
However about half a year later all changed as the list of failed banks grew to such lengths that
indications of a systemic meltdown around the corner were evident. The list includes Lehman
Brothers, AIG, Fannie May and Freddie Mac, Wachovia, Washington Mutual and a few more.Nonetheless the governments were fast to respond. The damage would have been shocking
had it not been for a variety of rescue operations that the governments undertook.
With the fall of Lehmann brothers, investors became even more wary about the risk that bank
portfolios contained. As a result of this, it became even more difficult for such banks to raise
capital via the routes of deposits and shares. It came to a situation that the institutions that
were deemed at risk could no longer finance themselves through conventional means involving
banks. As a result of this, they has to sell assets at 'fire sale prices' and restrict their lending.
Thus the prices of similar assets fell even more and thereby reduced capital and lending further
a vicious cycle came into being. This can be compared to an adverse 'feedback loop' wherein
economic downturn increased the credit risk, eroded bank capital even further.
The primary response of major central banks - those that are situated in the United States and
in Europe was to reduce common systemic factor interest rates down to a historical low
thereby contain funding cost of banks.
They also gave additional required liquidity against collateral so as to ensure that financial
institutions didnt need to resort to fire sales. These measures resulted in huge expansion of
central banks' balance sheets. This bank lending to the non-financial corporate sector
eventually tapered off. The governments soon came to know that the provision of liquidity
albeit essential, were not sufficient to restore normal functioning of the banking system. This
was due to the deeper problem of probable insolvency associated with under capitalization.
The write-downs of the banks were estimated to be well over 300 billion US dollars in the
United Kingdom and well over EUR 500 to 800 billion in the euro area. In both cases this
accounted for almost 10% of the GDP of the country and/or union. It was agreed in 2008 that
countries would put in place financial programs to make sure that the capital losses of the
banks would be counteracted.
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CAUSES OF THE CRISISPICTORAL REPRESENTATION
Relaxed lending practices
Excessive investment
Risk assessment not proper
Global ImbalancesUSA Subprime Crisis
Improper fiscal policies framed by individual nations
Contagion Problemsno proper contingency measures in place.
A Single Currency
Then there were 27 countries
27 electoral democracies, 54 different points ofview.
Culture, history, technology, language, customs,socioeconomic structure etc are not at all the same.
Crisis:
Hard
Reasons
Crisis:
SoftReasons
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CAUSES OF THE EUROZONE CRISIS
The Eurozone crisis has been caused from a blend of intricate factors. These factors vary from
the globalization of finance; easy lending norms during the 20022008 period that stimulated
high-risk lending and borrowing; the financial crisis of 200708; international trade imbalances;
real estate bubbles; the Great Recession of 20082012; fiscal policy choices related togovernment incomes and expenditures; and methodologies used by nations to move out
troubled banking units and private bondholders, supposing private debt burdens or socializing
losses. These factors vary from country to country in the entire Eurozone. A few of them fell
into the crisis because of the government debt while others lost a lot of money in the property
bubble. We will now take the country wise analysis of the turnout of events that triggered the
outbreak of crisis in them.
PORTUGAL
Government Spending & public funds mismanagement
The democratic Portuguese Republic governments were involved in over-expenditure and
investment bubbles via hazy publicprivate partnerships. They funded many unnecessary
external aids to the government by consultancies which drilled deep holes in to the government
pockets. This caused significant loss in state-managed public works, extravagant top
management and head officer bonuses and
wages.
Over Employment in public jobs
The Portugal government followed an oldrecruitment program for the public jobs
without keeping an eye on the actual
requirement in the sectors. The public
servants to population ratio was one of the
highest in Portugal (708 as compared to 624 Euro zone average). Also, an example stating that
Portugal judicial system was the second slowest in
Europe despite having maximum number of judges
shows how inefficient and ineffective the public system
was.
Portugal Banking system breakdown
Other reason for the failure of the Portugal economy
was failure of the Portugal banking system attributed to
large scale bad investments, embezzlement and
accounting frauds. In the grounds of avoiding a
potentially serious financial crisis in the Portuguese
Government Expenditure (annual % GDP)
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economy, the Portuguese government decided to give them a bailout, eventually at a future
loss to taxpayers.
