15 52 EuroZone Financial Crisis

8/2/2019 15 52 EuroZone Financial Crisis

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THE EUROZONEFINANCIAL CRISIS

Presented By:

Dhawal Sah (MS-15)

Sonam Gensapa (MS-)


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FLOW OF PRESENTATION


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TRANSMISSION FROM UNITED STATES


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http://mjperry.blogspot.com/2009/04/house-price-indexes-usa-vs-europe.html


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EUROPEAN CRISIS BEGAN LATER

US Housing Prices peaked in late 2006

European Housing Prices peaked a year later

Financial Crisis struck Europe & US at same

time, August 2007, after Bear, Stearns,Fannie Mae & Freddie Mac taken over withUS Government assistance in April and Julyof 2007

International credit markets froze up inAugust 2007 when subprime based hedgefunds collapsed in Europe and US. No longerable to borrow short-term funds, banks facedmuch higherrisk premia


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INTEREST RATE SPREADS IN DOLLARS AND

EUROS


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WHY DID THE CRISIS SPREAD?

Subprime Debt Obligations made in USA heldaround the world caused global financial shock.

Housing bubbles burst in UK , Ireland, Spain aswell as US.

Failure ofLehman Bros in September 2007 causedmassive panic over counterparty risk. AIG required$180 billion bailout to coverCredit Default Swaps,insurance against bond defaults underwrittenwithout reserves.

Stress on banks around the world led to shrinkingcredit availability. Shadow off-balance-sheetbanking sector collapsed as short-term fundingvanished.

Falling demand spread from US to all countries; as

US imports dropped, other countries exports fell.


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BANKS UNDER DURESS: WRITEDOWNS AND CAPITAL

RAISED

(US$ BILLIONS)

S

ource: International Monetary Fund (2008)


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QUARTERLY REAL GDP GROWTH RATES

Source: International Financial Statistics, IMF.


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EUROPEAN FINANCIAL INSTITUTIONS

UNDER STRESS

BNP-Paribas forced to close funds in August 2007

UK bank Northern Rock taken over by government

German state banks IKB, WestLB, BayernLB andSachsenLB bailed out by government

Irish banks given government deposit guarantees

Switzerland injects funds into UBS

Icelands banks unable to roll over short term borrowing,default on deposits of foreigners


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CREDIT IN THE EUROZONE (%

CHANGE)

Source: European Commission (2009).


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MONETARYPOLICYRESPONSE BY

EUROPEAN CENTRAL BANK(ECB)

ECB injected liquidity into European banksunable to obtain short-term funds in market.

Federal Reserve used Euro-dollar swaps to

make dollars available to ECB to lend tobanks.

ECB did not lower interest rates untilOctober 2008 because of its focus on inflation.

Euro fell against the dollar due to safehaven flight to US Treasury securities.


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INTEREST RATES IN THE EUROZONE

AND THE US (INTERBANK RATES)

Sources: ECB, Federal Reserve Bank of New York


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FINANCIAL SECTOR BAILOUTS IN US &

EUROPE

TARP and Federal Reserve programs in US

National programs in European countries,due to absence ofEurozone-wide regulator.

Beggar-thy-neighbor effect, as first Irelandgave deposit guarantees, then UK, then

Netherlands, to avoid bank deposit flight.


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PUBLIC SUPPORT TO THE FINANCIAL

SECTOR

(AS OF 18 FEBRUARY 2009, % OF GDP)

Source: International Monetary Fund (2009).


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FISCAL POLICYRESPONSES TO RECESSION

Automatic Stabilizers of falling taxes, rising welfareand unemployment payments kick in as incomes fall

and unemployment rises.

Discretionary Fiscal Stimulus enacted in mostcountries, depending on their fiscal positions.

European countries limited by Stability and GrowthPact to 3% fiscal deficits, except in time of exceptional

economic distress.


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CHANGES IN BUDGET BALANCES,

OCTOBER 2008

Source: IMF (2009)


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THE ROLE OF THE EURO

Previous economic crises in Europe haveled to large devaluations of currencies.

Within eurozone, single currency preventsdevaluation , provides automatic financialsupport through capital markets.

Non-euro currencies depreciated sharplyin 2008, British pound sterling, Swedishkronor, Polish zloty, Hungarian forint.


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EXCHANGE RATES VS THE DMARK OR EURO

(LEFT INDEX: 1970Q1 = 100 RIGHT INDEX: 2007M1

= 100)

Source: International Financial Statistics, IMF, Monthly Bulletin, European Central Bank


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GREECES FINANCIAL PROBLEMS

Since joining the euro, Greece has had higherinflation than otherEurozone members.

Greece has also increased debt faster than others tofinance generous public sector pay, welfare, and

retirement benefits, while collecting a lower sharein taxes due to widespread tax evasion.

As a result, Greek goods have become increasinglyexpensive and uncompetitive, causing loss of

market share and further reducing revenues.


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RELATIVE PRICE INDICATORS BASED ON

EXPORT PRICES

80

85

90

95

100

105

110

115

120

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Germany

Greece

Spain

France

Source: European Commission (2010)


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THE GREEKDEBT CRISIS

Greek debt/GDPratio reached 113% and deficit/GDPratio reached12.7% in 2009.

Foreign bondholders became doubtful that Greece could continueto roll over its increasing debt, forced interest rates higher.

EU faced choice between Greek default and bailout with toughconditions.

IMF and EU agreed to lend Greece up to $146 billion over threeyears.

Greece to increase sales taxes, reduce public sector salaries,pensions, eliminate bonuses.


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GREECES DEBT DYNAMICS

Source: Economist.com


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CONCLUSION

Eurozone response: Interest rate policy reaction delayed:concentration on inflation target

Fiscal policy reaction muted: Stability & Growth Pact

Common currency members avoided large devaluationsand foreign currency debt.

European governments have tried to act together, notalways successfully.

Limited impact of falling exports due to extensiveinternal trade relationships.

Greece facing difficult adjustment problems, Europeanbanks avoiding losses on Greek bonds.


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THANK YOU !!

15 52 EuroZone Financial Crisis

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