EURO Crisis

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The European Debt Crisis


Cultural Dimension

The Euro has been a political integration project

It was also an attempt to engineer European identity and citizenship by creating a monetary symbol

Money has historically been a driver of identity and statehood creation


Background :

• Began in late 2009, is the shorthand term for the region’s struggle to pay the debts it has built up in recent decades.

• Five of the region’s countries – Greece, Portugal, Ireland, Italy, and Spain – have, to varying degrees, failed to generate enough economic growth to make their ability to pay back bondholders the guarantee it’s intended to be.

• Although these five were seen as being the countries in immediate danger of a possible default, the crisis has far-reaching consequences that extend beyond their borders to the world as a whole.

• The head of the Bank of England referred to it as “the most serious financial crisis at least since the 1930s, if not ever,” in October 2011.


Causes that led to Crisis :

• Housing Price Bubble and Collapse• Financial Market Freeze and Collapse• Policy Response

• Support for Financial Sector• Monetary Policy• Fiscal Policy

• Greece’s Problems• Rising Debt Level – an accumulation• Trade Imbalances

• The cultural dimension (identity + mobility) and the misconstruction of the Eurozone

The EU Aim / Objective :


Housing Price Bubble and Collapse• Low interest rates• Lax regulation of sub-prime mortgages with adjustable rates, two year teaser rates• Securitization of mortgages, sold to unwary buyers as highly rated

• A transmission effect from the US property bubble collapse. Once interest rates rose, housing prices fell. Hence -> subprime mortgages and securities defaulted.

• Bubbles burst causing asset prices (e.g., housing and commercial property) to decline, the liabilities owed to global investors remain at full price, generating questions regarding the solvency of governments and their banking systems

• Ireland's banks lent the money to property developers, generating a massive property bubble. When the bubble burst, Ireland's government and taxpayers assumed private debts


Financial Markets Freeze & Collapse

Trade Imbalance

• Crisis in Balance Payments - when a nation is unable to pay for essential imports and/or service its debt repayments• Germany had a considerably better public debt and fiscal deficit relative to GDP than some of the worse affected Eurozone members like Spain and Ireland. Whereas in the same period, all the worse affected major countries (Portugal, Ireland, Italy and Spain) had a far worse balance of payments position than Germany.• Balance of Payments - are an accounting record of all monetary transactions between a country and the rest of the world.[1] These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers.

• European debt crisis a key focal point for the world financial markets in the 2010-2011 period. With the market turmoil of 2008 and 2009 in fairly recent memory, investors’ reaction to any bad news out of Europe was swift: sell anything risky, and buy the government bonds of the largest, most financially sound countries.


Periphery countries: Portugal, Ireland, Greece, Spain

The euro area: core and periphery countries

Core countries: Germany, France, Netherlands, Austria, etc.


Monetary policy: one size fits all

Source: IMF

Real GDP growth rate %


Greece’s Financial Problems

• Since joining the euro, Greece has had higher inflation than other Eurozone members.

• Greece has also increased debt faster than others to finance generous public sector pay, welfare, and retirement benefits, while collecting a lower share in taxes due to widespread tax evasion.

• As a result, Greek goods have become increasingly expensive and uncompetitive, causing loss of market share and further reducing revenues.


The origins of the Greek crisis

Greece’s euro membership marked by consumption, investment booms

Wages rise faster than productivity, competitiveness deteriorates

Low interest rates fuel credit growth

Poor fiscal discipline and weak institutions

Large revisions to budgetary statistics

Unsustainable pension, health systems


Greece and the EU rise to the challenge

May 2010: Greece adopts €110bn program supported by the EU and IMF

Program aims to restore sustainable public finances and recover lost competitiveness

Far-reaching structural reforms being adopted (e.g. landmark pension reform)

Drastic cuts in public expenditure across all levels of government

Program will stabilize debt ratio (but at a high level)


The origins of the Irish crisis

Ireland experienced strong growth in recent decades

Transformation from agricultural economy to “Celtic Tiger”

Strong presence of multinational companies, skilled workforce

But reckless lending by banks to commercial property developers

Bad debt of banks causes problems for whole economy

Deep recession – 14% unemployment


Ireland and the EU rise to the challenge

Government already taking drastic measures over last several years

November 2010: Ireland adopts €85bn program supported by the EU and IMF

Program aims to cut budget deficit and repair the damage caused by the banking crisis

Shrinking and restructuring of banking sectors

Drastic cuts in public expenditure across all levels of government


Where will it end?

Financial markets have become much more reluctant to lend to euro area countries . . .

. . . especially those with higher debt and deficit levels:

• Portugal?

• Spain?

• Italy?

• Belgium?

Financial markets exhibit ‘herd behavior’


Eurozone’s Design Flaws

Supra-nationalised monetary policy but national fiscal policy

Levels of competitiveness went out of line (costs and prices) only internal devaluation

No automatic stabilisers that would soften the blows of asymmetric economic shocks (social security and medicare in US)


GREECE ECONOMIC CRISIS

Source:BBC

Documents

EURO Crisis