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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 !!
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