This essay will talk about what is currently going in Europe with the Eurozone sovereign debt crisis and the fiscal state the European Union is in, it is important and interesting because it is still current affairs and there are various factors and decisions that have helped the path that the crisis is going in, this essay will look at the crisis but on the implications and problems that European union face as well as what they have faced already and whether the European Central Bank are doing enough to improve the situation and what their plans are for the future. A sovereign bond serves as a floor for interest rates banks charged for loans and for the pricing of other financial contracts and securities. The global financial crisis led to the deterioration of government budgets and finances as nations utilized public expenditures to provide stability and stimulus. The Eurozone suffered because of heavy borrowing practices, property pebbles and living above their means. The Eurozone debt crisis started because Greece who had borrowed heavily in international capital markets over the past decade were turned against by investors this is because Greece in 2009 admitted that they had double the amount of debt that was allowed in the Eurozone limit. Ratings agencies started to downgrade Greek bank and government debt, and there was fear of Greece defaulting and not being able to pay back its debts but the Greek Prime Minister George Papandreou insisted otherwise however this was not true and would later lead to packages of emergency measures to halt the rising financial market tensions which had stemmed from the concern about fiscal solvency of Greece and several other Eurozone countries. As well as Greece starting off a chain of events, the sovereign debt crisis was caused by access to capital at low interest rates and weak enforcement of EU rules as there was no specific debt or deficit ceilings, The EU did establish a stability and Growth pact in 1997 to set a budget deficit ceiling of 3% of GDP and an external debt ceiling of 60% of GDP however not enough regulation was used to control or look at what was happening in Greece which is how they were able to run up a high debt. The pact was made to make sure member states maintained budget discipline in order t diminish systematic risk and encourage monetary stability. The diagram below shows the euro area where the government gross debt is the most, the most alarming country is Greece as it has a debt of over 125%, most of the countries have 75% or more debt which is a serious matter.

There are a group of countries that have been affected by the debt crisis more than other Eurozone countries they have been referred to as “PIIGS” and they make up Portugal, Ireland, Italy, Greece and Spain, on the diagram above apart from Spain the four other countries have extremely high debts of over 100%. The crisis in Greece was made possible through the management and deception by the Greek authorities and because of their huge credibility problem, they cannot be trusted anymore. The lowered rating of the Greek government bonds by the ECB that came afterwards to BBB+ meant that financial institutions holding Greek government bonds found that the bonds would become illiquid. In Italy with the bond yields rising, it panics investors as it is more expensive for them to trade Italian debt. Italy is at the moment running a primary budget surplus so it can afford to borrow at higher rates for the short term; it is still facing a liquidity crisis. Italy had no one that wanted to buy their debt because of fears over the lack of economic growth which will make it difficult to reduce their debt to GDP ratio, but they have had in December 2011 an austerity package passed that would enable them to try and get the country back on track even though there is a fear that this may not work and Italy may have to exit the euro. The scepticism comes from what Italy’s lack of economic growth for various reasons one of which is political instability and corruption, they have a long term debt of 110% of GDP, and they have an ageing population which means that they will have higher taxes because there will more retired workers in comparison to workers which means they will have to pay for the retired workers. Italy have the same problem as all the other PIIG countries in that it is seen as uncompetitive and cannot devalue its currency as it is part of the euro so it will mean economic growth will be lower. IMF and the European Central Bank (ECB) were giving financial assistance to Greece, Ireland and Portugal but there was a fear at the time it would spread to Italy and Spain, it has recently gone to Italy but there is fear of contagion spreading to Spain. What has occurred in Greece, Portugal, Ireland and Italy has brought panic into the markets of Spain’s own debt. There is also the financial assistance that other Eurozone countries give to one another; there is the European Financial Stability Mechanism (EFSM) where the loan facility is available to any EU country member facing financial difficulties and there is the European Financial Stability Facility (EFSF) which is a legal entity limited company set up by members of the Eurozone to combat European Sovereign debt crisis it has €750 billion for member states that are in difficult circumstances and beyond control. These two will be succeeded by a permanent rescue funding programme called the European Stability Mechanism (ESM) which will be used in July 2012.
Europe became disengaged from their fellow member states and focused on their own nation’s economic problems but the economic meltdown happening meant that regardless of if the countries focused on their own problems it would spill into the rest of the other European countries.
