The Euro Crises - Dissertation Example

? The euro crises Contents 3 Introduction 3 Literature Review 6 Research design and methods 8 Methodology 8 Method 9 Results 16 Discussion 17 Effects of euro crisis 18 Conclusion 19 Reference 21 Abstract The research paper will talk about the crisis in the euro zone. It will take into account the various aspects of the crisis and will try to reach a conclusion. The aim of the research is to find the impact of the economic factor productivity on total exports during the crisis as well as the impact of the net domestic credit on the exports during the same period. The focus of the research will be to explain if there is any relation between the current account deficits and the growth crisis. The research concludes that import of final goods as well as the foreign demand played the strongest role in the development of exports during the Euro zone crisis between 2008 and 2009. The paper will also take into account the causes behind the crisis and the impacts it sheds around the globe. Introduction The elimination of the barriers to trade and to trade on a single currency is some of the conclusions that were reached by the members of Euro zone. The collaborative district enhanced the expansion as well as speeded up the cross border entrepreneurship with the aim to support exports and achieve the path of growth. In order to follow the growth curve it is necessary that exports play a crucial role. During the second half of the year 2008, Euro zone was confronted with decrease in the volume of trade. The collaboration witnessed biggest decline in trade volume since World War II. The development of the district in the arena of international trade gained worldwide attention. It ensured that demand drop into the negative spiral and the prices of the assets collapse. The effect of the crisis led to remarkable drop in the export for Euro zone. The effect of intensive collaboration showed a similar trend for the selected Euro zone countries in the diagram below. (Thurik and Hessels, 2011, p. 7). There are two key problems that led to the crisis. The debt problem is one of the problems of the Euro zone while the Euro zone lost its competitiveness. The burden of debt gathered fuel not only because of the profligacy from the part of the government but also because the region enjoyed a decade when the rates of interest was low and then had to face the financial crisis. The availability of easy credit fuelled into the households and the financial sector. The Central bank of Europe managed the cross border lending. The bill of welfare took the upward rising curve when the level of unemployment deepened. Some of the countries had to launch upon in order to find money for their banks. The new expenses had to be borne by the state. The tax receipts collapsed as well. The rates of interest surged. It was assumed by the investors that no government of the Euro zone will default on account of debt before the crisis. Even some of the investors were asked to get rewarded for taking the extra risk while others walked away as they were unwilling to pay for credit crunch. All this led to bond prices to fall which weakened the banks and slowed down growth. The countries of Euro zone were following the unsustainable current account deficits from before the crisis. The domestic spending took the leap as the interest rate was low and wages and the goods got inflated. This resulted in exports being costly while the imports being cheaper. Germany was recycling the surpluses that were produced by the export machines and financed their consumption. It was anticipated that restoring the continent to its health will take few years because the troubled countries required to control the deficits of the government and reestablish the current accounts so that to improve the competitiveness. A research on the topic will help to analyze the effects of the crisis and the required steps from the countries in order to avoid the crisis. The decreases in output as well as in employment were dampened by the fiscal policies during the periods of financial crisis and the subsequent global recession. The negative impacts of the crisis were alleviated by the automatic stabilizers as well as by the wide ranging discretionary policy measures. The resultant was weakening of the public sector finances in euro zone. Uncertainty is accrued to the fiscal policies used to smoothen the cycles of economy. The fiscal policies can result in ineffectiveness and the effects can drastically differ from the effects that were estimated. The fiscal policies can be effective as well when the policy makers fail to notice the behavior of the economic agents with changes in policies. It is also difficult to estimate the impacts of fiscal measures. The main risk in inappropriate decision on policies is posted by the errors in forecasting. There are some advantages of a single monetary union. Existence of a single monetary union reduces the rate of exchange risks. Existence of single currency promotes the level of trade within a monetary union by lowering the costs of transaction as well as reduces the uncertainty. A regime of single currency also prevents the mistakes in the balance sheets. However there are some disadvantages as well. The countries will loss the independent authority in monetary as well as in exchange rate policies. Before the introduction of euro, there was limited discretion policy in the countries of Croatia and Bulgaria. The countries will also lose the ability to improve the competitiveness with the help of either devaluation or depreciation. But most of the countries in the European Union opined that the benefits are of less importance. The issues regarding productivity as well as competitiveness have to be addressed using the non monetary tools. Therefore, the stability as well as the growth