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Eurozone Crisis

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Presenters

1. Priyamvada Jha(2749)2. Ankita Deambi(27)3. Shiffali Garg(2704)4. Gurleen Kaur(2744)5. Ranu Aggarwal(2745)

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Outline

The European Union

Genesis of Euro

Genesis of Crisis

Remedies/Solutions

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The European Union

Comprises a set of common supranational institutions established by the member states, each of which gives up some of its sovereignty, to make decisions on matters of joint interest at a European level.

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Historical Roots

• Precursor to the European Union : established after World War II in the late 1940s in an effort to unite the countries of Europe

• A pooling of coal and steel production and the sources of all military power proposed as "the first concrete foundation of a European federation” by the French Foreign Minister Robert Schuman on 9 May 1950

• Founding members of EU: Belgium, France, Germany, Italy, Luxembourg, and the Netherlands (European

• Coal and Steel Community)• The six member states then signed the Treaty of Rome in 1957

forming the European Economic Community which created a common market between the countries allowing goods and services to move freely between them

Apr 1951

• Treaty of Paris

Mar 1957

• Treaty of Rome

Feb 1986

• Single European Act

Feb 1992

• Treaty of Maastricht

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Growth of the EU

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Purpose of the EU

Strengthen the democratic governing of participating nations

Improve the efficiency of the nations

Establish an economic and financial unification

Develop the "Community social dimension."

Date of joining the EU

Benefits for the

Members

• Members may use a common currency (Euro) that makes trade easier• EU works to improve trade, education, farming and industry among its

members• No tariffs among member countries-free trade zone• Citizens of one country can move freely to another country• Citizens can live and work in any other EU nation• Citizens can vote in local elections even if they aren’t the citizens of

that country

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Euro-The Common Currency

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1990

1979

1969

Timeline of Euro

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1 Jan 1999 1 Jan 2002

1992 Maastricht Treaty

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Second largest reserve currency

Second most traded currency

Replacing European currency unit (ECU)

International adoption of euro outside the EU

(used in a further five European countries)

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Price Stability

(low inflation)

Public finance discipline

(low government debt and deficit)

Interest rate convergence

%

Exchange rate stability

Convergence (or “Maastricht”) Criteria

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Euro-zone European UnionEconomic & Monetary Union

Economic & Political Union – Single Market

18 Member States of EU 28 Member States

Common Monetary Policy set by ECB for Low Inflation

Common Trade Policy & Free Movement of People, Goods & Services

EU vs. Euro-zone

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Increased competition

Lower prices

Wider choice of products and services

More jobs

More opportunities to live, work and study in other EU countries

Easier travel

Benefits of Single Market

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Price stability and security of purchasing power

Elimination of transaction costs

Price transparency across countries

Countries can no longer change their interest rate or their exchange rate.

Elimination of exchange rate risks

1990 1997 2004

1990 1997 2004

1€2€

Countries could not have an independent monetary policy!

Additional Benefits of Adopting Euro

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The Crisis

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Before Crisis

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Increasing Order of Destruction

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Monetary Policy, Multiple Fiscal Policies

Globalization of Finance

Financial Crisis of 2007-08

Real estate bubbles

Fiscal policy choices related to government revenues and expenses

Approaches used by states to bail out troubled banking industries and private bondholders

Under-reporting of budget deficit by countries like Greece

Greek debt exceeded $400 billion (over 120% of GDP)

France owned 10% of that debt

CAUSES

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Greece

Low interest rates and no

limit

High interest

rates

Upto a limit

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Big Daddy

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Tourism Defense

Social welfare Schemes

High public sector wage and pension

commitments

Greece

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IrelandHousing Bubble : state

guaranteeing the six main Irish-based banks who had financed a property bubble

Defaulted loans to property developers and homeowners

made in the midst of the property bubble, which burst

around 2007

The economy collapsed during 2008

Unemployment rose : 4% in 2006 to 14% by 2010

National budget : surplus in 2007 to a deficit of 32% GDP

in 2010 (the highest in the history of the eurozone,

despite austerity measures)

Ireland's credit rating falling rapidly

Guaranteed depositors and bondholders cashed in

during 2009–10

In return of bailout, Ireland agreed to decrease it’s

budget deficit to 3% of GDP

In April 2011, despite all the measures

taken, Moody's downgraded the banks' debt to junk

status.

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Portugal

Portugal was one of the first and most affected economies to succumb

Persistent and lasting recruitment policies!!

Uncountable redundant public servants

Considerable slippage in state-managed public works

Inflated top management and head officer bonuses and wages after Carnation Revolution

Risky credit, public debt creation

European structural and cohesion funds were mismanaged across almost four decades

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Spain

Housing bubble!!

