Eurozone Crisis

Today’s Agenda
Presentation
outlines
1. What is Euro Zone Crisis
2. Reasons behind the crisis
3. Short term remedies
4. Long term Proposals
5. Impact on other economies

What is Euro-zone ?
Countries having their official
currency as EURO.

A Brief History :Why EUROZONE
was formed?

 The eurozone officially called the euro area is a monetary union of 19
European Union (EU) member states that have adopted the euro (€) as
their common currency and sole legal tender.
 The eurozone consists
of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany,
Greece, Ireland,
Italy, Latvia, Lithuania, Luxembourg, Malta,
the Netherlands, Portugal, Slovakia, Slovenia, and Spain.
 Other EU states (except for Denmark and the United Kingdom) are
obliged to join once they meet the criteria to do so. No state has left, and
there are no provisions to do so or to be expelled. Andorra, Monaco, San
Marino, and Vatican City have formal agreements with the EU to use the
euro as their official currency and issue their own coins
 Other states, like Kosovo and Montenegro, have adopted the euro
unilaterally but these countries do not officially form part of the eurozone
and do not have representation in the ECB or the Eurogroup.

 Monetary policy of the zone is the responsibility of the European
Central Bank (ECB) which is governed by a president and a board of
the heads of national central banks. The principal task of the ECB is to
keep inflation under control.
 Though there is no common representation, governance or fiscal policy
for
the currency union, some co-operation does take place through the
Eurogroup,
which makes political decisions regarding the eurozone and the euro.
 The Eurogroup is composed of the finance ministers of eurozone
states, but in emergencies, national leaders also form the Eurogroup.
 To Execute this , the prospective members nations were to sign
“Maastricht treaty” which would lead to formation of a single currency
Euro and contained the convergence criteria for the nations.

MAASTRICHT TREATY
 The treaty was signed on February 1992 in Maastricht , Netherlands
which
lead to formation of Euro by the members of European Community.
THE MAASTRICHT CRITERIA:
1. Inflation Rates
2. Government Finance :
- Debt
- Deficit
3.Exchange Rate
4. Long term interest rates.

MONETARY POLICY VS.FISCAL POLICY
The countries which signed the Maastricht treaty had common
monetary policies, set by the EUROPEAN CENTRAL BANK.
Due to united monetary policy the amount countries like Greece
could borrow skyrocketed – at cheaper interest rates.
Each country in the Euro zone followed their
own fiscal policy.
INCREASE ACCESS TO LOAN for smaller countries - Deficit
spending increased.

 But one main obstacle was the different currencies , therefore the
member nations discontinued their own currency and gave rise to
the uniform currency “EURO” and lead to the formation of Eurozone
in 1999.
 They also discontinued their monetary policy giving rise to European
Central Bank but had separate fiscal policies.
 This was one of the main reasons for the crisis since they failed to
realise the
need for fiscal integration along with the monetary.

CRISI
S
Large pre-
existing
debt to
GDP
ratios.
Currency
Union
without
fiscal
Union
2008 –
Financial
Crisis-
Bubble
Burst.
Maastricht
Treaty-

THECRISIS
Euozone crisis , also known as European
debt crisis is the failure of Euro , the
currency that ties together 19 European
nations in an intimate but flawed manner.
PIIGS-(Portugal , Ireland , Italy , Greece ,
Spain) economies has teetered down on the
brink of financial collapse threating the bring
down the entire European Economy and the
rest of the world.

 The European debt crisis (often also referred to as the Eurozone crisis or
the European sovereign debt crisis) is an ongoing multi-year long debt
crisis taking place in a handful of Eurozone member states since the end of
2009. These states were unable to repay or refinance their government
debt or to bail-out over- indebted banks under their national supervision
without the assistance of third parties like the ECB, or the IMF.
 The European debt crisis erupted in the wake of the Great Recession around
late 2009, and was characterized by an environment of overly high
government structural deficits and accelerating debt levels. The states
getting adversely hit by the crisis, faced a strong rise of interest rate spreads
for government bonds, as a result of investor concerns about their future
debt sustainability, to the extent that four eurozone states needed to be
rescued by sovereign bailout programs, delivered jointly by the
International Monetary Fund and European Commission - with
additional support at the technical level by the European Central Bank.
Together these three international organisations representing the bailout
creditors, became nicknamed "the Troika".

