5. Rising household and government debt levels • A number of economists have dismissed the popular belief that the debt crisis was caused by excessive social welfare spending. • According to their analysis, increased debt levels were mostly due to the large bailout packages provided to the financial sector during the late-2000s financial crisis.6. • The average fiscal deficit in the euro area in 2007 was only 0.6% before it grew to 7% during the financial crisis. • The International Monetary Fund (IMF) reported in April 2012 that in advanced economies,the ratio of household debt to income rose by an average of 39 percentage points, to 138 percent in Denmark, Iceland, Ireland, the Netherlands.7. • In the same period, the average government debt rose from 66% to 84% of GDP. • By the end of 2011, real house prices had fallen from their peak by about 41% in Ireland, 29% in Iceland, 23% in Spain and the United States, and 21% in Denmark.8. TRADE IMBALANCES • A trade deficit can also be affected by changes in relative labor costs, which made southern nations less competitive and increased trade imbalances. • Since 2001, Italy's unit labor costs rose 32% relative to Germany's. • Greek unit labor costs rose much faster than Germany's during the last decade.9. STRUCTURAL PROBLEM OF EUROZONE SYSTEM • There is a structural contradiction within the euro system, namely that there is a monetary union without a fiscal union (e.g., common taxation, pension, and treasury functions). • In the Eurozone system, the countries are required to follow a similar fiscal path, but they do not have common treasury to enforce it.10. • That is, countries with the same monetary system have freedom in fiscal policies in taxation and expenditure. • Eurozone, having 17 nations as its members, require unanimous agreement for a decision making process.11. • This would lead to failure in complete prevention of contagion of other areas, as it would be hard for the Euro zone to respond quickly to the problem. • That is, countries with the same monetary system have freedom in fiscal policies in taxation and expenditure12. MONETARY POLICY INFLEXIBILITY • Eurozone establishes a single monetary policy, individual member states can no longer act independently, preventing them from printing money in order to pay creditors and ease their risk of default. • By "printing money", a country's currency is devalued relative to its (eurozone) trading partners, making its exports cheaper,increased GDP and higher tax revenues in nominal terms.13. LOSS OF CONFIDENCE • The loss of confidence is marked by rising sovereign CDS (credit-default swaps) prices, indicating market expectations about countries creditworthiness. • Since countries that use the euro as their currency have fewer monetary policy choices certain solutions require multi-national cooperation.
European Sovereign Debt Crisis
Praxis Business School 1
In 1992, members of the European Union signed the Maastricht Treaty.
To join the currency, member states had to qualify by meeting the stringent economic
requirements, known as “convergence criteria”.
Price Developments: Inflation can only be 1.5% more than the average of the
three best-performing member states.
Fiscal Developments: Budget deficits that cannot exceed 3% of GDP and total
sovereign debt amounts or public debt cannot exceed 60% of GDP.
Exchange-Rate Developments: A prospective member cannot have devalued its
currency relative to any other member state’s currency for the preceding two
Eurozone is an economic and monetary union of 17 European Union member states
that have adopted the euro as their common currency.
Praxis Business School 2
When does debt become a big problem?
Praxis Business School 3
It is a combined sovereign debt crisis, a banking crisis, a growth and
The Eurozone debt crisis is an economic crisis due to the:-
Collapse of financial institutions
High government debt
Rapidly rising bond yield spreads in government securities
The European sovereign debt crisis started in 2008, with the collapse of
Iceland’s banking system
Three countries significantly affected Greece, Ireland and Portugal during
2009 and collectively accounted for 6% of the Eurozone’s GDP.
This led to a crisis of confidence for European businesses and economies
Praxis Business School 4
Praxis Business School 5
The Irish sovereign debt crisis was not based on government over-
spending, but from property bubble burst in 2007 which cause the economy
Irish banks had lost an estimated 100 billion euros, much of it related to
defaulted loans to:-
Unemployment rose from 4% in 2006 to 14% by 2010
National budget went from a surplus in 2007 to a deficit of 32% GDP in 2010
By April 2011, despite receiving a 67.5 billion euros bailout, the bank debt
downgraded to the junk status.
Praxis Business School 6
Before the Eurozone crisis, Spain had low debt level compare to other
Debt to GDP in 2010 was only 60%
Spain spent large sums of money on bank bailouts after the property
bubble unacceptably burst.
In 2011 the government announced austerity measures
Praxis Business School 7
In the early mid-2000s, Greece's economy was one of the fastest growing in
When Greece revealed that its budget deficit was 12.7% of gross domestic
product (GDP), more than twice what the country had previously disclosed.
In Greece, high public sector wage and pension commitments were connected
to the debt increase
Greece receives rescue packages of 110 billion euros in 2010 and than further
130 billion euros in 2012
Ratings agencies Fitch and Standard & Poor’s downgrade Greece’s credit
rating to junk status
Greece implements austerity measures to reduce budget deficit
Praxis Business School 8
Portugal came into trouble because of decades-long governmental
Portugal requested a 78 billion euros IMF-EU bailout package in a bid to
stabilize it’s public finances.
On 16th May 2011, the Eurozone leaders officially approved a 78 billion
euros bailout package for Portugal
The average interest rate on the bailout loan is expected to be 5.1%.
Portugal became the 3rd Eurozone country, after Ireland and Greece to
receive emergency funds.
Praxis Business School 9
Emergency loans have been extended as bailouts mainly by stronger
economies like France and Germany, as also by the IMF.
The EU member states have also created the European Financial
Stability Facility (EFSF) to provide emergency loans.
Austerity measures have been enforced
Brussels has given to authority to serve as finance minister for the
They will be overseeing National Budget and imposing harsh economics
reforms to struggling countries
Praxis Business School 12