ITALY
Accumulating Government Debts
Italy has been very strangely has been shouldering the debt to GDP ratio well above 100% for
decades but very astonishingly no one cared as it was paying back the interest. In the year
1999, while Italy officially accepted the euro, its debt-to-GDP ratio was 126%. It was staying
afloat because of the slow steady growth which helped in the credibility of Italy. But then the
economy became stagnant and was slowly moving towards negative dip. This cause panic
among the investors and they raised the interest rates.
Low Productivity of Italy
Italy lacks in big industries to compete with the growing giants in Asia and rest of the world.Because the Italian economy is ruled by small and medium sized businesses, this can be thought
of all those charming artisanal cheese and pasta makersthe capital markets are poorly
developed. And these small scale industries are unable to reach either economics of scale or
efficiency owing to their small sizes.
Unemployment disparity, Mafia & Poor Governance
Some other factors that played minor roles are the existence of dual employment treatment in
the economy where old employers are permanent and with higher wages while youngemployers with temporary jobs and lower wages causing a great disparity in the unemployment
among the population. Also, wide spread black money market flourishes in Italy which eats
away a major part of the GDP reducing the government revenues. Poor governance is also a
major attributable cause for the above concerns.
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IRELAND
Property Bubble engulfed Irish Banks
The Irish sovereign debt unlike other Eurozone
crisis was not a result of government over-
spending, but due the guarantee that governmenttook for the six core Irish-based banks who were
deeply involved in financing a property bubble.
These Irish banks had vanished an assessed 100
billion euros, the unemployment peaked from 4%
in 2006 to 14% by 2010 and the national budget
went from a surplus in 2007 to a deficit of 32%
GDP in 2010. The highest ever in the history of the
Eurozone and the crisis was here.
Asset-Liability MismatchThe Irish banks had invested hugely in the
widespread infrastructure & building project, most
of which were not occupied even after being
completed for years. This led a massive misbalance between the Assets that banks were
banking upon to the liabilities that they were holding to the lenders. The government came to
the rescue of the banks but it was not sustainable as there nothing to cash back the already
occurred disaster. Ultimately the government had to lend money from IMF and European Union
to overcome their deficit.
GREECE
In the early mid-2000s, the economy of Greece was among one of the fastest proliferating in
the Eurozone. It propagated with an annual rate of 4.2%, as foreign money flew into the
economy. In spite of that, the economy remains persistent in delivering high annual budget
deficits. Major causes that led to this are below.
Government spending
The government was involved in huge military
expenditure, public sector jobs, pensions andother social benefits. Greece was able to get
finance for its spending until the world was hit by
the global economic crisis in 2008. It dried up the
global credit and which caused two prominent
industries shipping and tourism affect severely.
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Government tried to control the economy by borrowing and spending with open hands.
Tax evasion
The revenue from taxes for Greece has always been significantly below the expectation levels.
This was also one of the reason for growing deficit in the annual budget in the Greece economy.
Corruption & unethical deeds
In early 2010, it was exposed that Greece took the assistance of Goldman Sachs, JPMorgan
Chase and numerous other banks to develop the financial products which aided the
governments of Greece, Italy and many other Eurozone economies to conceal their borrowings
and meeting unethically the deficit target as put by the euro union.
SPAIN
Housing Bubble
Spain was relatively better off as far as the Debt to GDP ratio was considered among other
Eurozone economies. Somewhat similar to Irish crisis, the new properties including public
places, landmarks and houses were built massively
which involved huge investments. Subsequently,
there was no one to acquire or consume the
benefits which aroused bubble speculation.
Government could bear and back the deficit caused
owing to the large tax revenues it had generated of
the same construction spree. But this could not lastfor long.
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Sharp inflation & deflation
As Spain lacks in natural resources, it heavily depends on its import for fuelling the country. Due
to sharp rise in oil prices during the recession of 2008, the inflation reached its peak and a
record height with pressure on government mounting high which was already struggling to
cope with the housing bubble mishap. Then the prices fell drastically and this lead to deflation
in the economy and after that Spain economy could not recover from plunging negatively.