Austerity policies are often used by governments to reduce their deficit spending. This is the cases for the sovereign debt crisis, where the aim is to improve the countries fiscal position through the reduction of the budget deficit and improve public finances in the long term, this will improve confidence. However with the fall in government spending is a shift to the left for aggregate demand which is shown on the diagram below. This will lead to lower economic growth and a fall in output http://www.gucci.com/uk/styles/204283FP1G09768# is shown as y1 to y3, firms will employ less workers and this will lead to higher unemployment. There will be lower inflation pressures in the economy due to the fall in price level which will put a downward pressure on wages. This all ends up reducing confidence because it encourages consumers to save rather than spend because they fear they will lose their jobs, this is reflected in the negative growth of -0.8% that Eurozone is looking at in 2012. It is meant to enable a long term recovery for countries that are in distress, another of its objectives is to improve competitiveness which is important in countries like Ireland, Greece and Spain where they became uncompetitive which lead to current account deficits and lower export demand. A country that has benefited from the austerity already is Ireland who is moving from a trade deficit to a trade surplus.
The monetary policy in EMU is central bank independence and stability oriented and its main objective is to maintain price stability and an obligation for member states to follow the economic policy (Stauffer, 2010), it is managed by the ECB while the fiscal policy is made by the government. Monetary policy is used to manipulate the money supply in order to increase economic growth. The main objective of the monetary policy of EMU is to create a single currency and to ensure that the stability in contrast to price stability and market economy (Pogorelec, 2006).There is a problem because there is no European ministry of finance which means there is no way of controlling fiscal policy as there is no government department for Europe that specialises in this, this means that the high budget deficits and public debts may have resulted from lack of leadership and coordination from the Eurozone countries. As Cheng Cheng-mount, chief economist at Citigroup in Taipei said in a council for economic planning talking about the debt problem he said that fiscal integration would have helped the problem but it would however not have solved it especially if the EU formed a fiscal confederation the integration would not be able to sole the liquidity problems that are still occurring in some countries. He went on to give a solution of quantative easing which is something the ECB considered but nonetheless did not want to take part in. the quantative easing might have helped maintain healthy liquidity for these countries but the ECB and Germany did not want such a move. Quantative easing works as a central bank would purchase assets which are government and corporate bonds financed by new money that the bank will create out of thin air (“electronically”); this will inject money directly into the economy as there was not enough money in the economy. The central banks try to raise the amount of lending indirectly by cutting interest rates. The institutions that are selling these assets will then have “new” money in their accounts which then boosts money supply. The bank will buy the bonds which will reduce the supply of the bonds in the economy this should increase the demand for new bonds and at the same time make it cheaper for businesses to borrow. If Quantative easing did work then the credit growth should pick up and businesses should find it easier to get credit which would help stimulate the economy.
To try and improve the European financial stability, the ECB have purchased the European sovereign debt outright in the secondary markets, before they were reluctant to do this because they wanted to keep independence of the secondary markets (financial markets). They hold 462 €billion in bonds. In order to solve any fiscal problems in the future, the Eurozone countries will set up a European fiscal union which is the proposed fiscal integration of European Union (EU) member states. Fiscal union is the integration of the fiscal policy of nations or states. Under fiscal union decisions about the collection and expenditure of taxes are taken by common institutions, shared by the participating governments. This is a planned solution the sovereign crisis because most of the problems come from lack of fiscal coordination. The European Monetary Union which is part of the EU is not like other monetary unions that oversee what the ECB does and controlling fiscal policy, this lack of control means that the coordination of the two policy instruments of macroeconomic policy is difficult and weakens the credibility of the ECB. The European Union bailout provided a back stop of the weaker members’ sovereign debt by the wealthier countries, effective shifting the fiscal burden of the weaker states onto the balance sheet of the larger and more stable Euro zone members this meant that Germany and France would feel what was going on. However the fiscal burden that is being shared by these countries becomes a drag on the ability of the wealthier countries to issue debt and access the markets (Basci et al, 2007). With the bailout, the EU provided a formal guarantee for effectively regionalizing the members’ debt. It provided benefit to the euro zone members with worse off fiscal indicators especially, Italy, Portugal and Spain. The losers are those members, which are better economic and fiscal fundamentals like Germany, France and Netherlands.
