The Eurozone Crisis

The Eurozone Crisis

Sagana J
11/18/2013
ECON 3860
Word Count: 1,495

The Eurozone Crisis The Eurozone is a combined group of countries using the euro as their only currency. It was created in 1999 and currently consists of 17 countries – not all part of the European Union (Investor Words). Within the Eurozone, the countries follow a monetary policy and controlled by the European Central Bank (in other words, the ECB controlled the supply of the euro within the 17 countries). In an attempt to control government debt levels and deficit spending the Maastricht Treaty was created. As years passed, some countries government deficit began to rise and increased debt levels. By 2010, Greece (3% of the Eurozone) had public debt around 100% of their GDP. In order to lower their debt levels, the Greek government had increased their taxes and their borrowing levels. Solutions for fixing this issue consisted of stronger countries paying off the Greek debt – however not everyone agreed to such methods. Eventually, the value of the euro went down in the exchange markets and other Eurozone countries such as: Portugal, Italy, Ireland and Spain faced the same problem as Greece. The International Monetary Fund (IMF) and the European Financial Stability Facility (EFSF) donated money to help reduce the amount of debt – however not enough (Krugman, Obstfeld, Melitz, 2011). Since the Eurozone is controlled by monetary rules and does not consist of fiscal union (government collection of tax’s), it has made it harder for countries to recuperate from the crisis. It has been said that this Eurozone crisis is like a currency crisis as they try to preserve the euro from depreciating and losing value. Although, this is an ongoing crisis, there are certain steps the Eurozone can take in order to release the countries from their ongoing debt levels and hopefully reverse the effects on the euro.

Germany’s idea of fixing the Eurozone crisis is to implement more austerity measure. Austerity is a government method to reduce spending while decreasing government budget deficit. Germany’s idea was to maintain taxes and a low unemployment rate (Westervelt, 2010). Although, this method was successful in Germany, it may not be the smartest route for the rest of the Eurozone since they also face a high private debt it can actually lead Portugal, Italy, Ireland, Greece and Spain (PIIGS) into a recession. It would be wise for them to create a system that will reverse the already designed austerity measures. It is important for them to start focusing more on the economic growth instead of only the budget cuts. Studies have shown that austerity will actually cause Europe to fall into a low-income period with unemployment at a 12.2% high by 2014 (Wishart, 2013). Like mentioned before, there is a high amount of private debt and borrowing from private lenders to repay will not help. The result of such high private debt is more credit on the consumers. As the households borrow more, it trims the consumption part of GDP and firms avoid investing as their bad debt increases the banks are reluctant to lend and eventually the economic growth will go up. One method that may help is to cut back the debt date and by then the interest rates may lower or they can write down the sovereign countries (The Economist, 2013). The austerity measure has failed to bring public finances and debt into control with their increase in taxes that may not work. It is not possible to ship the debt by shrinking the budget deficit. Since the risky Eurozone countries currently have a weak economic activity followed by high unemployment the government cannot go through smoothly with the austerity measures in the first place. It may just result in more debt which the ECB and the IMF will hold (Soros, 2013). The southern part of the Eurozone (PIGS) may not be able to recover from the effects of austerity if placed unlike the northern and much larger countries (Germany) (Stetter). Decreasing the government deficit could be done by increasing imports and or decreasing exports. However, the main idea of the euro was to create a common currency with a fixed exchange rate between the Eurozone countries – the process of paying the quotas or subsidising exports will not work in this case since it defeats the purpose of the euro. Increasing the balance of payment or records of exchange between countries could possibly do the same effects of the imports and exports. It is instead involving the Eurozone and foreign countries and exchange rates. With a cheaper exchange it will increase exports (foreign buyers). The study conducted by the Foundation for European Progressive Studies on Europe’s austerity measures quotes “So Europe does not have a sovereign debt crisis. Europe is facing a balance of payments crisis, more specifically a current account crisis in the peripheral economics as well the central countries which are doing well” (Stetter). He is implying that the Eurozone is facing a balance of payment crisis because of the single currency and exchange rates just by creating a cheaper exchange it will defeat the purpose of the Eurozone and again will not work. In order to stop the sovereign debt crisis, cutting down on expenses according to austerity may not work in the long run. It may be better to introduce more fiscal policy rather than the sole monetary ruling and increase income and eventually raise the economic growth and standard of living (Stetter). As austerity may work with Germany who is larger economically, but it will just bring the southern Eurozone into a recession. The Eurozone crisis has many names; it can be viewed as a political issue between the governments or the financial and economic crisis further causing a sovereign debt crisis, banking crisis and competition. Maastricht flawed in a sense that it is only a currency union and not political, these countries are being dragged together into debt. As they believed the private sector would fix it self, they made the mistake of purchasing government bonds (thinking it was risk free) further increasing deficit and working against the Maastricht Treaty. As countries began to default, the banks increased the premium and the bonds that were purchased are now invaluable, all the countries are in debt with no control and are at risk thus creating the financial crisis (Soros, 2013). As they do not have enough money to repay the debt, it is an issue with the circulation of the euro, making it also a nominal problem (The Economist, 2013). Why doesn’t the Eurozone print out more money? By choosing to print more, the value of their currency could go down. As the money supply increases, spending will also increase with more demand for goods. Retailers and producers will have to increase the price of goods to balance the quantity demanded, eventually causing a high inflation and degrades the value of the euro in the long run. Since circulating more money would not fix the Eurozone crisis, there is a drop in unemployment and productivity since there is no money to pay for wages. As the nominal GDP begins to decrease, it is the responsibility of the ECB to restore it – since the Eurozone is controlled by monetary rules. The monetary policy can actually solve the nominal issue by providing more cash to repay the debt (The Economist, 2013). As an attempt, ECB introduced outright monetary transactions (OMT) in 2012. This a program which the ECB buys short term government bonds in an attempt to lower interest rate. However, there are certain conditions included with the OMT such as the fact that the ECB will eventually have a say in decisions regarding government spending, spending cuts, taxes etc – unfortunately making it a political issue (Grauwe, 2013). Although the idea of the Eurozone is to maintain a single currency, with the current currency crisis, it has been suggested to split the euro into two – with northern and southern jurisdictions, with Germany as a lead of the northern half and PIGS as the weaker southern half. If the euro split, it will no longer be a fixed rate exchange system, but instead a floating rate system where Germany can even the exchange market without being the one who lends out money to the countries who face recession and high debt (Daily Mail, 2011). In order to prevent the separation of the euro, the Eurozone should focus less on austerity measures but more on growth while maintaining a healthy inflation rate and implying more fiscal policy. Overall, the movement of preserving the euro should not rely only on Germany but should be a combined measure from the central bank and other Eurozone countries in order to avoid the same consequences of the suffered countries.