pact has been left unobserved. Literature Review The sovereign crisis in debt has gone through acute phases where the yields of the government bonds triggered to high levels. The participants of the market tend to focus on the difference between the bonds of various countries with that of Germany as an indicator to find the stress in the debt market. Investors might demand different rates of interest for two countries. The investors may also be worried that the government will not repay the debt. If the probability for a country is higher to default then that country will have to pay higher interest rates in order to compensate the risks associated for the investors. Before the euro came in the purview, there was wide gap in the interest rates across the future members of euro. As Greece joined the European Union the interest rates converged later compared with the others. Until the crisis there were no gaps in the rates of interest. Even the first year of the crisis showed relatively low spreads. In some cases the announcements of some policy from the policy makers of the euro have calmed down the market temporarily but the spreads reappeared across time. The sovereign crisis in the euro has been viewed with the lens of fiscal profligacy. The first country to experience the turbulence was Greece and the problems centered on the inappropriate spending from the government (Valiante, 2011, p. 2). The root cause of the crisis was irresponsible fiscal policy. The steps that were required during the crisis from the part of the government included to limit the amount of deficit via some measures of austerity. If it is not possible to balance the budget immediately then it was required to launch upon some short term policies like financing from the monetary institutions or from governments of other countries (Dadush, Aleksashenko, Ali, Eidelman, Naim, 2010, p. 9). After 2009, when growth started to pick up pace a problem that emerged was unequal distribution of growth across the union. During the initial periods of the crisis the sentiments of Germany dropped below that of Greece and Spain and after the crisis the sentiments comparatively uniformly across the entire euro area. The imbalance in growth is often regarded as the imbalances in the current account deficits within the area. The deficit in the current account and the growth crisis is clearly linked. The imbalances in the current account prior to the crisis acted as the signal towards competitiveness problems and the present deficits in current accounts are acting to drag the demand. The competitiveness of the borrowing countries lowered as the inflows of capital contributed to increase the prices. As the prices started to increase the real interest rates fell further and paved down the path for more borrowing. The imbalances prior to the crisis highlighted the buildup of the debt. The debt now requires deleveraging. Some experts have argued that deficits in the current account may not be a problem as it can be expected that the economies with higher anticipated growth may increase the consumption in the newly formed market (Shambaugh, 2012, pp. 2-5). The decisions regarding fiscal policies are based on the available real time information. Before the publication of the estimates, several revision processes are undertaken. The stance of the policies may look different as compared to the real time data. A growing number of studies were undertaken with the aim to investigate the effects of the exceptional policy changes that were implemented during the periods of the crisis. The practical debates on fiscal policies do not consider the worsening fiscal policies as well as the weakening sustainability of the public finances as the centre of the debate. It had not been extensively the effects of the planes policies as well as the implemented policies during the crisis periods. Research design and methods Methodology The method which will form the methodology part of the project is secondary research. Data is to be collected from the concerned authorities that deal with the economic issues. The project is based on secondary research. The task of the secondary research is to take into account the relevant literature. The data accumulated through secondary research will focus on the exports and imports in the euro area. The recent euro crisis projects light on the uncertainty accrued in the effectiveness of the fiscal policy as well as the importance of the differences between the real time data with the final data in order to have a balanced assessment of fiscal policies. In order to get the correct perspective of the fiscal policy measures it is important to differentiate between planning stage of the budget and the implementation stage. The policy plans are made in the planning process of the budget. In the implementation stage the fiscal policies are referred to as the new policy decisions which are made taking into account the real time information. The two fiscal stages can be analyzed by using the real time information. Method The annual real time data is collected from the publications of the Organization for Economic Corporation and Development Economic Outlook for the months of June to December for the period 1997 to 2010. Twelve countries of the euro arena have been included in the study. Each of the outlook provides the time series of the growth rate of read GDP, ratio of the primary balance to potential Gross Domestic Product, the ratio of the gross debt of the government to GDP as well as the production function of the OECD that is based on the estimation of the gap in the levels of output. The panel data will include real time lagged values for more than a decade of all the variables and the estimates of the current year values as well as the forecasts for one or two years. The final data has been collected from the