Global Crisis Led to Euro Zone Crisis - Essay Example

?The Euro Crisis Table of Contents Table of Contents 2 Introduction 3 Background 4 Economic and Monetary Union (EMU) 5 Global Crisis led to Euro ZoneCrisis 5 Deeper Causes of the Euro Crisis 6 Types of Crisis 6 Euro Crisis as a Global Problem 11 Minimising Euro Crisis 14 Conclusion 16 References 19 Introduction In the euro zone, consisting of Greece, Portugal, Ireland, Italy and Spain, there had been a continuing economic crisis due to problematic sovereign debt and increase in borrowing cost. The euro crisis has affected as well as threatened the economy of the euro zone and may also adversely affect the future growth of the Euro, the currency of the European countries. In the year 1999, Euro was considered as a single national currency for all the European countries. This common national currency Euro is utilised by over 300 million people in the world’s most developed economic region, which is considered as a record in the international monetary system. The common currency Euro was established by the European nations with the objectives of acquiring better integration among member nations as well as to enhance the currency value in the global economy (Feenstra & Taylor, 2012). In the year 1999, Economic and Monetary Union (EMU) was also established with the motive of utilising the single national currency i.e. Euro for all the trade activities performed by the European nations. In the starting of 2002, there were 12 countries in Europe Union (EU) which include Germany, Austria, Belgium, Ireland, Finland, Italy, France, Greece, Netherlands, Spain, Luxembourg and Portugal that utilised Euro as their national currency. Later on many countries also joined EU and adopted Euro as a national currency. However, three EU member countries namely Sweden, United Kingdom and Denmark do not used Euro as their national currency. By the year 2010, there were 27 countries as members of EU. In Euro zone, the main objective of EMU was to establish a common monetary currency for EU members and to coordinate the monetary affairs of the member nations through European Central Bank (ECB). The euro zone has faced financial crisis due to sluggish economic growth as well as high rate of underemployment. Moreover, economic recession of 2008 has also raised many economic problems in the European nations (Arestis & Sawyer, 2012). Considering this aspect, the review will emphasize on the factors accountable for crisis in the European nations. The objective of the review is to recognise the reasons for Euro crisis. Moreover, review will also focus on remedies necessary for minimising the effects of Euro crisis in the European nations and other countries. The review includes other aspects related to the Euro crisis along with economic problems faced by the European nations. Background The Euro system of the European countries consists of ECB and 11 central banks of different nations. The Euro system has four major jobs with respect to economic growth and sustainability. The first job is to execute the monetary strategies implemented by Central Council of ECB. The second job is to undertake foreign exchange functions and the third job is to maintain money reserves of euro area nations. The Euro system is responsible for coordinating as well as managing monetary policy of EU. Euro was considered as a single common currency by EU members with the objective of acquiring a stabilised price for a long period of time. Moreover, with common currency it was expected that it would help to expand the market and also would assist in better integration of capital, goods and service. Furthermore, it was anticipated that with the introduction of common currency, Euro would be an important currency relating to foreign exchange markets (European Central Bank, 2009). Economic and Monetary Union (EMU) EMU was set up with the motive of stabilising the monetary operations as well as for prosperous economic development of the European nations. The vision of EMU is to develop an integrated framework for the financial sectors which enables the banking system to perform in a steady manner. An integrated financial system can empower the banking system to perform effectively in the euro zone countries. Moreover, an integrated budgetary framework had also been formulated by EMU with the intention of devising efficient fiscal policy, both at national as well as in European levels. This integrated budgetary framework can facilitate in better coordination and decision making. Furthermore, an integrated framework for economic policy was formulated for encouraging enhanced growth and competitiveness in EU member nations (Rompuy, 2012). These are the strategists of EMU which are devised for ensuring better performance in the euro zone countries in terms of economic, social as well as on political prospects. Global Crisis led to Euro Zone Crisis In the year 2008, there was a financial crisis on global prospect which led to increased debt in all the European countries. This increased amount of debt had declined the economic growth rate rapidly in euro zone area. Moreover, there has been a significant increase in the interest rates from 2006 