Eurozone Financial Crisis

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An analysis of the eurozone financial crisis FROM EURO TO ZERO

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Researched the effectiveness of the European Central Bank and peripheral countries’ responses to the Great Recession

Transcript of Eurozone Financial Crisis

Page 1: Eurozone Financial Crisis

An analysis of

the eurozone

financial crisisFROM EURO TO ZERO

Page 2: Eurozone Financial Crisis

• Formation of the eurozone

• Causes of the financial crisis

• Response of the ECB and governments

• Recommendations for the future

SUMMARY

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1970s: Creation of the European Monetary System within the

European Community

France/ German dynamic

Early 1989: Delors Plan instigated by France

Vague deadlines

FORMATION OF EUROZONE

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December 1989:

Importance of uniting Germany to Europe

Germany’s opposition and France’s concern

Chancellor Kohl and President Mitterand agree on details of

Delors Plan at Strasbourg Summit– known at the Maastricht

Treaty

TURMOIL BRINGS UNION

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Germany drags feet

Slow process– “low levels of inflation, interest rates, and budget

defects”

1990-1991: Maastricht Treaty finalized amid now -or-never

mentality

Ironically, neither Kohl nor Mitterand were proficient in

economics.

DEVIL IN THE DETAILS

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EMU Regulations Created

Requirements regarding budget deficits, debt-to-GDP ratios, inflation,

and interest rates

1997: Stability and Growth Pact enacted to continue these

No sovereign bailouts (oh really?)

EMU REGULATIONS

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1999: Currency implemented

Initial implementation: 11 of 15 EU countries members

2001: Greece joins

2002: Currency begins circulating

Greece and Italy do not achieve sufficient debt -to-GDP level.

AND SO IT BEGINS

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EMU Structure

Common currency between countries

European Central Bank charged with monetary policy

Economic autonomy with caveat of Stability and Growth Pact

HOW IT WORKS

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2008: Housing Bubble collapses (that’s another story)

Impact on Euro is dismal

2009: Greece’s debt equals 113% of its GDP

2010: Ireland receives bailout of 85 billion euros

GLOBAL RECESSION STRIKES

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The PIIGS wrecked havoc…

PIIGS=Portugal, Ireland, Italy, Greece, and Spain

Borrowing in their own currencies

Interest rates compounded problems

Rates converged at Germany’s (lower than other countries)

Sovereign debt increases

2008: Greece and Italy’s public debt as percent of GDP was 112.9

and 106.1

WHAT HAPPENED?

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Germany saw an opportunity

With low interest rates, the private sector was incentivized to

increase spending.

2007: Ireland’s private sector debt 184.3% of GDP

By 2010: Germany was the second largest creditor to Irish banks

WHAT HAPPENED (CONT.)

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2010: ECB requires austerity measures after discovery that

Greece l ied about debt levels

Austerity measures increase taxes and cut expenditures

Decreased revenue

April 2010: Bonds’ yields so high that Standard and Poor

downgraded them to junk status

Greece’s banks had about 25% of GDP in bonds

2010: International Monetary Fund and eurozone announce

first bailout for Greece

GREECE

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“ It is those countries that were borrowing (as opposed to

those whose governments were borrowing) that are currently

under attack” (Shambaugh).

Italy and Greece (sovereign debt); Ireland and Spain were not

guilty of this

Investments “that had little ef fect on future productivity

growth” ( ie housing bubble) major problem.

Revenue slowed, no liquidity (can’t print money, no profit)

MULTI-FACETED PROBLEM

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Austerity Measures--> stunted economic growth

Bailouts to Greece, Portugal, and Ireland

Three-year loans if they implemented austerity measures and

structural reforms

Banks invested in ECB bonds (not bad, just not fixing anything)

ECB bought bonds from countries (especially Italy and Spain)

Aimed at reducing bond yield

Temporary Fix

Current actions:

Stress tests to determine assets

ECB take over

ECB’S RESPONSE

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Option 1: Dissolve eurozone

Not optimal

Peripheral countries would lose 40-50% of GDP in first year alone

Option 2: Remove Greece

Run on banks (drachmas)

WHAT SHOULD BE DONE?

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Eurozone is politically beneficial, economically disastrous

Causes of the crisis are multi-faceted and debated

Solution is not clear

SUMMARY