The cause of the Euro-Zone crisis
Due to the financial crisis of the US in 2008-2009 the global economy has experienced slow growth. This caused the exposure of unsustainable fiscal policies in Europe and around the world. Greece felt the effects of slow growth substantially more than other countries in the euro zone because of their high spending rate throughout the years. Greece also failed to undertake fiscal reforms. Tax revenues decreased due to the slow growth and so the high budget deficits became unsustainable and the deficit increased. Greece’s debts were so significantly high that they actually exceed the size of the nation’s entire economy, and the country could no longer hide the problem. Investors demanded higher earnings on bonds they took out from Greece and so the cost of the country’s debt burden increased and needed bailouts by the European Union and European Central Bank. The markets began driving up bond yields in the other heavily indebted countries in the region, which fuelled problems similar to what happened in Greece. The primary course of action thus far has been a series of bailouts for Europe’s troubled economies.
What was the policy response?
The EU’s policy response so far
• Financial backstop to sovereigns (bilateral loans to Greece, EFSF, EFSM, ESM) – there was a limited lending capacity.
• Unlimited liquidity support to banks , this was very effective.
• Purchase of government bonds at the secondary market, only to help monetary transmission.
• Strengthened governance.
• New institutions for financial stability (eg ESRB, EBA) , but they must have limited power.
• Stress testing of European banks – discredited almost immediately.
The consequences of the EU crisis:
“The malaise afflicting Europe’s single currency is damaging the EU’s global standing and its ability to act and it’s a crisis that will be with us for years to come” Charls Grant(2010)
The Europe financial crisis will be with us for a lot of years. The underlying causes, which includes: Southern Europe’s lack of competitiveness, will not be sorted out overnight. Greece, Italy, Portugal and Spain face years of low growth, severe curbs on public spending and perhaps social unrest.
Implications for the break-up of the EU:
The EIU believes there is a 35% chance of a break-up of the euro zone, in which the most likely scenario would be the exit from the monetary union of the smaller economies and both Italy and Spain. The economic, social and political implications are very widespread.
The impact really depends on the size of the break-up. Ideas like a core group remaining in the euro zone or even establishing a stronger euro has been floating around for a while. More power for the European Union in fiscal policies of member states is a way to make the euro zone work.
A break-up would allow individual countries to restore control over monetary policy. A cheaper currency would help match wages with workers’ productivity. The break-up will cause runs, banks, limit withdrawals and capital flight. Banks and firms across the continent would struggle because their domestic and foreign assets and liabilities would no longer match.