The Eurozone Financial Crisis
Submitted by
Mohit mittal
Kapil bansal
The Eurozone Financial Crisis
• Transmission from the United States
• Housing Price Bubble and Collapse
• Financial Market...
Transmission from United States
• US Housing Bubble created by
– Low interest rates
– Lax regulation of sub-prime mortgage...
http://mjperry.blogspot.com/2009/04/house-price-indexes-usa-vs-europe.html
European Crisis Began Later
• US Housing Prices peaked in late 2006
• European Housing Prices peaked a year later
• Financ...
Interest Rate Spreads in Dollars and Euros
Why did the Crisis Spread?
• Subprime Debt Obligations made in USA held around the
world caused global financial shock.
• ...
Banks Under Duress: Writedowns and Capital Raised
(US$ billions)
Source: International Monetary Fund (2008)
Quarterly Real GDP Growth Rates
Source: International Financial Statistics, IMF.
European Financial Institutions under
Stress
• BNP-Paribas forced to close funds in August 2007
• UK bank Northern Rock ta...
Credit in the Eurozone (% change)
Source: European Commission (2009).
Monetary Policy Response by
European Central Bank (ECB)
• ECB injected liquidity into European banks
unable to obtain shor...
Interest Rates in the Eurozone and the US
(interbank rates)
Sources: ECB, Federal Reserve Bank of New York
Financial Sector Bailouts in US & Europe
• TARP and Federal Reserve programs in US
• National programs in European countri...
Public Support to the Financial Sector
(as of 18 February 2009, % of GDP)
Source: International Monetary Fund (2009).
Fiscal Policy Responses to Recession
• Automatic Stabilizers of falling taxes, rising
welfare and unemployment payments ki...
Changes in Budget Balances, October 2008
Source: IMF (2009)
The Role of the Euro
• Previous economic crises in Europe have led
to large devaluations of currencies.
• Within eurozone,...
Exchange Rates vs the Dmark or euro
(Left Index: 1970q1 = 100 Right Index: 2007m1 = 100)
Source: International Financial S...
Greece’s Financial Problems
• Since joining the euro, Greece has had higher
inflation than other Euro zone members.
• Gree...
Relative price indicators based on export prices
80
85
90
95
100
105
110
115
120
1999
2000
2001
2002
2003
2004
2005
2006
2...
The Greek Debt Crisis
• Greek debt/GDP ratio reached 113% and
deficit/GDP ratio reached 12.7% in 2009.
• Foreign bondholde...
Greece’s Debt Dynamics
Source: Economist.com
Greece rescue plan
•Greece has outlined plans to cut its budget
deficit, or the amount its public spending
exceeds taxatio...
Conclusions
• Cautious Eurozone response to Financial Crisis
– Interest rate policy reaction delayed: concentration on
inf...
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Euro Zone Crisis

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Transcript of " Euro Zone Crisis"

  1. 1. The Eurozone Financial Crisis Submitted by Mohit mittal Kapil bansal
  2. 2. 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 • Greece’s Problems
  3. 3. 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
  4. 4. http://mjperry.blogspot.com/2009/04/house-price-indexes-usa-vs-europe.html
  5. 5. 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 Government assistance in April and July of 2007 • International credit markets froze up in August 2007 when subprime based hedge funds collapsed in Europe and US. No longer able to borrow short-term funds, banks faced much higher risk premia
  6. 6. Interest Rate Spreads in Dollars and Euros
  7. 7. Why did the Crisis Spread? • Subprime Debt Obligations made in USA held around the world 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 $180 billion bailout to cover Credit Default Swaps, insurance against bond defaults underwritten without reserves. • Stress on banks around the world led to shrinking credit availability. “Shadow” off-balance-sheet banking sector collapsed as short-term funding vanished. • Falling demand spread from US to all countries; as US imports dropped, other countries’ exports fell.
  8. 8. Banks Under Duress: Writedowns and Capital Raised (US$ billions) Source: International Monetary Fund (2008)
  9. 9. Quarterly Real GDP Growth Rates Source: International Financial Statistics, IMF.
  10. 10. 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 • Iceland’s banks unable to roll over short term borrowing, default on deposits of foreigners
  11. 11. Credit in the Eurozone (% change) Source: European Commission (2009).
  12. 12. 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 to make 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.
  13. 13. Interest Rates in the Eurozone and the US (interbank rates) Sources: ECB, Federal Reserve Bank of New York
  14. 14. 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.
  15. 15. Public Support to the Financial Sector (as of 18 February 2009, % of GDP) Source: International Monetary Fund (2009).
  16. 16. 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.”
  17. 17. Changes in Budget Balances, October 2008 Source: IMF (2009)
  18. 18. The Role of the Euro • Previous economic crises in Europe have led to large devaluations of currencies. • Within eurozone, single currency prevents devaluation , provides automatic financial support through capital markets. • Non-euro currencies depreciated sharply in 2008, British pound sterling, Swedish kronor, Polish zloty, Hungarian forint.
  19. 19. 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
  20. 20. Greece’s Financial Problems • Since joining the euro, Greece has had higher inflation than other Euro zone 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.
  21. 21. 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)
  22. 22. The Greek Debt Crisis • Greek debt/GDP ratio reached 113% and deficit/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 bailout with tough conditions. • IMF and EU agreed to lend Greece up to $146 billion over three years. • Greece to increase sales taxes, reduce public sector salaries, pensions, eliminate bonuses.
  23. 23. Greece’s Debt Dynamics Source: Economist.com
  24. 24. Greece rescue plan •Greece has outlined plans to cut its budget deficit, or the amount its public spending exceeds taxation, to 8.7% of its GDP in 2010, and to less than 3% by 2012. •Just before the massive bail-out package was announced the Greek government pledged to make further spending cuts and tax increases totalling 30bn euros over three years - on top of austerity measures already taken.
  25. 25. Conclusions • Cautious Eurozone response to Financial Crisis – Interest rate policy reaction delayed: concentration on inflation target – Fiscal policy reaction muted: Stability & Growth Pact • Common currency members avoided large devaluations and foreign currency debt. • European governments have tried to act together, not always successfully. • Limited impact of falling exports due to extensive internal trade relationships. • Greece facing difficult adjustment problems, European banks avoiding losses on Greek bonds.
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