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Macroeconomics

Contents

European debt crisis.

Caused of the crisis.

Greece.

Ireland.

Portugal

Spain.

Impact on the financial system..

Learning from the crisis.

Conclusion.

References.

European Debt Crisis

The 2010 debt crisis of Europe which is considered as euro zone crisis that has been sustaining in the euro zone since the end of 2009. Five countries- Greece, Ireland Italy, Portugal and Spain had been struggling to pay the debts that have been built in recent decades (Kenny, 2019). This led to failure of countries to generate economic growth to a level which would have allowed them to pay their debts. The crisis far reached to affect the euro zone and the world as well. It was considered as the biggest financial crisis since the great depression of 1920s and that the crisis constituted a serious challenge to the European unity (Frieden & Walter, 2017). The aim of this report is to shed light on some important aspects related to this crisis in detail. In this report, the causes of crisis, comparison between different countries, impact on financial system, its end, policy response and learning will be discussed in detail.

Caused of The Crisis

The crisis caused due to the dual reasons of European financial institutions’ eagerness to lend and some European countries’ need to borrow to finance their local consumption needs. This crisis can be considered as a classic example of debt and balance of payment crisis. Current account deficits emerged with capital flowing out of surplus countries into the countries with current account deficits (Kenny, 2019). This balance of payment led a series of causes of economic downturn which are as follows-

  1. A sudden stop of foreign capital into countries that were dependant on other countries for their lending needs, financing their consumption and to make the economy enough to pay their debts (Kenny, 2019).
  2. Excess borrowing led to imbalanced economic expansion, which led to boom and then the bubble burst.
  3. Lending was halted, countries were not able to repay their debts, unable to compensate the collapses of crisis by increasing exports and led to insufficiency to borrow more. Lending was stopped, and the countries were unable to pay their debts, unable to compensate the collapse by exporting more and unable to borrow additional funds.
  4. The crisis was worsened by the inability of the deficit state to devalue their currency in order to increase exports and decrease imports as whole of euro zone had resorted to a single currency in 1999.
  5. Lenders and bondholders started to take their capital back from those infected countries as a result of the loss of trust in the growth potential of those countries.
  6. This development led to economic distress and political conflict of the responsibility of the euro crisis (Frieden & Walter, 2017).

The accumulation of debt in some of the euro zone countries was in part because of the economic differences among the members before the adopting of the euro. Partly the culprit was also the European central bank which adopted an interest rate enticing to lender of the northern euro zone to lend to the south zone and in interesting interest rate to borrow to the southern zone countries. It increased the uncontrolled flooding of investments without a firm and consolidated macroeconomic policy of the euro zone.

Hardest Hits Countries

The crisis had a significant economic mal effect with reference to economic conditions and labor market effects, with unemployment rate in Greece and Spain reaching a whopping 27%. These two countries were blamed for the crisis of the entire eurozone and 10 in 119 eurozone countries had major political changes in the governments (Frieden & Walter, 2017).

Greece

The Greek economy was doing well for whole of 20tth century with high growth rate and low public debt. By 2007, it was the highest growing economy in the eurozone with debt-to-GDP ratio not exceeding 104%, but the problem lied in the large structural deficit. The structural problem was the economy which relied heavily on the shipping and tourism industry which is very susceptible towards changes in the business cycle. Again, the government spent heavily on these industries to keep going, and the deficit increased. A high budget deficit with high debt to GDP ratio led to the start of the crisis from Greece, which had reached 127% by the end of 2009 (Knoema.com, n.d.).

Ireland

The Irish sovereign financial crisis was not due to the excessive government spending but government ensuring guarantees for the five major Irish banks for two years to their depositor’s and bondholders, consequently, these banks financed excessively to create a property bubble (Frieden & Walter, 2017). The banks lost around 100 B Euros which they financed since 2007. Unemployment rose from 4% in 2006 to14 % in 2008. Subsequently, Ireland credit rating fell drastically and creditors and bondholders started to withdraw their moneys furthering the crisis.GDP fell from 276 B in 2008 to 236 B in 2009 and 222 b in 2010 (Countryeconomy.com, n.d.).

Portugal

The GDP of Portugal increased 2.5% in 2007 to $ 240b, with a -3.1% decrease compared to previous year in 2009, and 238 B in 2010. Unemployment rate rose to 10.77% in 2010, today it is back to normal with 6.1% in 2019 (countryeconnomy.com, n.d.). Portugal already had the signs of economic crisis since 2000, and the government authorized fiscal austerity measures furthered the crisis. The debt to GGDP ratio was 100% in 20101 and 132% in 2014 and was only 72% in 2007 (countryeconnomy.com, n.d.).