Spain on the Edge of Deflation
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POLICYMEASURES
European Financial Stabilization Mechanism (EFSM)
It is a mechanism referring on article 122(2) of the TFEU that foresees financial support for
member countries in difficulties caused by extraordinary circumstances beyond their control. It
is an intergovernmental agreement to provide financial assistance of up to EUR 60 billionsubject to strong conditionality in the context of a joint EU and IMF support which will be on
terms and conditions comparable to those levied by the IMF. On 5 January 2011, the European
Union created the European Financial Stabilization Mechanism (EFSM), an emergency funding
program reliant upon funds raised on the financial markets and guaranteed by the European
Commission using the budget of the European Union as collateral. It works under the authority
of the Commission and aims at preserving financial stability in Europe by providing financial
assistance to EU member states in economic problems. The Commission fund, backed by all 27
European Union members, has the authority to generate up to 60 billion and is given a rating
of AAA by agencies like Fitch, and Standard & Poor's.
Under the EFSM, the EU successfully placed in the capital markets a 5 billion issue of bonds as
part of the financial support package agreed for Ireland, at a borrowing price for the EFSM of
3.59%.
European Financial Stabilisation Facility (EFSF)
It is a temporary credit-enhanced SPV with minimal capitalization created to raise funds from
the capital markets on its investment grade rating and provide financial assistance to distressed
EAMS at lower interest rates than those available to the latter. The financial support provided
to EAMS through the EFSF shall be provided on comparable terms to the stability support loansadvanced by EAMS to Greece.
The total volume of these two mechanisms is EUR 500 billion. While EFSM is available to EAMS
and non-EAMS member states, the EFSF is only available to the EAMS.
The European Union (EU) finance ministers created the European Financial Stability Facility
(EFSF) to deal with the European debt scenario, which started in 2009, and was a part of the
larger global financial crisis. To realise why the EFSF was created, one must first understand the
fundamental requirements of becoming a member of the European Monetary Union (EMU).
To become a member of the EMU, a country must follow and retain, among other specified
criteria, a deficit below 3% of GDP and debt below 60% of GDP. Once a country becomes partof the EMU, it is subject to a single monetary and foreign exchange policy. However,
essentially, the country does not lose its ability to set its own fiscal policy.
Because of the EMU countries' ability to set their own fiscal policy, many EMU nations, like
Portugal, Ireland, Italy, Greece, and Spain, spent a lot, taxed very less, and issued too much
debt, which lead them into large deficits. This would not have been a problem if these
countries were not part of the EMUthey could have printed more money to pay for their
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excessive spending and debt issuances. However, with a unitary monetary policy, countries
within the EMU lose the facility to print money, and therefore, lack the ability to pay their debts
by printing more money. This becomes a problem area when, as in the EMU, there are no
limits on fiscal policy. Generally speaking, the easy-going fiscal policies of some EU member
states along with deceptive statistical reporting by Greece were the major causes of the debt
crisis.
In early 2009, Greece claimed that its deficit was 3.7% of GDP. In October 2009, Eurostat,
whose primary responsibilities are to provide the EU with European-level statistical
information, published a press report stating that the Greek government misreported its deficit
and debt figures. Shortly thereafter, the government of Greece adjusted the projected deficit
to 12.7% of GDP, more than four times the 3% limit levied by the EMU. The Greek government
also reported that its debt was 121% of GDP (well above the EMU limit of 60% of GDP). As a
result, the major credit-rating firms downgraded Greek debt while investors became unsettled
about other European countries with large debt and deficits.
Notwithstanding opposition from some EMU member states hoping to restore confidence and
safeguard financial stability in the Euro-Zone area, leaders of the Europian continent and the
International Monetary Fund (IMF) agreed to make available a 110 billion rescue package to
Greece if Greece implemented austerity measures. This did not in any way ease investors
fears.
After the Greek bailout, investors worried that other EU nations would break their promises of
always being capable of paying back their debts or interest on their loans. As a result, euro-
zone nations government bond prices dropped significantly and market interest rates for
financially distressed EU government bonds in Greece, Spain, and Ireland increased. Shortly
thereafter, investors began to worry that government finance problems would spread to
European banks which held a lot of EU governments debt. Because of this, there were news of
rift and that the EMU might break apart. To put an end to this speculation, calm the financial
markets, and fight another sovereign debt crisis, the EU finance ministers created the European
Financial Stability Facilitya limited liability company that could sell up to 440 billion of debt
on capital markets and lend the proceeds to euro area member states in troublewhich was
part of a larger 750 billion rescue facility.
