The European Crisis

By

Miss Suttapa

Chawiengwas

ID 51010913007 ( IB51 )

The Euro in Crisis

In 1958, an organization called European Coal and Steel Community was formed and evolves into the European Union (EU), it was established by the Maastricht Treaty in 1993. The EU introduced the Euro on January 1, 1999 and on this day 11 EU start to use euro as their currency, then the 27 member countries of the EU member state today, 15 have adopted the euro. It benefited countries including Greece, Ireland, Italy, Portugal, and Spain that we know as the GIIPS. The European Union (EU) is the largest economic body in the world, one of the most striking benefits of a single European currency is low interest rate due to a high degree of price stability. The euro is as stable and credible as the best-performing currencies previously used in the euro area countries. (Ann, 2010) The emergence of the euro currency has more impact on the economies of EU member states, particularly in small countries. Since, they joining the European Union, the economic status of these small countries have been more acceptable from each other. The transition to use the euro currency, which is stronger, making a small country have the power to buy more products (The stronger currency makes goods imported low cost) and debt it would be easier with a lower cost. Since, the euro currency has been secured by the credibility of the European Union. The consumption and investment of most small countries are bigger than themselves. Through the welfare state than is necessary. Investment in large projects that generate returns not worth it, and have more spends at a loan or credit card. (Adolfo, Ralph, Raphael & Heiko, 2011) Pervasive state intervention in Greece has mired the economy with large-scale inefficiencies and an uneven playing field, protecting insiders and rent-seekers to the detriment of its underlying growth potential, with the political class at the same time failing miserably to address the aspirations of the people. (Michael, 2010) As a result, many countries in Europe began with the fiscal deficit. In the first phase, the fiscal deficit is not a big problem because it is easy to raise a loan. Since, both public and private partners of the European Union, but after U.S. economic crisis in 2008 the euro currency weakened steadily and raise some questions in the minds of investors with that bonds, fixed income and currencies in the euro currency will remain a reliable asset for another or not.( F. Gerard 2009) The Making of a Crisis This is justified given the analysis of Paradigm lost (2010) and analysis information from another person that provide the main reason that making of a crisis as follow; y Confidence in the prospects for growth and stability of the economies of Greece, Ireland, Italy, Portugal, and Spain (GIIPS) surged when the euro was introduced, because their interest rates to decline to those of Europes more stable members. (Sheetal K, 2009)

y Improved confidence and lower interest rates drove up domestic demand in the GIIPS and investors and consumers were embolden to increase spending and run up debts, often owed abroad as foreign capital flowed in. y Growth accelerate and the prices of domestic activities (i.e., those least exposed to international competition, such as housing) rose relative to the price of exportable or importable products, attracting investment into the less productive non-tradable sectors and away from exports and industries competing with imports. y Meanwhile, exports rose sharply as a share of GDP in Germany, the Netherlands, and other historically stable countries in the European core. Growing demand in the GIIPS enabled these core countries to increase exports. The adoption of a common currency, whose value was based on broader European competitiveness trends that made it lower than the deutschmark or guilder might have been, made their exported goods more affordable. (Prakash & Jair, 2008) y The domestic demand boom in the GIIPS induced rapid wage growth that outpaced productivity, increasing unit labor costs and eroding external competitiveness further. This trend was reinforced by especially rigid labor markets in most of the GIIPS. The emergence of China, as well as currency depreciation and rapid labor productivity growth in the export sectors of the United States and Japan, added to the competitiveness problems of the GIIPS. (Michael, 2010) y The single European monetary policy was too loose for the rapidly growing GIIPS (Spain, Greece, and Ireland) and too tight for Germany, whose domestic demand and wages grew very slowly compared to the European average. This reinforced the loss of competitiveness in the GIIPS. y Lower costs of borrowing and the expansion of domestic demand boosted tax revenues in the GIIPS. Instead of recognizing this as temporary revenue and saving the windfall gains for when growth slowed, GIIPS governments significantly increased spending. Blatant fiscal mismanagement added to the problems in Greece. (Lars & Giancarlo, 2011) y The financial crisis in 2008 brought an abrupt end to the post-euro growth model in the GIIPS. As they plunged into recession and tax revenues collapsed, government spending was revealed to be unsustainable and their loss of competitiveness dimmed hopes of turning to foreign demand for recovery. The GIIPS are left with high public and private debts and weak long-term growth prospects, unless they make difficult adjustments to cut deficits and restore competitiveness. (Jim, 2011) Clas, Thomas D. & Nan (2010) state that the crisis in Greece and other mainly Southern euro zone countries has been discussed primarily as a fiscal issue. Current account deficits of the same countries have received less attention in spite of the relatedness of current account and fiscal deficits. European Debt Surveillance Authority should include surveillance of intra-euro payment flows, imbalances and adjustment in labor and goods markets, and setting benchmarks for the euro zone guarantees of sovereign debt based on ability to adjust internally. Thereby, a potential moral hazard problem of an implicit euro zone guarantee of countries sovereign debt could be avoided.

