An Analysis of the eurozone fi nancial crisis

EURO TO HERO

• Formation of the eurozone • Causes of the financial crisis• Response of the ECB and governments• Recommendations for the future

SUMMARY

1970s: Creation of the European Monetary System within the European Community France/ German dynamic

Early 1989: Delors Plan instigated by France Vague deadlines

FORMATION OF EUROZONE

December 1989: Importance of uniting Germany to Europe Germany’s opposition and France’s concern Chancellor Kohl and President Mitterand agree

on details of Delors Plan at Strasbourg Summit– known at the Maastricht Treaty

TURMOIL BRINGS UNION

Germany drags feet Slow process– “low levels of inflation, interest rates,

and budget defects”1990-1991: Maastricht Treaty fi nalized amid

now-or-never mentality Ironically, neither Kohl nor Mitterand were

profi cient in economics.

DEVIL IN THE DETAILS

EMU Regulations Created Requirements regarding budget deficits, debt-to-GDP ratios,

inflation, and interest rates 1997: Stability and Growth Pact enacted to continue these

No sovereign bailouts (oh really?)

EMU REGULATIONS

1999: Currency implemented Initial implementation: 11 of 15 EU countries

members2001: Greece joins2002: Currency begins circulating

Greece and Italy do not achieve suffi cient debt-to-GDP level.

AND SO IT BEGINS

EMU Structure Common currency between countries European Central Bank charged with monetary policy Economic autonomy with caveat of Stability and

Growth Pact

HOW IT WORKS

2008: Housing Bubble collapses (that’s another story)

Impact on Euro is dismal 2009: Greece’s debt equals 113% of its GDP 2010: Ireland receives bailout of 85 billion euros

GLOBAL RECESSION STRIKES

The PIIGS wrecked havoc… PIIGS=Portugal, Ireland, Italy, Greece, and Spain Borrowing in their own currencies

Interest rates compounded problems Rates converged at Germany’s (lower than other countries) Sovereign debt increases 2008: Greece and Italy’s public debt as percent of GDP was

112.9 and 106.1

WHAT HAPPENED?

Germany saw an opportunity With low interest rates, the private sector was incentivized

to increase spending. 2007: Ireland’s private sector debt 184.3% of GDP By 2010: Germany was the second largest creditor to Irish

banks

WHAT HAPPENED (CONT.)

2010: ECB requires austerity measures after discovery that Greece lied about debt levels Austerity measures increase taxes and cut

expenditures Decreased revenue

April 2010: Bonds’ yields so high that Standard and Poor downgraded them to junk status

Greece’s banks had about 25% of GDP in bonds2010: International Monetary Fund and eurozone

announce first bailout for Greece

GREECE

“It is those countries that were borrowing (as opposed to those whose governments were borrowing) that are currently under attack” (Shambaugh).

Italy and Greece (sovereign debt); Ireland and Spain were not guilty of this

Investments “that had little eff ect on future productivity growth” (ie housing bubble) major problem. Revenue slowed, no liquidity (can’t print money, no profit)

MULTI-FACETED PROBLEM

Austerity Measures--> stunted economic growthBailouts to Greece, Portugal, and Ireland

Three-year loans if they implemented austerity measures and structural reforms

Banks invested in ECB bonds (not bad, just not fixing anything)

ECB bought bonds from countries (especially Italy and Spain) Aimed at reducing bond yield Temporary Fix

Current actions: Stress tests to determine assets ECB take over

ECB’S RESPONSE

Option 1: Dissolve eurozone Not optimal Peripheral countries would lose 40-50% of GDP in first year

aloneOption 2: Remove Greece

Run on banks (drachmas)

WHAT SHOULD BE DONE?

Eurozone is politically beneficial, economically disastrous

Causes of the crisis are multi-faceted and debatedSolution is not clear

SUMMARY