The 750 billion rescue package consists of 500 billion from the twenty-seven countries of the
EU and 250 billion from the IMF. The majority (440 billion) of the European contribution
comes from sixteen-nation euro-zone bloc. The European Commission (EC), a branch of the
governing body of the EU, made 60 billion immediately available at their disposable.
European Stability Mechanism (ESM)
In October 2010 (after financial assistance was provided to Greece and while conditions
continued deteriorating), with the motive of ensuring balanced and sustainable growth, the EU
Council agreed on the need for member states to establish a permanent crisis mechanism to
safeguard the financial stability of the euro area as a whole. It was resolved that consultations
should be undertaken towards a limited treaty change for said purpose but not modifying
the so-called nobail-out clause included in article 125 of the TFEU. Further, the EU Council
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agreed in December 2010 that there is a need for EAMS to establish a permanent stability
mechanism, i.e. the ESM. This was immediately followed by the Conclusions of the European
Council57 and the EU Council decision 2011/199/EU amending Article 136 of the TFEU with
regard to a stability mechanism for EAMS, both were adopted on 25 March 2011.
When the EFSF expires, the EU will replace it with a permanent crisis mechanism called theEuropean Stabilization Mechanism (ESM). The ESM will provide funds to any member state
whose debt problems would threaten the euro zone. The ESM would want the private sector
bondholders to share the cost of any debt restructuring on a case-by-case basis.
A solvent euro-zone member experiencing liquidity problems can apply for emergency funding
from the ESM and would have to implement austerity measures similar to those required by
the EFSF. The country would not have to restructure its loans or decide on coming to a
standstill (i.e. cease payments on its debt until a restructuring agreement has been negotiated
with its creditors). However, if the IMF and the European Commission believe the country is
insolvent or that its debt position is unsustainable, the country requesting the funds would
have to negotiate with its creditors to restructure its debt as a condition of further bail-out
funding.
To facilitate the restructuring process, the European Stability Mechanism will require future
bond issuances by member states to include collective action clauses (CAC). The CAC enables a
majority of creditors to pass a legally binding agreement changing the terms of payment
(standstill, extension of the maturity, interest rate cut and/or haircut) in the event the debtor is
unable to pay. CACs are typical of the bonds issued under English law and help facilitate
restructuring.
EUROPEAN CENTRAL BANK
TheEuropean Central Bank (ECB) has taken a series of measures aimed at reducing volatility in
the financial markets and at improvingliquidity.
In May 2010 it resorted to the following actions:
It beganopen market operations buying government and private debt
securities, reaching 219.5 billionin February 2012, though it simultaneously absorbed the
same amount of liquidity to prevent a rise in inflation. According to Rabobank economist Elwin
de Groot, there is a "natural limit" of 300 billionthe ECB can sterilize.
It reactivated the dollarswap lines withFederal Reserve support. It changed its policy measures regarding the necessary credit rating for loan deposits,
accepting as collateral all outstanding and new debt instruments issued or guaranteed by
the Greek government, regardless of the nation's credit rating.
With the aim of boosting the recovery in the Eurozone economy by lowering interest rates for
businesses, the ECB cut itsbank rates down in multiple steps in 20122013, reaching the
http://en.wikipedia.org/wiki/European_Central_Bankhttp://en.wikipedia.org/wiki/Liquidityhttp://en.wikipedia.org/wiki/Open_market_operationshttp://en.wikipedia.org/wiki/Rabobankhttp://en.wikipedia.org/wiki/Currency_swaphttp://en.wikipedia.org/wiki/Federal_Reservehttp://en.wikipedia.org/wiki/Bank_ratehttp://en.wikipedia.org/wiki/Bank_ratehttp://en.wikipedia.org/wiki/Federal_Reservehttp://en.wikipedia.org/wiki/Currency_swaphttp://en.wikipedia.org/wiki/Rabobankhttp://en.wikipedia.org/wiki/Open_market_operationshttp://en.wikipedia.org/wiki/Liquidityhttp://en.wikipedia.org/wiki/European_Central_Bank -
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historic lows of only 0.25% in November 2013. The lowered borrowing rates have also caused
the euro to fall in relation to other currencies, which is expected to boost exports from the
Eurozone and further aid the recovery.