References:
1. What is the eurozone?. (n.d.). Retrieved from http://www.investorwords.com/5555/Eurozone.html
2. Krugman, P., Obstfeld, M., & Melitz, M. (2011). International economics: theory and policy. (9 ed., pp. 559-580). Pearson.
3. Westervelt, E. (2010, June 8). Germany introduces austerity measures. National public radio. Retrieved from http://www.npr.org/templates/story/story.php?storyId=127552896
4. Wishart, I. (2013, November 5). Eu lowers euro-area growth outlook as debt crisis lingers. Bloomberg. Retrieved from http://www.bloomberg.com/news/2013-11-05/eu-lowers-euro-area-growth-outlook-as-debt-crisis-lingers.html
5. Debtor 's prison. (2013, October 26). The Economist. Retrieved from http://www.economist.com/news/finance-and-economics/21588382-euro-zone-blighted-private-debt-even-more-government-debt-debtors
6. Soros, G. (2013, April 9). How to save the eu from the euro crisis?. The Guardian. Retrieved from http://www.theguardian.com/business/2013/apr/09/george-soros-save-eu-from-euro-crisis-speech
7. Stetter, E. (n.d.). Austerity is not the solution. Foundation for European Progressive Studies, Retrieved from http://www.feps-europe.eu/assets/9549a450-68b1-479f-9ab9-9bba1bdff0c0/austerity-is-not-the-solution.pdf
8. Grauwe, P. (2013). Design failures in the eurozone: can they be fixed?. London School of Economics, (57), Retrieved from http://www.lse.ac.uk/europeanInstitute/LEQS/LEQSPaper57.pdf
9. The eurozone has a choice: Split up or die read more. (2011, July 18). Daily Mail. Retrieved from http://www.dailymail.co.uk/debate/article-2015428/The-eurozone-choice-Split-die.html

References: 1. What is the eurozone?. (n.d.). Retrieved from http://www.investorwords.com/5555/Eurozone.html 2. Krugman, P., Obstfeld, M., & Melitz, M. (2011). International economics: theory and policy. (9 ed., pp. 559-580). Pearson. 3. Westervelt, E. (2010, June 8). Germany introduces austerity measures. National public radio. Retrieved from http://www.npr.org/templates/story/story.php?storyId=127552896 4. Wishart, I. (2013, November 5). Eu lowers euro-area growth outlook as debt crisis lingers. Bloomberg. Retrieved from http://www.bloomberg.com/news/2013-11-05/eu-lowers-euro-area-growth-outlook-as-debt-crisis-lingers.html 5. Debtor 's prison. (2013, October 26). The Economist. Retrieved from http://www.economist.com/news/finance-and-economics/21588382-euro-zone-blighted-private-debt-even-more-government-debt-debtors 6. Soros, G. (2013, April 9). How to save the eu from the euro crisis?. The Guardian. Retrieved from http://www.theguardian.com/business/2013/apr/09/george-soros-save-eu-from-euro-crisis-speech 7. Stetter, E. (n.d.). Austerity is not the solution. Foundation for European Progressive Studies, Retrieved from http://www.feps-europe.eu/assets/9549a450-68b1-479f-9ab9-9bba1bdff0c0/austerity-is-not-the-solution.pdf 8. Grauwe, P. (2013). Design failures in the eurozone: can they be fixed?. London School of Economics, (57), Retrieved from http://www.lse.ac.uk/europeanInstitute/LEQS/LEQSPaper57.pdf 9. The eurozone has a choice: Split up or die read more. (2011, July 18). Daily Mail. Retrieved from http://www.dailymail.co.uk/debate/article-2015428/The-eurozone-choice-Split-die.html