Take example the case of Greece Mitsopoulos and Pelagidis (2010) state that during the last year the documented weaknesses of the Greek economy have been shown up in the spotlight of the attention of international markets. This is justified given the analysis of Haugh, Ollivaud and Turner (2009), who investigate the factors that affect sovereign debt risk premiums. The unfavorable focus on Greek debt happened in spite of the achievements of the past decades, which had attracted the buying interest of international markets from the EMU accession of the country until the emergence of the current crisis. This followed as the strong growth of previous years, which had highlighted the successes rather than the failings of the country, seemed to peter out at the same time as the creditworthiness of the Greek government came under scrutiny and doubt. (William & Richhild, 2010) Furthermore, this happened at a time after global solvency risks had been transferred from the private sector to the public sector as a result of the rescues of the global banking sector crisis. As a result sovereign risk was being reassessed by markets along with private sector risk. The challenging situation of public debt and Greek government finances is in sharp contrast with the situation of the Greek banking system at the beginning of the global banking crisis compared with the situation in the other major European countries. Uri (2010) states that to be sure, the euro is no longer a foreign currency to Greece, but it would become so if Greece chooses to leave the Euro area to regain its competitiveness, which may one day proved to be Greeces best viable option for dealing with the crisis. The Deeper Causes of the Euro Crisis while balloon public debt may be the clearest manifestation of the Euro crisis, its roots go much deeper to the secular loss of competitiveness that has been associated with euro adoption in countries including Greece, Ireland, Italy, Portugal, and Spain (GIIPS). As follow the sequence of events that led to the secular loss of competitiveness is depressingly similar among the GIIPS; The adoption of the euro was accompanied by a large fall in interest rates and a surge in confidence as institutions and incomes expected to converge to those of Europes northern core economies. y Domestic demand surged, bidding up the price of non-tradable relative to tradable and of wages relative to productivity. y Growth accelerated, driven by domestic services, construction, and an expanding government, while exports stagnated as a share of GDP, and imports and the current account deficit soared amid abundant foreign capital. (Peter, Andreas and Sebastian, 2011) y The result was that indebtedness public, private, or both surges. Those entire is the basic story fits the Euro area periphery, but the details vary within each country. For the countries who enjoy in the biggest boom, the single monetary policy of the euro was too loose and accentuated their inflation and competitiveness loss, while it was

too tight for larger economies like Germany, depressing domestic demand there and widening its unit labor cost advantage vis--vis the GIIPS. (Michael, 2010) From the reason of Uri in above he wants to show some of the case happened in other countries before, and give some example which what happen in case of Greece. Greeces Debt Crisis has put the EU under the scope, and it has shifted the attention to the efficiency and the success of the Euro-zone. Its considered as probably the biggest test the EU has gone through. How the EU and Greece are handling the crisis with the whole bail-out plan will reflect to what extent the EU is able to function on its own as a powerful economic entity. And its too early yet to measure the effectiveness of the bail-out plan. y Seriously consider restructuring the debt, allow time for creditors to prepare to facilitate progress on an agreed solution. y Prepare for a severe contraction in employment and income likely larger than forecasts predict regardless of how the crisis is resolved. Summary of policy recommendations of Greece, Ireland, Italy, Portugal, and Spain y Implement fiscal consolidation to stabilize the debt to GDP ratio within 3 years. y Structural reforms designed to rebalance the economy toward the tradable sectors and increase competitiveness are essential. To facilitate this, reduce unit labor costs by at least 6 percent over three years-either immediately with a 6 percent across-the-board wage cut, or more gradually-and institute structural reforms to raise productivity. Begin with public sector wages. y To explain the severity of the situation to citizens in order to build the public will necessary for these adjustments. Distribute the adjustments in a transparent and fair way to ensure that specific groups do not feel unjustly hit, and that the most vulnerable are protected.