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ECONOMIC REFORMS & RECOVERY PROPOSALS
The Euro zone debt crisis in the euro area during the spring of 2010 has revealed that the
monetary and fiscal policy framework of the European Monetary Union (EMU) is still
incomplete. Understandably, the rules-based framework for fiscal policy created by the
Excessive Deficit Procedure and the Stability and Growth Pact was insufficient to prevent a debtcrisis despite its emphasis on keeping public sector deficits low and strengthening forward-
looking budgetary planning. Once the crisis occurred and financial markets were stirred up by it,
it became obvious that EMU did not have policy tools to manage and resolve the crisis. Lastly,
the European Union responded to the crisis by agreeing on stabilisation for Greece and by
creating the European Financial Stability Facility (EFSF) that succeeded in calming the markets.
Nevertheless, these responses were developed in an ad-hoc manner and on a temporary basis
only and do not provide an adequate basis for dealing with any possible future debt crises in
the euro area.
Several proposals have been put forward for how to improve the euro zones capacity to dealwith problems of excessive public debts. To prevent sovereign crises, the European Commission
(2010) has proposed a number of measures to strengthen the Excessive Deficit and the Stability
and Growth Pact. The above proposals focus mainly on making the rules of the current
framework more effective and on strengthening their enforcement by introducing stiffer and
more automatic penalties for violating these rules. The European Central Bank (ECB) has made
proposals (2010) on the same lines and, at the same time, has called for the creation of a crisis
management fund for the euro area, which would come into play if the strengthening of the
rules-based framework does not suffice to prevent future debt crises. According to the ECBs
proposal, such a fund should provide last-resort financ- ing at penalty rates to governments
facing difficulties in accessing private credit markets.
We agree that the euro area needs a mechanism for dealing with sovereign-debt crises in an
effective and predictable way. Even the most effectively enforced set of fiscal rules will not do
away with the possibility of future debt crises in the euro area. One of the crucial problems of
the crisis of 2010 was clearly that policymakers had no game plan for dealing with it. The lack of
any sensible rules guiding market expectations about how governments and the Commission
would respond to the crisis contributed to the volatility of financial markets during the crisis
and this contributed to the sense of urgency policymakers felt about the need to act.
LESS AUSTERITY, MORE INVESTMENT
In the public sector, as a result of the austerity policy, wages have been frozen or cut. Greece (
20 per cent) and Portugal (10 per cent) have been at the forefront of cuts in real wages
throughout the economy. Spain (5.9 per cent) and Italy (2.6 per cent) have also experienced
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above-average real wage losses during this period. This showcases an opening of the floodgates
in comparison to the situation before the crisis of 2008/2009.
In pension policy, Portugal introduced reforms in 2007 and Greece, Italy and Spain in 2010,
which many other EU states had launched a decade before. Besides raising of the statutory
retirement age, a toughening of the conditions for early retirement, the equalization of menand women and the abolition of job-specific differences, individual components of pension
reform have been adjusted in such a way that the rise in pension costs in relation to GDP by
2040 has been slowed down significantly. Relative pension levels will fall drastically in the GIPS
states by 2040.
The pension reforms that have been implemented will have long-term negative consequences,
especially for those future pensioner generations who have more adverse employment
biographies. Longer periods of unemployment conditions entail gaps in social insurance
contributions and thus reduce pension levels.
Privatization policy has taken on new impetus in the GIPS states because of the Euro-crisis and
the accompanying austerity policy. In Greece and Portugal, the granting of loans by the EU
states was linked to extensive privatization. Spain and Italy, under pressure from the ECB and
international institutions, have announced far-reaching privatizations. Among the GIPS states,
Greece has been most affected and plans a veritable fire sale of state property.
INCREASE COMPETITIVENESS
Internal devaluationMany policy makers try to restore competitiveness through internal devaluation, an economic
adjustment process, where a country aims to decrease its unit labour costs. In 2012, Ireland
was the only country that had implemented relative wage moderation in the last five years,
which helped decrease its relative price/wage levels by 16%. Greece would need to bring this
figure down by 31%. Wages in Greece have been cut to a level last seen in the late 1990s.
Buying power dropped even more to the level of 1986.
