Free Essay

Causes of Euro Debt Crisis

In: Business and Management

Submitted By zhuyun
Words 1239
Pages 5
Causes of Euro debt crisis

1. Profligacy of the European Government & Unsustainable Fiscal Policy

Countries including Greece, Portugal, Ireland, Spain and Italy in Europe are now paying a heavy price on their profligate way of spending, as reflected by the Euro debt crisis starting from late 2009. Fiscal policy is the use of government expenses and taxation income so as to influence the economy, while the average fiscal deficits had grown from 0.6% in 2007 to 7% at the beginning of the debt crisis across the Europe (Économistes Atterrés, 2010). Therefore, more and more debts were being issued by the above governments so as to support their national expenses, leading to an excessive rise in government debt levels. For instance, the average government debts per GDP had raised from 66% to 84% in the same period (Krugman, 2012).Basically, government debt is the money owed by the central government to the debt holders. As a result, with a high level of the debt-to-GDP ratio may imply that the country is less likely to repay the debt holders but higher chance to default on its debt obligations.

Greece, contributing about 3.3% of the annual GDP towards the European Union (Central Intelligence Agency, 2012), with a 165.3 % of debt-to GDP ratio in 2011, was responsible for the outbreak of the Euro debt crisis. Historically, Greece Government’s Debt to GDP ratio was already at a relatively high level across Europe (McAuley, 2011)(Graph 1). Following by the adoption of the single currency “EURO”, the difference between the public spending and the income of Greece started to rise eventually (BBC Business NEWS, 2012a). Owing to the poor planning of the fiscal policies, Greek has been suffering from budget deficit since 1995(Graph 2), thus, more debt was issued so as to sustain the government expenditures. The Greece Government Debt level was about 99.2% of the national GDP since 1995 and had risen exponentially throughout the past to 165.3% in 2012 (Graph 3). Yet, the Greece Government was running out of money and had to default their debts eventually, reaching the highest amount of debts in modern history on 2009 with 300 billion euros (BBC Business NEWS, 2012b). Greece debt holders, mainly governments from the euro zone have to write off the debts then, leading to a loss of capital and affecting their ability to repay their own government debts. As a result, domino effect has raised, where it is a chain reaction that the government in Europe were unable to get pay from the debts they hold and thus have to default their issued debts ultimately.

Figure 1 Government Debt to GDP ratio from countries across Europe Source: http://www.tradingeconomics.com/greece/government-budget

Figure 2 Greece Government Budget (1995 – current) Source: http://www.tradingeconomics.com/greece/government-debt-to-gdp

Figure 3Greece Government Debt to GDP (1995-current)

Source: http://www.tradingeconomics.com/government-debt-to-gdp-list-by-country?c=euro+area

2.1 Monetary policy inflexibility

Monetary policies are rulings by the government authorities so as to achieve a target interest rate and keeping inflation under control by controlling the supply of money (Friedman, 2002). However, there is only one single monetary policy being established within the Euro zone. And thus, none of the individual member is able to implement any independent monetary policy that is suitable for their own countries during debt crisis (Cox, 2012). Throughout the outbreak of Euro debt crisis, loosing monetary policy such as increasing the money supply would be helpful to alleviate the crisis. Printing money from the respective reserve bank could devalue a country’s currency and thus being able to repay debt holders and easing the risk of default. On top of that, increase in money supply could be beneficial in terms of making its exports more attractive to foreigners at a cheaper price. An increase on tax revenue based on an increased GDP can then be expected. Hence, this may help to relieve the fiscal deficit by regaining competitiveness even there is a need to pursue deflationary policies (Pettinger, 2011). Yet, it is prohibited for the countries within the euro union to do so.

2.2 Prohibition of devaluating EURO currency

Euro was officially comes into existence on 1 January 1999(BBC News, 2012). While the European Union consists of 27 sovereign member states, and all of these countries used the same currency, “EURO” except Britain. Thus none of its member could adjust EURO based on its own economic conditions. For most countries, the government would devaluate its currency when they face financial downturn. As the lower exchange rate for its currency would attract more exports and foreign business for the lower cost of operations, which then would assist the growth of local economy If Greece could devaluate EURO freely at an early stage during the outbreak of the crisis, it would be possible for Greece to have more sources of funds being collected and tried to pay out its government debt as much as it could. This could then mitigate the impacts of the spread of its crisis.

3. Overconfidence of investors and government

One potential cause of the debt crisis is the overconfidence by investors and European government in the sovereign bond market in the first stage.

As it has been all known, the government bonds are the most stable and safe financial instruments for investors with lower return than corporation bonds. Government debts are always seemed as an AAA+ credit rating. Thus investors would not worry about the default risk of these bonds. Thus, investors were happy to invest in the European sovereign bonds for a lower but safe return.
With a total of $402 billion Greek debt (Reuter, 2009), it reflected the confidence level on the government bonds of investors.

