3 Eurozone Crisis

8/3/2019 3 Eurozone Crisis

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The Eurozone Financial Crisis


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Facts about European Union

Europe Population 731000000

Europe Area 10181000 Sq Km

All Europe Countries 50-Countries

Europe Time Zones From UTC to UTC+5

European Union 27-Countries

Euro. Union Website http://europa.eu/

Europe Council Web. http://www.coe.int/Eu. Union Currency Euro. Symbol-

Eu. Union President Fredrik Reinfeldt


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The Eurozone is a term used to describe the region

of countries using the Euro (currency). This then includes

many of the countries of the EU such as Germany, Franceand Greece, but not all of them (countries like England

and Poland still use their own currencies). The Eurozone

crisis then refers to the plunging value of the Euro

caused by the economic crisis and amplified by themultitude of countries using the system. The problem is,

that while one country might be coping well with the

financial hardships, others that are fairing less well (such

as Greece) can end up pulling the value back downmaking it a vicious cycle and one that is hard to escape

from.


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This Eurozone crisis however is not a problem

that is contained to Europe; rather it is one

that affects the rest of the world through

investments, debt and trade and that is risking

serious global economic decline. It is in every

ones best interests to solve this crisis as soonas possible. Many meetings have been held

between the member states of the EU to this

end, but as yet no satisfactory solution hasbeen found.


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Germany has been shouldering much of the brunt of

the economic turmoil and handing bail outs to

Greece, but this not yet enough. Other causes of the Eurozone crisis include too much

debt from the member states, a lack of competition

between the countries, the differing mechanisms of

the various economies tied to one currency, anddisagreements coming from the lack of a single

authority and so many different member states each

with vested interests a 17 headed hydra.

Criticisms have been leveled at the very idea of asingle currency which some skeptics see as unstable

and unfeasible.


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What went wrong in Greece?

Greece's economic reforms, which led to it

abandoning the drachma as its currency in

favour of the euro in 2002, made it easier for

the country to borrow money.

Greece went on a big, debt-funded spending

spree, including paying for high-profile

projects such as the 2004 Athens Olympics,which went well over its budget.


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Opening Ceremony


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The country was hit by the downturn, which meant it

had to spend more on benefits and received less in

taxes. There were also doubts about the accuracy ofits economic statistics. Greece's economic problems

meant lenders started charging higher interest rates

to lend it money.Widespread tax evasion also hit the

government's coffers. There have beendemonstrations against the government's austerity

measures to deal with its debt, such as cuts to public

sector pay and pensions, reduced benefits and

increased taxes.


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Greece's economic problems meant lenders started charging

higher interest rates to lend it money.Widespread tax

evasion also hit the government's coffers. There have been

demonstrations against the government's austeritymeasures to deal with its debt, such as cuts to public sector

pay and pensions, reduced benefits and increased taxes.

The EU, IMF and European Central Bank agreed 229bn

euros ($300bn; 190bn) of rescue loans for Greece. Prime

Minister George Papandreou quit in November 2011 after

trying to call a referendum. If Greece were to default, and

even leave the euro, it would cause a major financial crisis

that could spread to much bigger economies such as Italy

and Spain. Under Prime Minister Lucas Papademos, Greece

is trying to negotiate a big write-off of private debts and

secure a second bail-out of 130bn euros ($170bn, 80bn)

before a 20 March deadline.


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The Eurozone Financial Crisis

Transmission from the United States

Housing Price Bubble and Collapse

Financial Market Freeze and Collapse

Policy Response

Support for Financial Sector

Monetary Policy

Fiscal Policy Effect of the Euro Currency Zone

Greeces Problems


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Transmission from United States

US Housing Bubble created by

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

US Bubble popped when

Interest rates rose in 2006, housing prices fell

Subprime mortgages and securities defaulted


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http://mjperry.blogspot.com/2009/04/house-price-indexes-usa-vs-europe.html


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European Crisis Began Later

US Housing Prices peaked in late 2006

European Housing Prices peaked a year later

Financial Crisis struck Europe & US at same time,

August 2007, after Bear, Stearns, Fannie Mae &Freddie Mac taken over with US Governmentassistance in April and July of 2007

International credit markets froze up in August 2007

when subprime based hedge funds collapsed inEurope and US. No longer able to borrow short-termfunds, banks faced much higher risk premia


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Interest Rate Spreads in Dollars and Euros


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Why did the Crisis Spread?

Subprime Debt Obligations made in USA held around theworld caused global financial shock.

Housing bubbles burst in UK , Ireland, Spain as well as US.

Failure of Lehman Bros in September 2007 caused massive

panic over counterparty risk. AIG required $180 billionbailout to cover Credit Default Swaps, insurance againstbond defaults underwritten without reserves.

Stress on banks around the world led to shrinking creditavailability. Shadow off-balance-sheet banking sector

collapsed as short-term funding vanished. Falling demand spread from US to all countries; as US

imports dropped, other countries exports fell.


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Banks Under Duress: Writedowns and Capital Raised

(US$ billions)

Source: International Monetary Fund (2008)


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Quarterly Real GDP Growth Rates

Source: International Financial Statistics, IMF.