The Political Side of the Story
1970s: High inflation and high unemployment
(stagflation)
Bundesbank gains great reputation for keeping
inflation under control
This despite the ‘dollar weapon’ used by the US
ERM becomes de facto a D-Mark zone, Germany
increases its influence and power in the 1980s
Weaker countries try to regain competiveness through
devaluations: last experience 1992 devaluations,
collapse of the ERM
France accepts German reunification only if Germany
agrees to form a monetary union
Germany sees some advantages: more protection
against ‘dollar weapon’ and elimination of competitive
devaluations

Different theoretical
approaches on EMU
The ‘Monetarist School’: let’s start with MU and then we will achieve
economic converge and OCA (French position)
The ‘Economic School: First we need economic convergence and
OCA and then we can create MU (German position)
Introduction of Convergence Criteria:
Inflation needs to be kept under control
Debt levels: 3% budget deficit, 60% gross government debt to GDP
Inclusion in the ERM
Convergence in the interest rates
German position: You cannot have MU without political union, and
political union is more than institutions

Orthodox understanding of the
nature of money
Money has three main functions:
Unit of Account
Medium of Exchange
Store of Value
Orthodox view: medium of exchange function is
preponderant… (Ex. cigarettes in a concentration camp)
Heterodox/nominalist view: the unit of account function is
crucial (you cannot have money without a political authority
behind it)
Bankers/investors favour the first, political economists point
to the latter (especially in times of crisis and uncertainty)
History: Constant struggle between bondholders
(creditors) and Governments (debtors)
Current EMU gives power to the bondholders and reduces
power of the states

The Creation of an Orphan
Currency
“The Euro, probably more than any other currency, represents the mutual
confidence at the heart of our community. It is the first currency that has
not only severed its link to gold, but also its link to the nation state”
Wim Duisenberg, President European Central Bank, 2002
 EMU was created with a fully independent central bank
 And on top of this the ECB was not given the lender-of-last resort function
(the no bail-out clause)
 The idea was to avoid political interference in the managing of the
currency
 This has created an appreciation bias in the euro

High indebtedness in the
Periphery

Great Imbalances in the Current
Account Balance

Public indebtedness has been constant

The problem has been mostly private
debt

Inflation Levels in the EZ 1999-
2007

The real exchange rate
differs

Loss of competiveness in the
periphery

But this is also the case in
the US…

The Real Causes of the Crisis
The Appreciation Bias of the Euro = loss of
competitiveness in the periphery
Huge imbalances between surplus countries
(Germany, Holland, Finland) and deficit countries
(Spain, Portugal, Italy)
Real Estate bubbles, especially in Spain and Ireland
Lack of macroeconomic coordination
Lack of supervision in the levels of private debt, and
asset bubbles
Lack of a centralised budget to overcome asymmetric
shocks
Lack of a pan-European debt market (Eurobonds)
Lack of a lender of last resort
Lack of jurisdiction on derivative markets and credit
rating agencies

Conclusion
Monetary Union is flawed without political union
behind it
There needs to be more macroeconomic
cooperation to avoid internal imbalances
Germany needs to stimulate internal demand
EZ periphery needs to be more productive and
competitive
The EZ needs to create a ministry of finance
The creation of eurobonds is also necessary
Apart from price stability there needs to be a
growth strategy, especially for the periphery
The EZ needs to tackle the appreciation bias of
the euro

Economic reforms and
recoveryproposals
Address current account imbalances :–
Case-1 Country with Trade Surplus-This currency appreciation occurs as
the importing country sells its currency to buy the exporting country's
currency used to purchase the goods. Alternatively, trade imbalances can be
reduced if a country encouraged domestic saving by restricting or penalizing
the flow of capital across borders, or by raising interest rates, although this
benefit is likely offset by slowing down the economy and increasing
government interest payments.
Case-2 Country with Trade Deficit - The only solution left to raise a
country's level of saving is to reduce budget deficits and to change
consumption and savings habits. For example, if a country's citizens saved
more instead of consuming imports, this would reduce its trade deficit.