Figure 4 Monetary aggregate M3

Source: http://sdw.ecb.europa.eu/servlet/quickviewChart?SERIES_KEY=117.BSI.M.U2.Y.V.M30.X.I.U2.2300.Z01.A
And because the interest rate had an increase trend from 2004 with 5% to 2008 with over 12%, investors had an optimistic prospect on its return, as shown in the above figure. The major debt holders such as Greek bonds are euro system and EU loans with €45 billions, and Greek public funds with €75 billion (Barclays capital, 2011). This highlighted the response to the increase of interest rate, and also the bond’s yields. The investors assumed that all European sovereign debts and bank debt were risk-free and they would not default until 2008 (Boone & Johnson, 2011), which in deep would be seen as an overconfident behavior. But after Germany had signaled the possibility of default, investors may bear the lots for the euro-zone debts.

Moreover, the first stress test held by European central bank omitted the chances of default of the debts. And the north European leader claimed that they believed Europe was sufficiently prepared for the likelihood of default (Atwater, 2012), but actually this was not the case.

Owing to a lack of assessments and cautious planning on their current national financial situation, the Euro government debt, especially the Greece government had been accumulated exponentially. On top of that, the Global Financial Crisis in 2008 had also lead to a serious economic downturn, causing an increase on government Debt to GDP ratio and serious fiscal deficit across Europe, triggering the outbreak of the euro debt crisis.

Similar Documents

Premium Essay

Piigs

...Topic: PIIGS (European debt crisis) 吳宇綸D0131292 劉昱顯D0131156 王謙 周雋彥D0125599 Contents 1. Introduction 2. Overview of the European sovereign debt problem 3. Relief measures of the European sovereign debt crisis 4. European debt crisis 5. Conclusion 6. References I. Introduction The PIIGS is a group that composed of five countries that have some commonality in location and economic environments. In this case, PIIGS includes Portugal, Italy, Ireland, Greece and Spain. The countries which be mentioned are all part of European Union members and have been noted for having weak economics and bad situation of financial problems. In 2008, economic crisis came to all over the world, during the worldwide economic crisis, Portugal, Italy, Ireland, Greece and Spain began to come out the grave and serious concern in the European Union refer to the enormous amount of sovereign debt that they were carrying. The problem with the PIIGS is that speculators dropped, compounding their debt issues and the situation might be much more worse. Many European Union members were also unwilling to rescue these struggling nations although when it became very clear that assistance would be needed. The sovereign debt crisis sparked a number of conversations about reforming financial policy in the European Union to prevent similar problems in the future....

Words: 6354 - Pages: 26

Premium Essay

International Finance

...Introduction To understand into the trend of European currency change nowadays, the origins of the Euro (€) had been studied. From the background of Euro, initial idea for the creation of Euro can be trace back to 1979 when European Union (EU) set up European monetary system (EMS). Due to the successful of EMS, the European Union decided to form the Economy and Monetary Union (EMU) to create Euro in December 1991.The main advantages and disadvantages of a single currency for the countries and the zone had been analysis with the macroeconomics knowledge that has learnt from this course. The advantages mainly help to eliminate the floating exchange rate, transaction cost and price transparency, whereas the disadvantages include loss of sovereignty, cost of Euro and budget position. Thus, the significant influences of Euro dollar from birth to now, it can be known that Euro currency is defined under flexible exchange rate system. With flexible exchange rate, the currency can be effort between the capital movements, tax and subsidize international trade and therefore the currency from overseas will influenced the demand. 2. Analysis 1. History of Euro In January of 1999, single currency, Euro has been introduced by members of European Union. It has been approved by Maastricht Treaty and used by its members currently who called as Eurozone....

Words: 2771 - Pages: 12

Premium Essay

Eurozone

...In particular, Germany, one of Greece’s biggest critics for failing to manage the crisis correctly, “flouted the rules for four years from 2003 (and avoided punishment)” (“The causes: A very short history of the crisis,” 2011). Furthermore, Italy, Spain and...

Words: 2584 - Pages: 11

Premium Essay

The Italian Crisis - Causes, Actions and Reactions

...Italy is the third largest economy in the Euro Zone, only behind Germany and France; a blow to the Italian economy is surely a blow to the Euro Zone (EZ). This is the truth that has unfolded in the past three months or so, but the drama seems not in a hurry to end anytime soon. In this paper, I will be examining some of the causes of the current crisis in Italy, both immediate and remote causes. I...

