Eurozone in crisis: what is way forward?

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As you know some of Eurozone member countries are running budget deficits and accumulated large public debts. Discuss reasons why it has happened. What scenarios you can envision when financial markets refuse to further finance the deficits? In your answer, consider the reaction of domestic citizens as well as that of the various European institutions and Member states.

The financial crisis started in 2008. Greece, Spain, Portugal and Ireland were the first countries which had to deal with financial problems. The EU gave a big help to these countries, especially to Greece, which had a debt of around 300bn euros [1] . After everybody thought that the financial crisis had passed, another country came up with its huge debts and economic problems. As a surprise, one of the most powerful economies, Italy, was facing serious problems. Huge debts, high unemployment are some of the consequences of the financial crisis. During this article an analyse of the EU economic situation and the effectiveness of measures of the Italian government will be made.

The economic crisis exposed 2 main problems in the design of the EMU (European Monetary Union). The first problem concerns the sustainability of public finances of the EU countries and the second concerns the divergences in the international competitiveness of EU members due to the inadequate macroeconomic policy coordination. These problems are also threatening the existence of the Euro.

The Public debt table can give us a better overview of the financial situation in Europe.

Ireland's government debt has risen to almost 80 % of GDP, whereas the European Commission projected that it would be around 30 % of GDP. The same story is with Greece and Italy where the public debt is increased very much (more than 100 % of GDP). EU countries failed to coordinate the economic policies effectively and this resulted in divergences in the business cycle and in competitiveness. Rising government debt in 1 EMU country can have serious consequences for all members They are all responsible for the bad economic situation of these countries and all EMU members indirectly share the liability for fellow countries' private -sector debt.

What were the main solutions for EMU to solve the problem of the public debt ?

Solution 1 : Debt brake for EMU countries

The debt brake was proposed according to the Treaty of Maastricht [2] . They limit :

the deficit in general government finances to 3 % of GDP of the current year.

the public debt-to-GDP ratio to 60 %.

Every member state reports to the European Commission the planned and the government deficits and debt levels once in 6 months. Then the Commission decides if the country deficit is becoming or risks becoming excessive and it draws up a report which will be presented to the Council. The council gives the last word whether the country excessive deficit exists or not. If the results of the Council conclude that there is an excessive deficit, they will make a recommendation to the "excessive deficit" country and give a 6 months deadline for the necessary corrections to be taken. If the situation of that EU member state has not changed after 10 months, the Council will require the state to make a non- interest bearing deposit. These rules started the official function in 1993 but till by the end of 2001, 7 of 12 EMU States managed to achieve the target(balance or surplus). France, Germany and Italy are 3 largest economies who always failed to reach the balance.

Although these fiscal rules were introduced, the public debt in EU exceeds the 60 % reference value as a result of the impact of Greece, Ireland, Spain, Portugal, Italy and Belgium, which are highly indebted countries.

Solution 2 : EMF (European Monetary Fund) [3] 

The European Monetary Fund was created to take contributions from EMU countries. Contribution parameters consist of :

1 % annually of the stock of excess debt. This is actually the difference between the actual level of public debt at the end of the previous year and the Maastricht limit of 60 % of GDP.

1 % of the excessive deficit. This is the amount of the deficit for a given year that exceeds the Maastricht limit of 3 & of GDP

If we make a simple calculation for Greece, with a debt to GDP ratio of 115 %, its contribution would be equal to 0,55 % of GDP. As about the excessive deficit, Greece had a record level of 13 %, so its contribution would be 0,10 % of GDP. In total, Greece had to give a contribution of 0,65 % of GDP.

The deficit and debt level are warning signs for the EMU countries, so this is the reason why they were included in the Maastricht rules and why are taken as levels for contribution. Since EMF was created, they had a reserve of 120 billion Euros ready to finance any of the EMU Member States. In some cases like Greece, EMF sold even parts of its holdings to provide Greece with a loan of 110 billion euros.

There are some conditions for profiting from the EMU "rescue" money. The countries had the right to call for help, till the amount of money that they had deposited in the past including interests. More money could be given if the country would start to implement a tailor made programme(created and supervised by EMF and the European Commission.)

Greek economic situation

Although it was said that the European economy emerged from the crisis, however, reviving economic future is facing new difficulties. While some EU countries reported that their economic growth has stopped, Eurozone countries have announced that their economies grew only 0.1 percent during the last quarter of last year. However, Greece continues to be concerned about the future of the country's economy. The economic situation in Greece was desperate, the euro has plunged deeper into crisis since the creation of this coin 11 years ago. Among officials and European investors were growing concerns that the financial problems of Greece can be spread in other countries. Stock markets at the end of the week were up in the climate of optimism created by the European aid for Greece, the thought that this could help avoid a larger crisis between the 16 countries using the euro. The data(provided above) has shown that the financial crisis was worse than predicted and citizens of European countries express disbelief at improving the situation. Some months ago the state was involved from the protests of workers nationwide.

Italian economic situation

To understand the magnitude of the crisis in Italy should The analysis is focused in two main sectors of the economy, financial and the real one.