Fiscal devaluation
According to fiscal devaluation, policy makers can increase the competitiveness of an economy
by lowering corporate tax burden such as employer'ssocial security contributions, while
negating the loss of government revenues through higher taxes on consumption (VAT) and
pollution, which is called ecological tax reform. Germany has successfully pushed its economic
competitiveness by increasing the VAT in 2007, and using part of the additional revenues to
lower employer's unemployment insurance contribution. Portugal has taken a similar stance
and France appears to follow this suit.
http://en.wikipedia.org/wiki/Tax#Social_security_contributionshttp://en.wikipedia.org/wiki/VAThttp://en.wikipedia.org/wiki/VAThttp://en.wikipedia.org/wiki/Tax#Social_security_contributions -
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Progress
According to the Euro plus Monitor 2011 report, most critical euro zone member countries are
in the process of rapid reforms. Greece, Ireland and Spain are among the top five reformers and
Portugal is ranked seventh among 17 countries included in the report.
The Lisbon Council in November 2012 finds that the euro zone has slightly improved its overall
health. With the exception of Greece, all Eurozone crisis countries are either close to the point
where they have achieved the major adjustment or are likely to get there over the course of
2013. Overall, if the euro zone gets through the current acute crisis and stays on the reform
path it could eventually emerge from the crisis as the most dynamic of the major Western
economies.
ADDRESS CURRENT ACCOUNT IMBALANCES
Europe is in the grip of three interdependent crises: a sovereign-debt crisis, a banking crisis anda balance-of-payments crisis. Policymakers have primarily focused on the sovereign-debt and
banking crises. However, a convincing strategy for getting the Eurozone back on track needs to
tackle the problem of its large internal imbalances. Rebalancing will require countries with
current-account deficits to devalue. The critical question is how: internally without exiting the
euro or externally after exiting the euro.
Not much attention has been paid to the imbalances within the European Union or the
Eurozone. One of the reasons for this might have been that the current account of the
Eurozone was roughly balanced over the period from 1995 to 2011. The external balance of the
Eurozone, disguised the significant internal imbalances. Greece, Ireland, Italy, Portugal, and
Spain have been running a current account deficit that has been rising since the late 1990s. This
deficit was largely offset by the huge current account surplus in Germany during the whole
period. The rest of the Eurozone was more or less in balance. Current account deficits and
surpluses resulted in corresponding changes in the net international assets position. Germany
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slowly improved its asset position while Greece, Ireland, Italy, Portugal, and Spain accumulated
a large net liability position.
Greece, Ireland, Italy, Portugal, and Spain relied more and more on public support to finance
themselves internationally. Until 2007 the main source of this public support was ECB Target
credit. The public capital flows as reflected in the increase in the Target balances compensated
for the private capital flows. They have financed or co-financed the current account deficits of
Greece, Portugal and Spain since 2007/2008, and compensated for capital flight from Ireland
after the Lehman crisis.
WHAT IS THE WAY OUT?
The first option, the one favored by European
finance capital, is to grant emergency loans toGreece. Loans will allow Greece to continue to
service its debts so that bondholders do not
incur any losses. The conditionalitys include
reduction of government spending on social
sectors, freezing of government jobs, reduction
in wages, privatization of the pensions sector,
labor market reform and other such measures. It
will severely contract the level of aggregate demand in the Greek economy and thereby push it
into a prolonged and deep recession. This will ensure a deflation in the Greek economy relative
to Germany, leading to a possible reduction in the trade deficit.
The second option, the one that should be favored by the working class in Greece and other
countries, is to work out a credible debt-restructuring program with bondholders and force the
German economy to reflate. Debt-restructuring would ensure that some of the cost of re-
adjustment is borne by finance capital. Increasing aggregate demand in the German economy
through a mix of fiscal and monetary policy would revive demand, push up inflation, decrease
real interest rates and thereby boost private investments. Other options will open up, if Greece
and other countries in the periphery decide to opt out of the euro zone altogether.
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PROPOSED LONG TERM SOLUTIONS
1. EUROPEAN FISCAL UNION:Fiscal union is the integration of the fiscal policy of nations or states. Under fiscal union
decisions about the collection and expenditure of taxes are taken by common institutions,
shared by the participating governments.
It is often suggested that the European Union adopt a form of fiscal union. Most member states
of the EU take part in financial and monetary union (EMU), founded on the euro currency, but
most conclusions about levies and spending remain at the nationwide level. Thus, whereas the
European union has a monetary union, it does not maintain a fiscal union.