Words: 3651 - Pages: 15

Premium Essay

Greece's Economic State

...Euro Crisis: Greece’s Reform to Uphold the Euro Greece has been a significant trading partner within the EU as well with the global community at large. Public spending has been at its highest since the financial crisis in 2008 and with irrational investing behind banks and the private sectors; it only worsened their economy. The complicated areas of the European economy mostly have been due to countries spending vast amounts of borrowed finances than they have fluctuating within their own nation. Countries deficits are still increasing after the US financial crisis and it has led to continuous austerity agreements and negotiations to prevent these issues from relapsing. Greece is in a classic sovereign debt crisis and while struggling to fix their deficit, (currently the largest in the Eurozone) this turned to controversial debates whether or not to let Greece free of the euro, or continue to keep them in. The problem of the matter relies heavily on the political sector of the union as well as the economic foundation represented in Greece’s past, showing that releasing the nation from the euro will only cause more harm than actually stabilizing them in. The US financial crisis of 2008 grew strongly towards the inefficiency between the banks and investors, who failed to act rational in accordance with the economy (Heath 401)....

Words: 1483 - Pages: 6

Premium Essay

Internship Report

...Index Page No. 1.0 Overview 2 2.0 The Establishment of the Euro Zone and the introduction of the Euro 2 3.0 Key Causes of the European Financial and Economic Crises 3 4.0 The Start and Progression of the European Debt Crisis 5 5.1 Greece 6 5.2 Portugal 6 5.3 Italy 7 5.4 Spain 7 5.5 Ireland 8 5.6 Iceland 9 5.0 Measures Taken (so far) to Combat the Debt Crisis (European Level) 10 6.7 European Financial Stability Facility (EFSF). 10 6.8 European Financial Stabilization Mechanism (EFSM). 10 6.9 ECB interventions. 10 6.10 Brussels Agreement. 11 6.0 Implications of the European Debt Crisis: For the European Union 12 7.0 Implications of the European Debt Crisis: For the Global Economy 13 8.0 Implications of the European Debt Crisis: For Global Politics 14 9.0 Implications of the European Debt Crisis: For Pakistan 15 10.0 Implications of the European Debt Crisis: For the Welfare State 16 11.0 Solutions for the European Debt Crisis 16 12.11 Eurobonds. 16 12.12 Restructuring of Eurozone. 18 1.0 Overview: With a nominal GDP of $16,242 Billion in 2010 (20% of global GDP), the European monetary union is not only the world’s largest economic block, but also the foremost integrated economic and political association of nations in......

Words: 7079 - Pages: 29

Premium Essay

The Euro Crisis

...The Euro Crisis According to Wikipedia (2012), the Euro Zone is comprised of 17 members that have accepted the euro as their only method of payment for goods and services. Monetary policy and management of inflation levels is governed by the ECB (European Central Bank) which consists of a president and board originating from central banks within the area. Since the late 2000's the Euro zone has experienced financial troubles mainly resulting from the varying degrees of difference between fiscal and monetary policy within each country. The majority of the debt can be attributed to the increase in both public and government debt around the globe as well as the arising debt within the euro zone. Some countries were noted for their involvement in the property crisis while other countries including Greece developed most of their financial obligations from increased public sector wages and pension contributions at an unsustainable level. As the desire for higher yielding investments expanded, many investors sought global markets as those offered by the U.S. Treasury. Norbert Walter (2012) argues that different growth rates, employment levels and unit labor costs have attributed to the euro crisis leading to heightened risk premiums and increased capital flights to those with lower risk assessments....

Words: 3424 - Pages: 14

Premium Essay

The European Debt Crisis

...The European Debt Crisis In 2009, Greece came forward and announced that their financial management of their economy had gone awry. Greece's revealed their budget to be 12.7 percent of gross domestic product (GDP), in addition, its debt-to-GDP ratio at 120% was twice the limit allowed in the Maastricht treaty. This triggered what is now known as the European Debt Crisis, and led to similar announcements by Portugal, Italy, Ireland, Spain and most recently Cyprus. In the next pages we will attempt to explain the events leading up to the crisis and potential next steps for the European community. On February 7th, 1992 the 13 member nations of the European Council came together to sign the Maastricht Treaty. The treaty was designed to create financial stability throughout the Euro Zone by laying out fundamental fiscal policies for each country to follow. The treaty primarily encompasses four points: 1. Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing (lowest inflation) member states of the European Union (EU). 2. Government finance: Annual government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. Government debt: The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. 3....

Words: 1347 - Pages: 6

Premium Essay

European Union

...The fiscal crisis came about because some governments in the Euro zone have run up bills that now need to be repaid. They spent more money than they have been taking in, in terms of tax revenue. Greece’s band spending behavior was the upfront problem that led to...