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European Financial Institutions under

Stress

BNP-Paribas forced to close funds in August 2007

UK bank Northern Rock taken over by government

German state banks IKB,WestLB, BayernLB and

SachsenLB bailed out by government

Irish banks given government deposit guarantees

Switzerland injects funds into UBS

Icelands banks unable to roll over short termborrowing, default on deposits of foreigners


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Credit in the Eurozone (% change)

Source: European Commission (2009).


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Monetary Policy Response by

European Central Bank (ECB)

ECB injected liquidity into European banks

unable to obtain short-term funds in market.

Federal Reserve used Euro-dollar swaps tomake dollars available to ECB to lend to banks.

ECB did not lower interest rates until October

2008 because of its focus on inflation.

Euro fell against the dollar due to safe haven

flight to US Treasury securities.


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Interest Rates in the Eurozone and the US

(interbank rates)

Sources: ECB, Federal Reserve Bank of New York


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Financial Sector Bailouts in US & Europe

TARP and Federal Reserve programs in US

National programs in European countries, due

to absence of Eurozone-wide regulator. Beggar-thy-neighbor effect, as first Ireland

gave deposit guarantees, then UK, then

Netherlands, to avoid bank deposit flight.


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Beggar thy neighbour?

The term was originally devised to characterize

policies of trying to cure domestic depression

and unemployment by shifting effective

demand away from imports onto domestically

produced goods, either through tariffs and

quotas on imports, or by support to your own

banks. The policy can be associated withmercantilism and the resultant barriers to

pan-national single markets.


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Public Support to the Financial Sector

(as of 18 February 2009, % of GDP)

Source: International Monetary Fund (2009).


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Fiscal Policy Responses to Recession

Automatic Stabilizers of falling taxes, rising

welfare and unemployment payments kick in

as incomes fall and unemployment rises.

Discretionary Fiscal Stimulus enacted in most

countries, depending on their fiscal positions.

European countries limited by Stability and

Growth Pact to 3% fiscal deficits, except in

time of exceptional economic distress.


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Changes in Budget Balances, October 2008

Source: IMF (2009)


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The Role of the Euro

Previous economic crises in Europe have led

to large devaluations of currencies.

W

ithin eurozone, single currency preventsdevaluation , provides automatic financial

support through capital markets.

Non-euro currencies depreciated sharply in

2008, British pound sterling, Swedish kronor,

Polish zloty, Hungarian forint.


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Exchange Rates vs the Dmark or euro

(Left Index: 1970q1 = 100 Right Index: 2007m1 = 100)

Source: International Financial Statistics, IMF, Monthly Bulletin, European Central Bank


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What is the problem?

The Germans say that some lazy, spendthrift bums

(collectively called PIIGS Portugal, Italy, Ireland,

Greece and Spain) have run up huge fiscal deficits

and debts and want to be rescued time and again bythe productive, prudent Northern Europeans like the

Germans. Voters in the Northern Europe are now

revolting against further rescue of the bums.

Such rescues will be made only if the bums accept trulydraconian measures to shape up and reduce their

deficits.


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Greek protests against Austerity

Measures


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Greeces 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 increasinglyexpensive and uncompetitive, causing loss of

market share and further reducing revenues.


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Relative price indicators based on export prices

80

85

90

95

100

105

110

115

120

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Germany

Greece

Spain

France

Source: European Commission (2010)


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Why is this so?

The Euros value pools the strength and the weaknesses

of individual members. So, the Euro is greatly

undervalued for an economy as productive as

Germanys, and this artificially boosts GermanExports.

But the euro is also greatly overvalued for the less

productive economies of the PIIGS and prevents

them from exporting more.Seen in this light, the PIIGS are providing huge support

for Germanys exports at their own expense.


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3) The PIIGS certainly need to improve their

productivity, savings and exports. But they find

exports difficult not simply because they are lazybums but because they are locked into a common

currency, the Euro.

4) So they cannot devalue to offset the fact that

German Productivity and Quality is higher than theirsand thus they need to lower their prices in order to

get export orders.

5) Some Germans want to impose such humiliating

conditions on the PIIGS that they will be converted

into vassal states.

6) All government spending in these countries will be

controlled by a special EU commissioner.


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The Greek Debt Crisis

Greek debt/GDP ratio reached 113% anddeficit/GDP ratio reached 12.7% in 2009.

Foreign bondholders became doubtful that Greece

could continue to roll over its increasing debt,forced interest rates higher.

EU faced choice between Greek default and bailoutwith tough conditions.

IMF and EU agreed to lend Greece up to $146billion over three years.

Greece to increase sales taxes, reduce public sectorsalaries, pensions, eliminate bonuses.


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Greeces Debt Dynamics

Source: Economist.com


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7) The fiscal discipline demanded of them as of now

has already plunged the PIIGS into a deep

recession with wage freezes and mass

unemployment.

8) Any more external control of the Greeces

spending and Taxation will be a recipe for thebreaking up of the Eurozone.

9) Germans want to have the Euro and the

Eurozone. They just dont want to pay the pricerequired for its survival.

10) Something will have to give.


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The End

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3 Eurozone Crisis