Portugal had started to lower the public works expenditure and flooded top management and posts with employees and additional bonuses and wage increase, resulting in over expansion of employees number at the top level. Risky credit funds, public debt increased, European structural funds were mismanaged for a considerable period in Portugal before the economic crisis which resulted in the first and hardest hit country during the crisis (Kenny, 2019).

Spain

Spain’s debt to GDP ratio was 35% in 2007 which increased to 61% in 2010. The GDP was $1.4 Trillion in 2010, while it was 1.6 T in 2008 (Knoema.com, n.d.). The unemployment rate was 11.2% in 2008 while it soared to 20% in 2010 and it increased to 24% in 2013(Frieden & Walter, 2017), from there it started to go down. The debt ratio of Spain was lesser in comparison to big economies like Germany, France and USA. Till that time, debt in Spain was largely being avoided due to the tax revenue from housing bubble, which led to government spending without taking debt from outside. After bubble burst, Spain spent large amounts inn banks’ bailout, which increased the deficit off the country and credit rating went down substantially.

The debt to GDP ratio of Spain was even lesser to Germany, France or the USA. Debt in Spain was largely avoided by the increasing tax revenue from the housing bubble, which helped in government spending for decades without debt accumulation. When the bubble burst, Spain spent large amount of money in bailout of the banks. Then to build trust among the market, government started austerity measures.

Impact on The Financial System

Euro sovereign debt crisis had influenced international trade and global economy to a significant level and had the loss of trust of the world in the euro which had led to a chance for the Chinese to influence the rest of the world (left by or saturated by the US $) from its debt servicing. It had led to the Brexit which has heavy consequences both for the Britain and the rest of the eurozone. The crisis had affected the supply, consumer and investment and production efficiency factors around the world (Na, Minjun &Wen, n.d.).

The balancing and combined structuring of the euro economy before the introduction of the Euro was one of the major factors which were responsible for the euro zone crisis. The weak economic growth of the Euro zone has dragged the world into the downturn. Euro zone crisis to the rest of the world is the proof of the world’s interconnectivity and that the impact of one region has and can impact on all of the regions of the world. USA was hit badly of the financial crisis and a property bubble burst took place there and many banks got on the verge of bankruptcy.

The primary impact of this crisis in the financial systems that the world had adopted the BASEL 3 norms which prescribes better and sturdy financial backup in the form of CAR, CRR, RR, RRP, LAF, Bank rate and other norms which are for stability and liquidity of the financial system(Na et al., n.d.). It was expected that the European crisis will continue for several years, and that the fiscal austerity measures have accelerated the contracting demand, unemployment and had led the economic measures with little success. And the result and fallout can be seen in 2019 when Brexit finally took place. A normal economic balance is seen when credit flows around 500% of the available liquidity in a country. The balance should be maintained at that level only and BASEL 3 prescribes that. It is seen that since 2013, a slow yet positive recovery has been seen in the world including European Union (Na et al., n.d.).

Ending of The Crisis

The crisis was finally controlled by the collective efforts of eurozone, financial institutions, the G7, the G20 groups in a concerted effort. IMf and the eurozone members agreed for a 110 bn and then 155 bn bailout package for Greece, 78 bn for Portugal and 85 bn Euros to Ireland, and the Irish republic had set a benchmark by passing toughest budget ever (bbc.com, 2012).

Then the European finance ministers decided to set up a permanent bailout fund and called for European stability mechanism. The crisis was controlled by the financial guarantees of the European governments and financial institutions which led to some trust in the investors. It was the need of the hour to push more money into the economy, however the bailed out countries were ordered to follow strict austerity measures and that public spending was asked to discipline.

Policy Response to The Crisis

Emergency measure of the European union were led in which bailout packages for countries including Spain, Greece, Ireland, Portugal, Romania and others were carved out. 110 bn and then 155 bn bailout package for Greece, 78 bn for Portugal and 85 bn Euros to Ireland were formed (bbc.com, n.d.).

European Financial Stability Policy

The European Union agreed on creating a financial stability facility which will be an authoritative instrument which will aim at financial health of the eurozone by providing assistance to European nations in difficult situation (bbc.com, n.d.). It has the power to issue bond and debt instruments with the support of Germany in order to raise the funds to provide loans for the purpose of recapitalization, buying debt etc. Release of bonds is backed by the guarantees of the member states in proportion to their paid up capital in the ECB. The capacity of the lending facility was pegged at 440 bn Euros, with the IMF to obtain a financial safety of euro 750 bn (bbc.com, n.d.).