Words: 8065 - Pages: 33

Free Essay

Euro Paper

...“Will the European Union Abandoned the Euro and Go back to their own Currency?” Professor: Dr. Mague Managing in a Global Environment MG615 Winter 2011 In today’s economy there are many different countries using different currencies. The European currency is defined as the forerunner of the Euro. This was a stable means of exchange between the former national currencies as they prepared to give way to the single currency. There are only some countries in Europe who adopted the Euro which are; Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain. The countries who did not adopted the Euro are; Denmark, Sweden and the United Kingdom. This is because they fear adopting the Euro would devastate their economy. Adopting the Euro gave the country a new start and others though it was a investment disaster. There have been many problems in adopting the Euro and people question whether or not the European Union will abandon the Euro. In reading many articles the countries using Euro zone are going through different forms of an economic crisis. According to the Bloomberg report the Euro zone fluctuates by increasing or decreasing in value. The euro zone had a weekly loss against the dollar after Portugal’s credit cut leaving European leaders ready to discuss the region’s debt crisis. The European officials will try to control a sovereign-debt crisis....

Words: 965 - Pages: 4

Premium Essay

Euro Zone

...EUROZONE CRISIS ABSTRACT Euro crisis was not fortunate. It was something that could be avoided if proper care was taken. The European sovereign debt crisis has emerged out of a situation that has made it difficult or impossible for some countries in the euro area to re-finance their government debt without the assistance of third party. It was not only the government sector that lead to this crisis but major cause of it was the private sectors taking up too much of loans. The report also states the impact of euro zone crisis on the world and the India. The Eurozone crisis is systemic in nature. It is a result of policy failures in the way European Monetary Union (EMU) was designed, constructed and implemented. In particular, the crisis is a consequence of the failure to put in place certain necessary institutional components. INTRODUCTION The global economy has experienced slow growth since the U.S. financial crisis of 2008-2009, which has exposed the unsustainable fiscal policies of countries in Europe and around the globe. Greece, which spent heartily for years and failed to undertake fiscal reforms, was one of the first to feel the pinch of weaker growth. When growth slows, so do tax revenues – making high budget deficits unsustainable. The result was that the new Prime Minister George Papandreou, in late 2009, was forced to announce that previous governments had failed to reveal the size of the nation’s deficits....

Words: 3126 - Pages: 13

Premium Essay

Report - Greek Sovereign Debt Crisis

...In 2001 Greece adopted the euro as its currency, replacing the Greek drachma at an exchange rate of 340.75 drachmae per euro. Greece is a member of the International Monetary...

Words: 2375 - Pages: 10

Premium Essay

Can the Eurozone Survive?

...From more strongly integrated financial markets, to the potential for a unified European identity, the Euro certainly brings many advantages to Europe. However, the political and economic instability that both caused and was caused by the Euro crisis threatens the further perpetuation of this currency. The onset of the Euro crisis came about when the Greek government admitted to a budget deficit much larger than they had previously divulged. Interest rates skyrocketed and, despite efforts to reduce spending, Greece ultimately fell bankrupt. Concerns over the decline of a state that represents only 2.5% of the EU’s GDP could have been redressed, had it not been for inflexible provisions of the Treaty on European Union. The “no-bailout clause” did not permit the EU or any national governments to undertake the debts of another state, a rational but perhaps detrimental provision in 2010. Moreover, one may argue that the Eurozone was in jeopardy from the start when more than half of its members did not meet the debt limits. The Stability and Growth Pact, an instrument created to monitor these debt limits, was quickly ignored. Even Germany and France, the EU’s most influential members, regularly exceeded deficit allowances and thus smaller states like Greece were able to build debt unchecked (see Appendix A)....

Words: 1706 - Pages: 7

Premium Essay

International Marketing

...IWhat is International Marketing?   Marketing a product or service across national boundaries in order to satisfy the needs of customers and the objectives of the organization. Different Terms:  Multidomestic marketing: adapting product and marketing programs to each foreign market independently.  Global marketing: marketing activities in multiple country markets are coordinated and integrated.  Foreign marketing: loosely refers to marketing a product in a market outside the home market. International Marketing Environments Global Economic Environment Cultural Environment International Marketing Global Competitive Environment Political/Regulatory Environment Systems Global Systems Global Financial Systems International Monetary Systems and Foreign Exchange Market Global/regional Trading Systems (WTO, EU, NAFTA, ASEAN,...) Importance of International Marketing • • • • World trade has risen from $2 trillion to $18 trillion in last three decades. International trade grows twice as fast as domestic trade. Global marketing is a “must” for firms to achieve sustained growth. Marketing success will be defined on a global scale. Domestic and International Trade Growth Percentage of Growth 12% 10% 8% 6% 4% 2% 0% Year International Trade Domestic Trade Financial Statistics Yearbook Source: International 2011, International Monetary Fund, Washington D.......

Words: 1762 - Pages: 8

Premium Essay

The Eurozone Crisis

...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...

Words: 1718 - Pages: 7