Economic reforms andrecovery
proposals
Progress - European heads of state had given the green light to pilot projects worth
billions.
Provide guarantees that safeguard private investors and Historic decrease in Bank
Charges
 "Many of those countries most in need to adjust are now making the greatest
progress
towards restoring their fiscal balance and external competitiveness"
Increase competitiveness- Crisis countries must significantly increase their
international competitiveness to generate economic growth and improve their
terms of trade. Indian- American journalist notes in November 2011 that no debt
restructuring will work without growth.
 Facing problem on 3 fronts-Demography, Technology and Globalization
Internal devaluation - Where a country aims to reduce its unit labor costs
Fiscal devaluation - Shifting Corporate burdens on Consmers
Austerity Measures:

Long-term Proposals to deal
with the EurozoneCrises
 European fiscal union: creation of a fiscal union to match its
monetary union, fiscal union must have authority to set fiscal
policy in every euro country.
 Eurobonds: bonds issued jointly by the 17 euro nations would
be an effective way to tackle the financial crisis. Also, any
such plan would have to be matched by tight fiscal
surveillance and economic policy coordination to ensure
sustainable public finances
 European bank recovery and resolution authority: to avoid
banking failure. Powers over bank management. Each
institution would also be obliged to set aside at least one per
cent of the deposits covered by their national guarantees for a
special fund to finance the resolution of banking crisis
 Gexit

Long-term Proposals todeal
 European Monetary Fund: creation of European Monetary
Fund, which could provide governments with fixed interest rate
(non- tradable) Eurobonds at a slightly lower rate compared to
other financial institutions.
 Debt write-off based on international agreement: In 1953,
private sector lenders as well as governments agreed to write off
about half of West Germany’s outstanding debt, eventually leading
to the beginning of Germany's “economic miracle”. West Germany
only had to make repayments when it was running a trade surplus.
 Drastic debt write-off financed by wealth tax: most economies
would need 20 consecutive years of surpluses exceeding 2 per
cent of gross domestic product just to bring the debt-to-GDP ratio
back to its pre-crisis level.
To reach sustainable levels the Eurozone must reduce its
overall debt level, financed by a one-time wealth tax of
between 11 and 30% for most countries, apart from the
crisis countries.

Long-term Proposals to deal

Impact onSouth Asia
The euro area has traditionally been an important economic partner
for South Asia. Between 2011 and 2012, share of SAARC’s export
to euro area has contracted significantly.
Another way in which euro area crisis has impacted the South
Asian economies is through the finance channel. European banks
have been an important source of credit to South Asia.

Impact onIndian Economy
India was reeling under the American Subprime Crisis in 2008.
Then it was hit by Eurozone Crisis in 2009.
Falls in exports
Fall in FDI from Europe.
Deficit in balance of payments
Decline in capital inflows thus affecting stock market
speculations.
Fall in the economic growth rate

Impact inNumbers
India’s economy is currently facing inflationary pressures, trade deficits and public
debt. These internal weaknesses, together with an adverse international
environment, have prompted the IMF to revise India’s growth prospects
downwards in 2013 to around 4.9% and 6% respectively.
The EU countries have a share of 18.6 percent in India’s exports and it is the
second largest destination for our exports. The Euro area’s instability has
been negatively
reflected in India’s exports. India’s total exports has declined from 20.2 percent in
2009-10
to 18.6 percent in 201011.
The impact is negatively felt in textile and apparel exports as both Europe and US
are major importers. Europe accounts for nearly 50 per cent of India's total apparel
exports and hence it is no surprise that its debt crisis has adversely hit apparel
exports from India.
The Euro crisis has also affected India’s stock market. Due to crisis in USA in
2008-09 foreign institutional investors (FIIs) had pulled out money from India for
most part of the year because the many of these investors were facing difficulties
in their home markets. The reduced savings and lack of confidence among
investors has resulted in lower investment flows.

Steps taken byIndia
Oil and gold are the two major items of our imports. With regard to oil, the
domestic pricing has increasingly been made market determined. It is expected
that this will help economizing the domestic oil consumption. Recently import duty
on gold has been raised and bank finance against pledge of gold has been
restricted.
India has also introduced inflation indexed bonds which should help contain
gold demand to the extent these bonds are used as an investment hedge
against inflation.
The policy measures taken to encourage capital inflows include liberalisation
of the interest rates on non-resident deposits and external commercial
borrowings,
Rationalisation of norms related to foreign institutional investment (FII) in
infrastructure
debt and allowing foreign direct investment (FDI) in multi-brand retail.
The sectoral limit for FII investment in government securities and corporate
bonds has been hiked.

Eurozone Crisis

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