Economic analysts agree that the Italian financial system is solid and has not suffered the negative effects caused by the banking crisis erupted in the United States. The European Commission itself in the evaluation of the Italian stability program for 2008-2011 has stated that "the low private sector debt and a relatively solid financial system so far have sheltered Italy direct from the impact of financial crisis. " In short, it is stated that the Italian banking system is solid and has not been overly exposed to the speculation that has caused so much damage in other countries.

As for the real economy datas are significantly worse. Italian GDP ended 2008 with a massive drop of 2% over the previous quarter. The GDP in 2009 was around 2.6% on an annual basis.

More "interesting" are data's from industrial production which has slowed markedly in 2009 with a closing - 4% ​​compared to the previous years, with the decline even more sharply in the month of December by 12.2% over the same month of the year 2010. The same can be said for the number of unemployed grew in late 2009, reaching 6.7%, after years in which unemployment has been declining in Italy.

Of course, after looking the negative data's ,EMF started to think for the situation in Italy. Italy's economy is going down.

Source: "Total Exports April 2008- May 2010" Instituto Nazionale di Statistica

The table shows clearly that during a period of 1 year Italy had a negative balance for 9 months. In January 2010 the difference Export-Import was - 3700 million euro. This is a big loss for a EU country. The Italian economy was totally depending on the exports.

There were also external factors which affected the negative export balance. Since the financial crisis started, exports in Italy had declined. So, in money language, this means that billions of euros were going out of Italy month after month. In May 2009, the dynamic trend of exports was negative towards all the trading partners (Germany -34 %, France -28.7 %, The Netherlands -28.1 % etc.) [4] Only in the last months of 2009, did the statistics show signs of economic recovery. Another problem is the unemployment: Although the impact of the financial crisis on the Italian labour market was milder than in other countries, unemployment reached 8.7 % [5] in May 2010. There was an increase of 2 % points since the crisis started. The Government response to the job crisis was to support the labour demand by increasing the funds for the Italian short-time work scheme. This scheme was in general effective. Another measure that the Italian government took is to monitor external balances so that they can measure future default risks. The Bank of Italy tried to minimize the debt by selling some of its gold reserves. The total reserves were 38 billion euros worth of gold and 21 billion in foreign currency [6] . Some of this reserve had to be retained under an agreement with the European Central Bank.

Apart from Italy, which was in big trouble, other European countries like France, Holland and Germany sold off some of their central bank's gold reserves. This was done to prevent any financial crisis.

Spanish economic situation

The biggest industry which felt the crisis in Spain, was the construction industry. This was almost the same situation as in USA. People could not afford anymore the bank interests. Another fact that shows the bad situation in Spain is the unemployment [7] . It is currently at the level of 3,564,889 people unemployed but it is showing signs of improvement. The Social Security system received 1,3 % less than the same period of last year and paid around 9 % more than last year. As about the Spanish government debts, they reached around 100 billion of Euros or 10 % of GDP. This shows that the economic situation has a recession (the same as the Greek case).

Portugal economic situation

Portugal is a founding member of EFTA(European Free Trade Association) and NATO. Portugal is one of the countries which is included in the PIIGS [8] group.(Portugal, Italy, Ireland, Greece, Spain). The country was hardly hit by the crisis in 2008 and it has not yet recovered itself. Although Portugal was in big financial troubles, they did not ask for the rescuing financial package which is provided by the European Monetary Fund. According to analysts, the maximum amount of money for Portugal would be 80 billion Euros. The government has introduced some new regulations in order to manage the country debt. The debts will start to be paid during 2011 in forms of interest costs and maturing loans. In 5 June, there are the elections and this will be a very difficult period for Portugal because the elections are between the dates of redemption of 2 major bonds. In total, the value of bonds is around 9 billion Euros which is really a big help for a country to avoid the bailout.

Conclusion

To conclude, in a worst case scenario, this huge debt and deficit that Italy, Greece, Portugal and some other countries have can affect the Eurozone. This means that if these countries do not improve their monitoring and fiscal policies, they can be "kicked out" of the Eurozone or even the Eurozone could be broken up.

What can be the consequences of being kicked out of EU ?

Firstly, the enormous debts that countries like Greece, Italy and Portugal have, would probably increase or remain the same because they would not receive any more help from the EMU. Secondly, Italy would start to adopt again the old currency, Italian Lira. Greece would start to adopt the Drachma. This means that banks interest policy would change completely and it would depend on the exchange rates of their country currencies. The trade with other countries would also depend on the exchange rates. Adoption of a "new" currency could decrease the wages and the whole economy.

Greece is more risked than Italy to be "kicked out" of Eurozone due to the facts that they already have a public debt of 12,7 % of their GDP (4 times higher than EU norms) and a total debt equal to 113 % (double of the EU norms).

Another possibility is that "strong" EU countries go out of Eurozone. Germany has already discussed this possibility in their parliament [9] . The poll [10] from one of the biggest newspapers in Germany, Bild am Sonntag, showed that 53 % of Germany want at least Greece out of Eurozone or as a last possibility, Germany to quit from Euro currency. If Germany and any other EU country go out of Eurozone, this would lead to a breaking up of Eurozone. This would have further consequences. The European Union would be as stable as before due to the fact that the countries would cover by itself their economic and financial problems.

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