annual outlook of the year 2010. There are some advantages of using the data of OECD in the analysis of fiscal policy. The series are constructed the same methodology which makes it comparable across countries. The perception of the policy makers is incorporated in the forecasts. Now the project tries to show how real time estimates for a particular time evolved across time. The above figures show the estimates of economic developments. The period under consideration is 2008 to 2010. It can be depicted from the figures above that the crisis was deep. It was unexpected as well. The forecasts of real GDP made in 2008 for the year 2009 for all the countries were overoptimistic. The developments in output gap reflect sharp decreases in aggregate activities which were measured by real GDP. There was a substantial decrease in cyclically adjusted primary balances. This demonstrates exceptional large fiscal stimulus which was applied during the periods of the crisis. The above table provides information on the average accuracy on the forecasts of the month of December. The method is to compare the real time projections of the outcomes of the current year with the forecasts of the previous year of those outcomes. The different periods are taken into consideration are - 1998 to 2010 (comprise the whole sample), 1998 to 2007 (the period prior to the crisis), 2008 to 2010 (the period after the crisis). It can be interpreted from the above table that the forecasts were not very accurate during the years of recession. The calculated value of the mean absolute errors as well as that of the root mean square errors was twice as large as that of the previous years. Even the amount of debts was systematically underestimated. It can be summarized that the exceptional large forecasts errors can have shaded some impact on the prevailing fiscal policies in the periods of the crisis. The above figures show how the developments in economic assessments in 2009 changed over time. It was projected that the primary balances in 2009 to remain in surplus till the end of 2008. In the month of June, 2009, the projections were revised. Many of the projections were revised substantially downwards and some of them became negative as well. Until the end of the year 2009, the biggest downward projections were not made for the countries like Belgium and Greece. But the estimates for Italy remained unchanged for the year 2009. In the middle months of 2009, the estimates of the output gap as well as the estimates in growth in real GDP was revised downwards. The cyclical variables were revised slightly upwards as well. After the summer months of 2009, the estimates of gap in output as well as the growth in real GDP were revised further downwards for the country of Finland. It can be stated that the crisis hit the euro arena almost at the same time i.e. middle of 2009. Therefore it can further be stated that the recession was not at all expected and it was deep as well. Results The fiscal plans for the budget years and the changes in the policies during the implementation stages of the budget are investigated in the paper using real time data constructed from the months of June to December issues of the economic outlook of OECD. The focus of the study was on the fiscal adjustment undertaken during the financial and economic crisis. The countries of Greece as well as Ireland were excluded from the analysis since inclusion of those countries could have distorted the results. The results indicate that the errors in forecast during the crisis as well as the statistical revisions were larger than before. It can be interpreted that the crisis hit the euro area at the same time but it can be seen that there are cross country differences in the errors of forecasts and the statistical revisions were found to be significant. The condition prevailing on a particular country in the crisis was much different from the conditions prevailing in other countries. The results also indicate that the planned fiscal policies prevailing during the time of the monitory union were oriented towards long term and were counter cyclical. In the stages of implementation, new decisions in policy have been made in response to unexpected changes in economic developments. The crisis contributed in changing the discretionary policies of the euro area. The decision makers paid more attention towards cyclical developments in the fiscal planning process. During the stages of the implementation, the significant changes in the adjustments took place on the basis of available real time information. The fiscal adjustments may shed negative effects on the economy after the planning stage of the budget. If the implementation stages witness changes in the adjustment plans then it might be difficult for the economic agents to change to their behavior accordingly. The results depict that during the period of recession, economic uncertainty was wide spread. The monitory policy was believed to play the accommodative role which is partly based on the non standards measures. The policies related to finance was adjusted considerably in order to curb down the negative effects that the crisis cab shed on the economies of euro area. Discussion The impact of the euro crisis may not be same as the impacts posted by the financial crisis across the globe. The directions of the actions after the effects of financial crisis was recapitalization of the banks, measures on financial stimulus as well as steps to restore the confidence of the investors. The implications of the crisis have been of diverse nature. The characteristics of the crisis include decoupling of the important European countries, the setting up of European financial Stability facility, debates on derivatives as well as the regulations and on the topic of integration of Europe. One of the important implications of the