There have been calls for an early exit from the stimulus measures and these calls have become stronger in recent months. Although the fiscal stimulus packages only made a relatively minor contribution to the widening of deficits, the underlying deterioration in the fiscal positions has reinforced the view that a possible further prolongation of stimulus measures might be damaging growth prospects. For many countries the recent reappraisal in financial markets of associated sovereign risks has led to sharp increases in the cost of borrowing and made sharp retrenchment inevitable. In this section we focus first on the effects of the withdrawal of fiscal stimulus measures, and, second, on the effects of permanent fiscal consolidations that will be required to put public finances back on a sustainable path.

The nature of the crisis for the “PIIGS” countries were that Greece and Portugal’s problem was more fiscal related as opposed to Ireland and Spain where it was banking problems related to the property boom. Greece borrowed heavily from abroad to fund large deficits in its budget and current account. This meant that Greece would get a dramatic austerity in order to encourage monetary stability. Greece was forced to adopt new measures to ensure they got their rescue package which caused protests. Ireland’s fiscal problems came from banking issues where there was a problem of “propping up its undercapitalized banks”. The Irish unlike the Greek tried to bring measures in to try and stop their debt from increasing, but eventually Ireland themselves sought support from the IMF and EU and they agreed to an €80 billion bailout that required a new budget. Portugal had the same symptoms and asked for a bailout markets responded by slashing their credit rating to near junk status which would be bad for financial institutions holding Portuguese bonds. Spain like the rest of the fiscally failed countries lost its competitiveness and accumulated a large current account deficit which was similar to Greece and Portugal. The global reduction in demand reduced Italy’s exports which meant that were would be fall in Italy’s consumption and output, Italy however are limited in using fiscal policy (austerity measures) to help stimulate the markets because of the fear that the market will not react in favoured way. Below figure 1 shows that gross government debts in all five countries from 2010 to 2015, where some debts look like they are set to increase even higher, Italy seems to only increase by a small amount however this figure does not take into account recent Italian financial problems.

The implications and problems that the EU face is the doubt over their integrity and their currency, this is because of how the debt crisis has been handled. After everything that is happening in the EU, the confidence that the global economy have of it has fallen, it will be a priority of the EU to make sure they can instil confidence. The crisis could slow down the US’ economic recovery in the short term. In the long term, the crisis provides a stern warning to the US in regards to its fiscal policies.
There are solutions that were put forward to slow down the implications of the debt crisis; one is debt restructuring which was pitched to Greece in order to help them avoid any chance of a default, the problem with debt restructuring that the EU showed was that it would damage banking systems across Europe which would create panic in the markets which is not what they wanted. Looking for non-EU members to help stimulate the European economy was an option where China promised to help invest in Greek bonds once they had become available to the market. The exit from the European Monetary Union is a possible solution even though it is illegal if a country is forced or voluntarily exits within the EMU. If a country was to leave the EMU it would require that countries departing would adopt their own national currency but this would come at a great expense and economic uncertainty. There is a positive if they were to leave the EU they would be able to adopt their own monetary policy which means that they would able to devalue their currency which would stimulate the economy through more price competitive exports. If the Eurozone did break up as a result of the debt crisis not being solved, countries that were leaving would have to pay back any euro obligations to the remaining euro system central banks. There will be a large proportionate increase in the monetary base in the remaining euro area. The break up would lead to investors’ tilting away from government bonds towards European private sectors. There would be a global crisis that would be worse than 2008-2009 because the world’s most financially integrated region would be ripped apart by defaults, bank failures and the imposition of capital controls. This will bring panic within the markets.
The high debt level would mean that changes in policy would be hard to implement and there would be no changes which would be unfavourable to the EU. This favours fiscal consolidation which is a policy aimed at reducing government deficits and debt accumulation, this would be helpful in the debt crisis.
What is to come are years of stagnation which means low economic growth, high inflation and high unemployment which means there will be a prolonged recession. This means growth of less than 2-3% per year and even talk of contraction rather than growth in years to come. The policy response to the fiscal deficits could trigger a double dip recession and the growth between the “PIIGS” countries and the stronger Eurozone countries could widen. Germany themselves might experience flat to slow growth in years to come.