within euro zone. This significant increase in the interest rates as well as excessive money lending by banks during this period had resulted in high amount of bad debts in various banks and financial institutions. Besides, the government of the European nations also faced huge fiscal deficit as well as public deficit during that time period. These are the vital factors which are responsible for Euro crisis (Anand & et.al., 2012). Deeper Causes of the Euro Crisis Public debt is considered to be an important factor for the on-going crisis in the euro zone. The root of this crisis started from reduced competitiveness of Euro after it was adopted by countries comprising Greece, Ireland, Italy, Portugal and Spain which is also termed as GIIPS. On that time, Germany was acquiring the topmost position as an exporter. The adoption of common currency helped Germany to utilise the benefits of market expansion by the northern Europe countries. Moreover, this market expansion by Germany had led to reduced competition among GIIPS which hampered their economic growth. The low growth of economy in GIIPS raised domestic battles among these countries for better utilisation of limited resources available. The domestic battles further raised up crisis over other European nations (Dadush, 2010). Types of Crisis There are three types of crisis faced in the European countries in relation to Euro crisis which are as follows: The Banking Crisis in the Euro Areas According to Shambaugh (2012), the banking system in the euro area consists of ECB and state banks of member countries. The operations of state banks in Euro areas are large and extended in global context. The huge size of the banking operations implies that the firms in European countries are quite dependent on financial institutions for funding requirements in order to conduct business operations effectively. Whereas, American firms do not depend much on financial institutions as most of their financial requirements are accumulated from capital markets, the increased dependency of firms in European countries brings out the weakness of banking system in Europe. Banks provide financial support to investors as well as firms from funds which are acquired through liabilities such as savings and deposits by creditors. The major problems which are faced by banks in Euro zone are liquidity and solvency. In case of liquidity, solvent banks are unable to acquire necessary funds from creditors. In contrast solvency, it refers to the condition where banks are unable to pay off creditors for not possessing enough value assets. Therefore, at the times of Euro crisis, banks of Euro areas were not able to provide required financial support to retain the economic downfall, as European firms mostly depend on banks for gaining financial support to perform business activities. ECB was also unable to stabilise prices in the market of European countries (Shambaugh, 2012). According to Richter and Wahl (2011), the banking system of EU comprises ECB and central banks of EU member countries. The banking activities of euro zone is spread out internationally and the business activities of EU member countries are greatly dependant on those banks. The financial crisis in the year 2008 has resulted in hampering the economic conditions of EU member countries. The decline in the economic conditions of EU member countries had led to reduction of lending rates by their banking system for acquiring additional funds in order to improve the economic conditions of European nations. However, the banking system of EU was unable to repay debts which were accumulated from different countries. As a result, government bonds have been sold for acquiring funds to perform financial activities. Moreover, the banking system of EU was also unable to provide enough support for minimising the adverse impact of the 2008 economic recession. The economic recession had led to sovereign debt crisis, and the banking system of the European countries was unable to escape from the outcome of this financial as well as sovereign debt crisis (Richter & Wahl, 2011). From the review of Richter and Wahl, it has been observed that ECB and other state banks of EU member countries was unable to stabilise the economic conditions after financial crisis struck worldwide. The unstable economic conditions led to EU bank crisis and it was further transformed into sovereign debt crisis. These crises hampered the economic as well as business activities of the European nations. Furthermore, these crises adversely affected the value of Euro currency which led to Euro crisis. The Sovereign Debt Crisis According to Shambaugh (2012), in the Euro area, the sovereign debt crisis has passed through a number of phases where high return from government bonds has been observed. Investors investing in bonds are required to perform an analysis of the interest rates between the two countries on two perspectives. Firstly, the strength of currency is analysed and the country possessing the powerful currency enjoy more value of assets or bonds over time. Moreover, investors are always willing to acquire these bonds at minimum interest rates. Secondly, in countries with increased chances