Reference Ann. S 2010, The Collapse of Global Trade What a tangled web we weave, http://www.world-economics-journal.com, December 4, 2011. Adolfo. B, Ralph. C, Raphael. E & Heiko. H 2011, Further Fallout from the Global Financial Crisis Credit crunch in the 'periphery',Volume 12, Number 2, 2011, pages 153 176, http://www.world-economicsjournal.com/Contents/ArticleOverview.aspx?ID=475, December 2, 2011. Michael. M 2010, Greece and the State, Prometheus Bound?, Volume 11, Number 2, 2010, pages 45 - 66, http://www.world-economicsjournal.com/Contents/ArticleOverview.aspx?ID=415, December 3, 2011 F. Gerard. A 2009, The World Financial Crisis New economy, globalisation and oldfashioned philosophy,Volume 10, Number 1, 2009, pages 45 58 http://www.world-economics-journal.com/Contents/ArticleOverview.aspx?ID=366, December 2, 2011. Sheetal K. C 2009, The IMF, the Credit Crunch and Iceland A new fiscal saga? Volume 10, Number 3, 2009, pages 19 42 http://www.world-economicsjournal.com/Contents/ArticleOverview.aspx?ID=384, December 1, 2011. PARADIGM LOST 2010, The Making of A Crisis,THE EURO IN CRISIS, http://carnegieendowment.org/2010/06/02/making-of-crisis/3ol, December 1, 2011 Prakash. L & Jair. R 2008,Economic Forecasts Too smooth by far?,Vol. 9, No. 2, AprilJune 2008, http://www.imf.org/external/np/vc/2008/060108.htm, December 1, 2011. Michael. C 2010, The Economic Crisis and the Commonwealth, A review with analysis and solutions, Volume 11, Number 2, 2010, pages 101 113, http://www.worldeconomics-journal.com/Contents/ArticleOverview.aspx?ID=417, December 1, 2011. Lars. C & Giancarlo. C 2011, How to Reform Europes Fiscal Policy Framework, http://www.world-economics-journal.com/, December 1, 2011. Jim. T 2011,The Black Economy - Benefit frauds or tax evaders? ,Volume 1, Number 1, 2000, pages 167 175, http://www.world-economicsjournal.com/Contents/ArticleOverview.aspx?ID=10, December 4, 2011.

Clas.W, Thomas. D & Nan. Z 2010, The Euro Crisis It isnt just fiscal and it doesnt just involve Greece, It isnt just fiscal, Volume 11, Number 4, 2010, pages 51 - 79, pages 177 192, http://www.world-economicsjournal.com/Contents/ArticleOverview.aspx?ID=444, December 1, 2011. William. A & Richhild. M 2010, The International Liquidity Crisis of 20082009, Volume 12, Number 2, 2011, pages 183 198, http://www.world-economicsjournal.com/Contents/ArticleOverview.aspx?ID=477, December 1, 2011. Mitsopoulos. M & Pelagidis. C 2011, Understanding the Greek Crisis Michael, Unlocking the puzzle of Greek banks deteriorating performance, Volume 12, Number 1, 2011, pages 177 192, http://www.world-economicsjournal.com/Contents/ArticleOverview.aspx?ID=461, December 1, 2011. URI. D, SERGEY. A, SHIMELSE. A, VERA. E, MOISS. N, BENNETT. S, AND PAOLA. S 2011, PARADIGM LOST THE EURO IN CRISIS, www.CarnegieEndowment.org/EuroCrisis., December 1, 2011. Peter. D, Andreas. F and Sebastian. V 2011, Global Financial Crisis Protectionism and Current Account Deficit, Volume 12, Number 2, 2011, pages 129 152, http://www.world-economics-journal.com/Contents/ArticleOverview.aspx?ID=474 , December 2, 2011. Michael, M 2010 Greece and the State Prometheus Bound?, Volume 11, Number 2, 2010, pages 45 66 http://www.world-economicsjournal.com/Contents/ArticleOverview.aspx?ID=415, December 1, 2011.