Control over fiscal policy is advised central to nationwide sovereignty, and in the world today
there is no considerable fiscal union between independent countries. However the EU has
certain restricted fiscal forces. It has a role in concluding the level of VAT (consumption levies)and tariffs on external trade. It also spends a allowance of numerous billions of euros. There is
furthermore a Stability and Growth Pact (SGP) among members of the Eurozone (common
currency locality) proposed to co-ordinate the fiscal principles of constituent states. Under the
SGP, constituent states report their financial designs to the European Commission and interpret
how they are to accomplish medium-term budgetary objectives. Then the Commission assesses
these plans and the report is sent to the financial and economic managing group for remarks.
Eventually, the assembly of financial and Finance Ministers concludes by qualified majority
whether to accept the Commission's recommendation to the constituent state or to rewrite the
text. However, under the SGP, no nations have ever been penalised for not gathering the
objectives and the effort to penalize France and Germany in 2003 was not fulfilled. Thus, afterthe Eurozone urgent situation, some people in Europe sensed the need for a new union with
more powerful fiscal influence amidst constituent states.
On 2 March 2012, all constituents of the European Union, except the Czech Republic and the
United Kingdom, signed the European Fiscal Compact, which if ratified by the 25 countries
would implement stricter caps on government expending and borrowing, encompassing
automatic sanctions for nations breaking the rules.
However, following are the arguments advocating the introduction of fiscal union in the EU:
1. LOCAL PROBLEMS NEED LOCAL SOLUTIONS
As long as the European Union is made up of independent countries with their own voted-into-
office authorities, their troubles are going to be essentially localized and they will need localized
solutions. Squeezing them into a common monetary straightjacket has clearly failed and
supplementing a fiscal union would just exacerbate an existing unsustainable situation.
Governments need flexibility to deal with their own problems. Fiscal union would involve
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ballooning of the EU allowanceprovoking endless bickering among the 27 constituent states
on how to share it out, not to mention the amplified scope for graft and bureaucratic
inefficiency. Its a recipe for gridlock.
2. DEMOCRATIC DEFICIT
Fiscal union is often looked upon as detrimental to national independence. Setting budgets isessentially the responsibility of sovereign parliaments. Transferring that power to some distant,
opaque Brussels institution would be deeply undemocratic. History tells us citizens will not
agree to taxation without representation.
3. EVRERYONE PAYS MORE
The tax harmonization that will follow fiscal union will only move in one direction: up. Countries
like Ireland or Slovakia which boosted their economies with innovative revenue policies will be
forced to apply high taxes as part of a French-led crusade against fiscal dumping. This shall be
a major blow to Europes competitiveness.
FOR
NO EMU WITHOUT EFU: Combiningsupranational monetary policies withnational fiscal policies is unsustainable.A fiscal union run by a fullyempowered EU Finance Ministryunder proper democratic oversight willgive the Union strength and stability,mutualizing credit risk while imposingtough fiscal discipline.
UNITED WE STAND: Closer economicunion is the only way to halt Europesdecline in the new global environment.Fiscal union would raise Europesmarket credibility and eurobondswould rival US treasuries.
EFFICIENCY: A European fiscal union,with proper institutions would be ableto provide joined-up management ofthe EU economy as a whole.
AGAINST
LOCAL PROBLEMS NEED LOCALSOLUTIONS: Squeezing the EUmember nations into the samemonetary straightjacket has clearlyfailed and adding a fiscal union wouldjust exacerbate an alreadyunsustainable situation.
DEMOCRATIC DEFICIT: Setting budgetsis a core responsibility of sovereignparliaments. Transferring that powerto some distance, opaque Brusselsinstitution would be deeplyundemocratic. Citizens will not accepttaxation without representation.
WELL ALL PAY MORE: Countries likeIreland or Slovakia that boosted theireconomies with innovative revenuepolicies will be forced to apply hightaxes as part of a French-led crusade
against fiscal dumping.