After the creation and announcement of the work of EFSF, stocks were increased worldwide indicating a regaining of trust. Euro also made its biggest gain since a considerable time, commodity prices also increased. The EFSF financed a total of 68 bn Euros inn 2010 itself. It has contributed to the bailout packages of the member nations more than IMF or the World Bank

European Financial Stabilization Mechanism

In 2011, The European union has formed a new institution named European financial stability mechanism, which is an emergency facility of funding from financially markets and bonds which was guaranteed by European commission, it was one of the six institutions off the European union, with budget of the European Union as collateral. It aimed bringing financial stability and maintaining it within the EU.

Brussels Agreement

In 2011, 17 euro zone member countries met in Brussels, Belgium and agreed to write off 50% sovereign debt held by Greece, a four time increase in the bailout package to 1 trillion Euros held under European financial stability facility, increased bank capitalization of 9% within EU and promise from Italy to reduce its sovereign debt. The set off measures was called exceptional in exceptional times (Dyson, 2014).

Measures from European central bank to reduce volatility in the market and improving liquidity, in the middle of 2010, the ECB took following measures-

  • It began open market operations collecting 220 bn Euros and at the same time prevents the inflation of the same amount and it remained same.
  • It reactivated the dollar swap lines.
  • Changed its policy regarding the collaterals and guarantees against the loans and changed its stance on the credit ratings being given by independent agencies.
  • ECB took measures to stimulate the euro zone. It lowered the interest rates for busi9ness loans, cutting bank rates even to 0.25% in 2013.
  • Restructuring of the European banking system also took place with ECB becoming a bank regulator and forming deposit insurance funds for national programs (Singh, 2013).

Learning from The Crisis

J M Keynes in his book “the general theory of employment, interest and money” had advocated general laissez faire of the market independent of the government interruptions and disturbances. But he advocated government taking the responsibility of the sustenance of the economy during the times of recession, dumps, downturn and loss of faith in the market. He advised that at the time when the consumption function doesn’t work well in the market, the government should spend moneys in the market in different forms, give away money to people and employ as much people as it can, reviving the paying capacity, which will increase demand in the market and production will start to regain and subsequently, employment rate will increase and the market will grab its cycle.

It has been seen that the great depression of 1930s, when most of the countries were resorting to austerity measures, it was USA who boosted its economy by spending through government spending and its economy revived to a level alike any other countries. Even today Countries like India and USA have announced government packages to boosts the economy. The 2010 eurozone austerity measures were also been criticized by many and government finally resorted to bailouts.

Conclusion on Macroeconomics

The European crisis of 2010 was a classic example of debt and current account deficit misbalance which led the world to rethink on the global financial restructuring adopting the BASEL 3 norms which led for better structuring of the financial systems with more emphasis on the liquidity adjustments and availability. It was considered as the worst financial crisis since the 1930 global recession and the sole reason for it being the unstructured expansion of the economy and misbalanced debt and investment policies. Economy expansion in a balanced manner is the key to balanced expansion of the economy in which inflation rate and GDP increases at the same rate.

References for Macroeconomics

Bbc.com (2012). Timeline: The unfolding euro zone crisis. Retrieved from https://www.bbc.com/news/business-13856580

Countryeconomy.com. (n.d.). Debt to gdp ratio. Retrieved from https://countryeconomy.com/gdp/ireland?year=2010

Dyson, K. (2014). States, Debt, and Power: 'Saints' and 'Sinners' in European History. Retrieved from https://books.google.co.in/books?hl=en&lr=&id=UwrVAwAAQBAJ&oi=fnd&pg=PP1&ots=ZaluhltBuj&sig=rwVtJ10i_anai_a3PxQZa-V0bMc&redir_esc=y#v=onepage&q&f=false

Frieden, J. & Walter, S. (2017). Understanding the political economy of the eurozone crisis. Annual Review Of Political Science 20. Retrieved from https://www.annualreviews.org/doi/10.1146/annurev-polisci-051215-023101

Kenny,T.(2019). What is the European debt crisis. The balance.com. Retrieved from https://www.thebalance.com/what-is-the-european-debt-crisis-416918

Knoema.com (n.d.). Spain Unemployment Rate. Atlas. Retrieved from https://knoema.com/atlas/Spain/Unemployment-rate

Loman, H & Wijjfelaars, M. (2015). The eurozone (debt) crisis – causes and crisis response. Retrieved from https://economics.rabobank.com/publications/2015/december/the-eurozone-debt-crisis--causes-and-crisis-response/

Na,L., Minjun, S. & Wen, H. (n.d.). Impacts of the Euro sovereign debt crisis on global trade and economic growth: A General Equilibrium Analysis based on gtap model. Retrieved from https://www.gtap.agecon.purdue.edu/resources/download/6306.pdf

Oecd-ilibrary.org. (n.d.) Data.. Retrieved from https://www.oecd-ilibrary.org/

Singh, L. (2013). European sovereign debt crisis. 

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