3. Outline
The European Union
Genesis of Euro
Genesis of Crisis
Remedies/Solutions
3
4. 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.
4
5. 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
5
7. 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 7
12. 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)
12
13. Convergence (or “Maastricht”) Criteria
Price Stability
(low inflation)
Public finance
discipline
(low government
debt and deficit)
Interest rate
convergence
%
Exchange
rate stability
13
14. EU vs. Euro-zone
Euro-zone European Union
Economic & 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
14
15. Benefits of Single Market
Increased competition
Lower prices
Wider choice of
products and services
More jobs
Easier travel
More opportunities to live,
work and study in other EU countries
15
16. Additional Benefits of Adopting Euro
Price stability and
security of
purchasing power
Elimination of
transaction
costs
1€
Price transparency
across countries
Elimination of
exchange rate
risks
1990 1997 2004
2€
Countries can no longer change their interest rate or their
exchange rate.
Countries could not have an independent monetary
policy!
16
20. 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
20
27. Ireland
Housing 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.
27
29. 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
29
31. 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.
31
34. 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
34
35. EU Emergency Measures
Country Year Bailout Package
Greece 2nd bailout by
EC, ECB, IMF)
February 2012 130-billion euros
Spain June 2012 100-billion euros
Cyprus April 2013 12.5-billion euros
35
36. 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
36
37. 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 euros Ireland
• 2011-2014
• 26 billion euros Portugal
37
38. 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%.
38
39. 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
39
40. 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.
40
41. Economic reforms and recovery proposals
Direct loans to banks and banking regulation
Less austerity, more investment
Increase competitiveness
Address current account imbalances
41
43. 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.
43
45. 1. European Fiscal Union
Increased 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. Eurobonds
The Stability bonds issued jointly by 17 Euro
nations, matched by tight financial and budget
coordination, would be an effective way to tackle
crisis
4. 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
45
46. 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
46