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2. EUROBONDSEuropean bonds are proposed government bonds issued in Euros jointly by the 17 eurozone
countries. Eurobonds are liability investments whereby an shareholder loans a certain amount
of cash, for a certain amount of time, with a certain interest rate, to the eurozone bloc entirely,
which then ahead the cash to the individual national governments.Eurobonds these days are intended as a way to tackle the eurozone debt crisis. The idea,
propounded by the European Commission, appears to be of certificates that will fully replace
existing national bonds. Technically, a eurobond is a debt contract, that records the borrowers
obligation to pay interest at a given rate and therefore the principal quantity of the bond
on such dates.
Because Eurobonds would enable already highly-indebted states access to cheaper
credit because of the strength ofalternative Eurozone economies, they're disputed.
On 21 November 2011 the european Commission instructed European bonds
issued together by the seventeen eurozone nations as a probably effective way to handle
the monetary crisis. On 23 November 2011 a written report was presented, analyzingthe feasibleness of common issuance of sovereign bonds among the EU member states of the
eurozone. Sovereign issuance within the eurozone is presently conducted separately by
each EU member country. The introduction of commonly issued eurobonds would mean a
pooling of sovereign issuance among the member states and therefore the sharing of
associated revenue flows and debt-servicing costs.
3. EUROPEAN MONETARY FUNDGermany and France are designing the launch of a clearing new initiative to strengthen financial
co-operation and surveillance inside the eurozone, encompassing the establishment of a
European Monetary finance (EMF), according to senior government officials.
Their intention is to set up the directions and devices to prevent any recurrence of volatility in
the eurozone arising from the indebtedness of a single member state, such as Greece.
The first minutia of the plan, including support for an EMF modelled on the International
Monetary Fund, were revealed by Wolfgang Schuble, the German investment minister.
The fund would have assets to lend to eurozone constituent states in economic difficulty, but
only subject to very strict situation to constrain excessive allowance deficits and scrounging.
The concept was suggested by Germany and they are now endeavouring to get France onboard.
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CONCLUDING REMARKS
We believe that a little more prudence with regard to monitoring the fiscal policy of individual
countries of the Eurozone would have helped mitigate the crisis. Moreover, the austerity
measures taken by the Eurozone and especially those that were imposed on PIIGS did little to
improve the condition of those countries. The gaping deficit that was revealed at a later date
could have been seen to using growth measures, which we believe are more sustainable than
imposing austerity measures. Simply putits similar to jailing a person just because they cant
pay their debts. This doesnt help either party involved. The borrower cant make money
because of the restrictions and the lender cant get his principle back as the borrower will still
have little, if any, money to pay.
Policy changes are necessary. Steps in that direction have already been taken. Compliance to
the Maastricht treaty after grant of membership was an issue. As pointed out in the initial parts
of this report, the members of the Eurozone violated the treatys conditions time and again. It
also made membership for those countries failing to meet criteria as some of the criteria were
tied to the current performance of the member countries e.g. the inflation rate had to be theaverage of the three best countries with regard to that parameter. Thus, better compliance and
stricter action has to be imposed for offenders. Contingency measures need to be looked into
especially due to the Eurozone being a union sharing policies as well as a common currency.
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REFERENCES
1) Economic Crisis in Europe: Causes, Consequences and Responses, European Economy Publication Number 7, Year 2009, Economic and Financial Affairs Directorate, EU.
2) The Eurozone Crisis Its dimensions and Implications, January 2012; M R Anand, GLGupta, Ranjan Dash
3) Eurozone crisis: beggar thyself and thy Neighbor, Journal of Balkan and Near EasternStudies, December 2010, Costas Lapavitsas.
4) Eurozone crisis : The corporate perspective, January 2012, Herbert Smith5) Policy Lessons from the Eurozone Crisis - The International Spectator: Italian Journal of
International Affairs, December 2012, Chiara Angeloni.
6) EurostatStatistics Explained: Structure of government debt (October 2011 data)7) Budget deficit from 2007 to 2015 Economist Intelligence Unit 30 March 20118) Rainer Lenz: Crisis in the Eurozone Friedrich-Ebert-Stiftung, June 20119) Global Financial Stability Report International Monetary Fund, April 201210)Story, Louise; Landon Thomas Jr., Nelson D. Schwartz (14 February 2010).11)"Wall St. Helped to Mask Debt Fueling Europes Crisis". New York Times (New York)
September 2011.
12)International Monetary Fund: Independent Evaluation Office, Fiscal Adjustment in IMF-supported Programs (Washington, D.C.: International Monetary Fund, 2003).