of government default, investors are required to be provided funds with elevated rate of interest. After Euro has been introduced, interest rates among EU members demonstrated wider gaps and these gaps were reduced by adopting Euro as a common currency for stabilising interest rates of bonds. In the year 2001, Greece accepted Euro as a common currency and its interest rate was slightly different from other EU members, but was stabilised in later days. During the first year of Euro crisis, the interest rates gap between EU nations were minimum and later on in the year 2010 the interest rate gap grew from Greece with other members of GIIPS. Later the gap was spread out to other EU members. All these negative economic factors are responsible for raising sovereign debt crisis in European countries (Shambaugh, 2012). According to Menendaz (2012), countries sell bonds with the motive of performing financial operations of the government. During the maturity of bonds, bondholders are required to be paid with the bond’s face value along with the interest amount. In this context, it can be stated that countries with low economic growth rate such as Greece can face problems in raising funds required for making payments to bondholders as taxable incomes of the government declines. Furthermore, investors charge higher interest rates on bonds at times of financial crisis for minimising risk relating to failure of a country on making its debt payments. Countries in the euro zone were not out of options for undervaluing their currency as they share a common currency. Greece is a member of EU and adopted Euro as a common currency from 2002 and was able to acquire funds at minimum rates of interest for stabilised political as well as financial conditions on that time. The recession in the year 2008 had adversely affected the economy of Greece in a drastic manner. With this economic recession, Greece was unable to stabilise its economic conditions even by souring funds from other nations. In the year 2009, among all the members of the euro zone countries, Greece accumulated highest debt and was considered to increase the amount of debt with time. Greece was also extended the sovereign debt crisis among other European nations. Ultimately, the sovereign debt crisis prevailed in all the euro zone member countries resulted in Euro crisis (Menendaz, 2012). From analysing the viewpoints of different authors, it has been observed that government bonds play an important role in effectively conducting financial operations in a country. Both the authors have acknowledged that sovereign debt crisis started from Greece and it spread out in rest of the euro zone member countries. Moreover, sovereign debt crisis is one of the important factors of Euro crisis which had hampered the economic conditions of the euro zone. The Euro Area Growth Crisis According to Shambaugh (2012), in the year 2008, European countries as well as other emerging countries have faced economic recession and it has been observed that euro zone recovered at a fast pace from the recession in comparison to United States of America (USA) and Japan. However, recovery in the euro zone was not equally distributed among EU members and currency union members. However, the recession has negatively impacted the growth rate of Germany along with other GIIPS nations (Shambaugh, 2012). According to Brunetti (2012), the Euro crisis originated after GIIPS countries adopted Euro as a common currency, and with the adoption of Euro, the rates of interest of these GIIPS countries were reduced to German level. Moreover, it also resulted in loss of competitiveness of GIIPS countries in contrast to Germany. The recent economic recession had resulted in lowering the lending rates by ECB and other banks of EU member countries. However, the banks were unable to recover from this financial risk of lowering the lending rate. This aspect further led to sovereign debt crisis as banks were not able to provide enough funds to repay government debts. All these factors led to Euro crisis and hampered the economy as well as growth of the euro zone members (Brunetti, 2012). Thus, it can be observed that in accordance with the viewpoints of Shambaugh and Brunetti, recent economic crisis had negatively affected the banking system of the European nations as banks were unable to recover from the negative financial conditions. Moreover, this problem further initiated sovereign debt crisis due to the failure of European country’s government for repaying debts on bonds sold. These series of disasters are the main factors that are responsible for adverse economic condition as well as for sluggish economic growth of the euro zone member nations. These are the three main crises faced by the European nations and which has adversely affected the growth as well as economic conditions of euro zone. Euro Crisis as a Global Problem Euro crisis is a global problem as the economic conditions of Euro zone countries had affected the worldwide economy. The Euro crisis can adversely affect the international economy through varied ways which are as follows: The financial Sector The transmission of this Euro crisis has affected those European banks