Spain had a comparatively low debt level

Debt was largely avoided by the ballooning tax revenue from the housing bubble

The bank bailouts and the economic downturn increased the country's deficit and debt levels

Substantial downgrading of its credit rating

In June 2012, Spain became a prime concern for the Euro-zone when interest on Spain's 10-year bonds reached the 7% level and it faced difficulty in accessing bond

markets.

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Remedies

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Policy reactions

• EU emergency measures – A.1.1 European Financial Stability Facility (EFSF)– A.1.2 European Financial Stabilisation Mechanism (EFSM)– A.1.3 Brussels agreement and aftermath

• European Central Bank• European Stability Mechanism (ESM)• European Fiscal Compact

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EU Emergency Measures

Country Year Bailout PackageGreece 2nd bailout by EC, ECB, IMF)

February 2012 130-billion euros

Spain June 2012 100-billion eurosCyprus April 2013 12.5-billion euros

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European Financial Stability Facility (EFSF)

• An organization created by the European Union to provide assistance to member states with unstable economies.

• The fund raises money by issuing debt, and distributes the funds to eurozone countries

• November 2010 -• €17.7 billion Ireland

• May 2011 • One third of the €78 billion package Portugal

• Second bailout • €164 billion (130bn new package plus 34.4bn

remaining from Greek Loan Facility) Greece

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European Financial Stabilisation Mechanism (EFSM)

• On 5 January 2011, the European Union created the European Financial Stabilisation Mechanism (EFSM), an emergency funding programme reliant upon funds raised on the financial markets and guaranteed by the European Commission using the budget of the European Union as collateral.

• Authority to raise up to €60 billion• Like the EFSF, the EFSM was replaced by the permanent rescue funding

programme ESM (September 2012)

• 2010-2013• 22.4 billion eurosIreland

• 2011-2014• 26 billion eurosPortugal

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European Central

Bank

Reducing Volatility

Improving Liquidity

In May 2010 it took the following actions:• It began open market operations buying

government and private debt securities• It simultaneously absorbed the same amount

of liquidity to prevent a rise in inflation• It changed its policy 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.

• It has cut its bank rates in multiple steps in 2012–2013, reaching an historic low of 0.25% in November 2013.

• Long Term Refinancing Operation (LTRO) - loaned €489 billion - 523 banks - three years – 1%.

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European Stability Mechanism (ESM)

• EFSF and EFSM were followed by permanent ESM in Sep 2012• Permanent firewall for the eurozone to safeguard and provide

instant access to financial assistance programs for member states

• Maximum lending capacity of €500 billion• All new bailouts for any eurozone member state will now be

covered by ESM

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European Fiscal Compact

Known as Fiscal Stability Treaty (1 January 2013)-

• Adopting an automatic procedure for imposing of penalties in case of breaches of either the 3% deficit or the 60% debt rules.

• New intergovernmental treaty to put strict caps on government spending and borrowing, with penalties for those countries who violate the limits.

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Economic reforms and recovery proposals

Direct loans to banks and banking regulation

Less austerity, more investment

Increase competitiveness

Address current account imbalances

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Increase competitiveness

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Address current account imbalances • The 2009 trade deficits for Italy, Spain, Greece, and Portugal were

estimated to be $42.96 billion, $75.31bn and $35.97bn, and $25.6bn respectively, while Germany's trade surplus was $188.6bn.

• devaluation, individual interest rates and capital controls are not available• Solution –

• reduce budget deficits• change consumption and savings habits• improve their exporting industries• Export driven countries with a large trade surplus, such as Germany, Austria and the

Netherlands would need to shift their economies more towards domestic services and increase wages to support domestic consumption.

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Proposed Long-term Solutions

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1. European Fiscal UnionIncreased European integration giving a central body increased control over the budgets of member states.2. European bank recovery and resolution authority• Proposed framework sets out the necessary steps

and powers to ensure that bank failures across the EU are managed in a way which avoids financial instability

• The member states will get the power to impose losses, resulting from a bank failure, on the bondholders to minimize costs for taxpayers

3. EurobondsThe Stability bonds issued jointly by 17 Euro nations, matched by tight financial and budget coordination, would be an effective way to tackle crisis4. European Monetary Fund• EMF would provide governments with fixed

interest rate Eurobonds at a rate slightly below medium-term economic growth

• Non-tradable but could be held by investors with the EMF and liquidated at any time

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5. Drastic debt write-off financed by wealth tax• To aim for an overall debt level well below 180 percent for the private and government sector• To reach sustainable levels the Eurozone must reduce its overall debt level by €6.1 trillion• This could be financed by a one-time wealth tax of between 11 and 30% for most countries,

apart from the crisis countries (particularly Ireland) where a write-off would have to be substantially higher

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