crisis is big divergence between the countries like Germany and France with the peripheral countries like Ireland, Spain or Portugal. Since 2010, the core countries started to recover from the crisis but the peripheral countries were on the process of recovery. The countries are governed by same monetary authority. There was no debate regarding the appropriateness of the monitory policy as all the countries of the euro zone were suffering from financial or economic crisis. The recent crisis has also contributed in debt issuance of the government. Prior to the crisis, the common practices included involvement of fixed and long term rate debt via the competitive auctions denominated in national currency. Effects of euro crisis The expenditure by the government and the exports contributed in the recent growth of the United States. But the growth curve is likely to face hurdles because of the euro crisis. Europe is one of the biggest export markets for U.S. The euro crisis is likely to reduce the amount of trade possibilities between the countries. Experts are also of the opinion that widespread failures from the euro banks can act as the disaster for U.S. If the euro banks are exposed to a run, then the equity market will crash and the dream of U.S. to continue the economy on the recovery curve will get diluted. The stocks which will feel the heat most include aircrafts, financial services as well as machinery. But it cannot be said with utmost certainty which of the stocks will suffer the most but it can be said with certainty that the equity market of the globe will suffer. The funds in the money market are considered as relatively safe. But the funds are exposed to falling prices of the assets. If the funds in the money market are exposed to the sovereign debt prevailing in euro zone, then there is a risk that it can break the buck. The euro is currently under pressure and losing its value. It can be asserted that the dollar will gain from this situation but it is hard to predict the movements in the currency market. If the movements of the market can be expected then it can be said that U.S. dollar stands to strengthen itself quite significantly. With the euro losing its value it would be easier for the tourists from the U.S. to arrange trips in the continent. Conclusion The dent crisis points to a gap between the legal and political thinking in the euro area. The tension between the sovereignty and solidarity has been revealed by the crisis. The government of France acted defend claims regarding the fiscal sovereignty. It also acted to confine the management of the crisis to the intergovernmental rather than Community method. As a result the governments have sidelined the European parliament and decided to favor the European Council. The lessons that the crisis taught is if two folds. The intergovernmental method is not suited to the requirements of the decisive actions during the crisis and there is a mismatch between the speeds in decision making between the council and the markets. This type of problem is regarded as the problem of inter temporal inconsistency. The crisis brought the power realities of the emerging continent. The negotiating power of UK also got limited because of the crisis in the Euro zone. The crisis raised the stakes of the European integration to new levels, as well as provided the incentives to move ahead by following the policies of differentiated integration in the reform process of tax and economic governance. The crisis also calls for political populism. The crisis highlighted the economic situation and the financial situation of UK relative to the core Euro countries like Germany. At the time of the establishment the Economic and Monetary Union was less economic than political project. The debt crisis cannot be attributed just as the crisis belonging to the peripheral countries of Europe. The rapid recapitalization of the banking sector of the continent will not be the solution of the crisis. The European monetary Union has not performed at the level of the monetary union of United States. The member states of the European Union are not excited on shifting the power to the institutions of the country. It is necessary to set up one regulatory authority as well as one rescue fund to deal with the crisis of Euro zone. A permanent regulatory authority would ensure that the crisis hit countries can avoid the crisis regarding liquidity as crisis can take place not directly because of the faults from the part of the crisis hit countries. If the history of the continent is taken into consideration, then one can think that the crisis will lead to an institutional breakthrough. The country that can emerge with solutions with the crisis is Germany but currently the country is wrestling with contradictions (Europe in crisis, 2011, pp. 1-3). The initiatives from the government proved unwilling to engage the European Commission in fiscal surveillance as well as monitoring in the fiscal policies so that the excessive imbalances can be corrected. The crisis paved the way for rising appeals to solidarity. The experts not only in the continent need to face the depth of the crisis and come out with the solutions which will again bring the continent on the curve of growth. It can easily be judged that currently the continent is not facing in the right direction as the crisis is going deeper and deeper day by day. Reference Shambaugh, J. 2012. “The Euro’s Three Crises”. [Pdf]. Available at: http://www.brookings.edu/~/media/Files/Programs/ES/BPEA/2012_spring_bpea_papers/2012_spring_BPEA_shambaugh.pdf. [Accessed: 19th July, 2012]. Thurik, R. and Hessels, J. 2011. “International trade and the crisis in the Eurozone”. [Pdf]. Available at: http://oaithesis.eur.nl/ir/repub/asset/10665/MA-Thesis%20Henri%20Nuijten.pdf. 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