in US as excessive government debts are being accumulated for bonds sold (Furth & Ligon, 2012). Demand Europe is one of the major markets of export from US and with the origin of Euro crisis there has been an adverse effect on the margin of export for poor economic growth and demand. Moreover, with increased uncertainty in Europe, the value of US dollar can be raised which might hamper worldwide US exports (Furth & Ligon, 2012). Supply As a consequence of Euro crisis, the supplies of European products might face disorder condition which can disrupt the global supply chain process. Moreover, this disruption in the supply chain can also affect the economic growth of US in the short-run (Furth & Ligon, 2012). Political The Euro crisis also creates a political threat as performing elections in Europe may hamper cooperation on varied fronts relating to trade policy and other business related aspects (Furth & Ligon, 2012). Furthermore, the fiscal as well as financial problems in the Euro zone may affect in the recovery of the global economy. The Euro crisis is considered to increase the market prices of commodities in the emerging markets. Moreover, the Euro crisis can also extend from the euro zone countries to other countries of the world (Guraziu & Zepo, 2012). The ways through which Euro crisis can nagateively impact on other countries of the world are as follows: Firstly, the Euro crisis may lead to decline in the economic growth ratio of the European countries. This declined economic growth may influence other countries worldwide as almost one fourth of the world exports are performed to Europe (Dadush, 2010). Secondly, the Euro crisis will further depreciate the value of Euro which will result in reduction of profits acquired from export activities conducted to Europe by other countries. Besides, low profitability may lead to intense competitions from different nations with the European continent (Dadush, 2010). Thirdly, capital investment may be encouraged to emerging markets due to Euro crisis by devising minimum rate policy in Europe as well as in other industrialised countries (Dadush, 2010). Fourthly, the Euro crisis can also exaggerate instability in the financial markets and may result in avoidance of risk by investors in the international financial market (Dadush, 2010). Thus, it can be stated that if the Euro crisis is not controlled in an effective manner, the problem of sovereign debt may arise in industrialised countries as well as in other emerging market (Dadush, 2010). These are the major problems which might affect the global economy for Euro crisis. The trade activities are mostly been affected in developed markets as well as in emerging markets for inefficient supply network and high prices. Moreover, for all these problems, Euro crisis is considered to be a major problem for global economy. Minimising Euro Crisis The Stability and Growth Pact (SGP) SGP is a policy which requires EU members to avoid a huge amount of deficits. It is a framework, based on the rules for coordinating fiscal policies at national levels in EMU. Moreover, SGP is formulated with the motive of conducting the operations of EMU in an appropriate manner. This policy consists of two aspects which are described below: (European Commission, 2012). The Preventive Arm In the preventive arm of SGP, the EU member countries are required to provide ‘annual stability or convergence programmes’, demonstrating the way they intend to accomplish safeguard for maintaining sound fiscal positions. Under preventive arm method, the European Commission analyses those programmes and the Council provides opinion on the basis of information acquired from those analysed programmes. The preventive arm has two fiscal policy instruments which include early warning and policy advice. In early warning, the Council provides an alert in the incidence of extreme deficit from the information gathered by the European Commission on the basis of analysis of convergence programmes. On the other hand, in policy advice, the European Commission provides recommendations about policies to the EU member countries for better financial performance (European Commission, 2012). The Dissuasive Arm Unlike preventive arm, the dissuasive arm is concerned with governing as well as maintaining the Excessive Deficit Procedures (EDP). In this financial tool, the member countries are provided with recommendations for recovering from excessive deficit and are required to recover within a specified time period. Non performance of the recommendations within the specified time period may lead to taking further actions or procedures to recover from excessive deficit conditions (European Commission, 2012). The SGP is an essential policy in regulating the fiscal policy of the EU member countries for a steady financial performance. New reforms are required to be formulated for minimising the affect of Euro crisis as well as to retain growth of the European nations as well as stability of global economy. In almost every euro zone member countries, fiscal adjustments are required to be made for better fiscal sustainability over a long period of time. An enhanced framework for better sustainability of fiscal policy is required to be formulated for sustaining steady growth in the European countries economy (Schuknecht & et.al., 2011). European Stability Mechanism (ESM) In order to stabilise the financial condition in Euro zone countries, the European Council had formulated a crisis management mechanism namely ESM. ESM was established for offering better financial support to the euro zone member countries which are hampered severely for Euro crisis. ESM had been founded on the basis of public international law which must be signed by all the euro zone member countries. ESM performs its tasks as an intergovernmental institution where all the important decisions are required to be made by Board of Governors. These Board of Governors acts as finance ministers in the euro zone member countries. By assisting in stabilising the financial conditions, ESM ensures better economic, social as well as political conditions in EU member countries. Furthermore, it also assists to improve growth as well as to aid in recovering the global economy for improved trade activities among the nations (European Central Bank, 2011). These are the steps acquired in the EU member countries for stabilising the financial as well as economic conditions. These steps are essential for enhanced growth as well as prosperity in the global economy. Conclusion From the above review, it can be observed that euro crisis is the result of sovereign debt crisis and macroeconomic crisis. The European countries had adopted Euro to be the common currency for EU member countries in order to stabilise the economy. However, the euro crisis has made the EU members countries quite vulnerable to pay the debts and destabilised the economy. In European countries, a banking system was established which comprises of ECB and state banks of the EU member countries. ECB was assigned with the task of coordinating as well as controlling monetary policy for the EU member countries. ECB was entitled to seek that the EU member countries are financially performing in an effective manner. Moreover, EMU was established with the motive of determining steady financial performances of the euro zone member countries as well as to ensure steady economic development of the member countries. The review makes it clear that the financial crisis such as recession in the year 2009 had adversely affected the economy of the European countries. The Euro crisis is a major disaster for the economic as well as financial performance in the European nations. It had adversely affected the European countries with sluggish economic growth and trade. The global financial crisis led to inefficient financial performances as well as hampered the economic conditions of the European member countries. This financial crisis had transferred to banks for default in the payment of debts for government bonds. This bank crisis is further transferred to sovereign debt risks which mainly originated from Greece. The financial crisis of 2008 had affected Greece in a drastic manner where the government of Greece was unable to stabilise its financial conditions. This sovereign debt risks was spread out to other European countries and it further diminished the economic growth rate of the euro zone member countries. Therefore, bank crisis as well as sovereign debt crisis along with growth crisis is the types of crisis altogether resulted in drastic Euro crisis. The Euro crisis not only impacted the eupean nations, but also affected the global economy. It had already affected the import and export trade practices between US and European countries. Moreover, it may also influence the US dollar value which may further affect the global economy as well as international trade activities. Euro crisis will mostly affect the developing countries as well as emerging markets for increased commodity prices as well as ineffective supply chain. Thus, in order to minimise the effects of Euro crisis, the European Commission as well as European Council had formulated varied methods as well as policy. For instance, SGP had been reformed to provide better fiscal policy for EMU. Furthermore, ESM has been planned with the intention of stabilising the financial conditions of the euro zone countries. Furthermore, financial reform in order to establish a true economic union can help to solve the present problems of crisis. References Anand, M. R. & et.al., 2012. The Euro Zone Crisis Its dimensions and Implications. Working Paper. [Online] Available at: http://finmin.nic.in/workingpaper/euro_zone_crisis.pdf [Accessed December 13, 2012]. Arestis, P. & Sawyer, M., 2012. The Euro Crisis: Volume 8 of International Papers in Political Economy. Palgrave Macmillan. Brunetti, A., 2012. The Euro Crisis and the Role of the Banks. University of Bern. [Online] Available at: http://www.swissfinanceinstitute.ch/brunettitheeurocrisisroleofbanks.pdf [Accessed December 13, 2012]. Dadush, U., 2010. Paradigm Lost the Euro in Crisis. Files. [Online] Available at: http://carnegieendowment.org/files/Paradigm_Lost.pdf [Accessed December 13, 2012]. European Commission, 2012. Stability and Growth Pact. Economic and Financial Affairs. 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