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Paneuropean University
January, 2014
The Impact of Debt Crisis on the Economy in the Countries
of
European Monetary Union
Antonia FICOVA
Doctoral Student at Faculty of Economics and Business
Paneuropean University, Bratislava
antonia.ficova@yahoo.com
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OUTLINE
irst, adoption of the euro led to convergence of interest rates in countries
to the levels in core countries, second in combination with rising capital
inflows owing to greater financial integration, third set off a consumption, fourth real
estate boom in the countries. These factors resulted to higher growth and increases in
government revenue and spending. On the other hand, appreciation led to a loss of
competitiveness in the countries, adversely affecting export performance and causing
rising current account imbalances. In sum, euro exacerbated intra-European
imbalances whose unsustainability triggered the current sovereign debt crisis.
What is the solution to end the European Debt Crisis? Answer provided by
Schäfer, H. B. (2012, p. 7) suggests that eurobonds would have been pool the public
debts of all countries in the Euro zone, proposed by the former Eurocrat Jakob von
Weizsäcker. So the question is: What would be the consequence of converting all
Euro zone public debt into Eurobonds with a joint and several guarantee of liability?
The interest rates for Greek, Irish, Spanish, Portuguese and Italian government bonds
would fall dramatically as a result of a diminishing insolvency risk.
1 INTRODUCTION
f we look at the European debt crisis, that is defined by shorthand term for
Europe’s struggle to pay the debts it has built up in recent decades.
Especially, five of the region’s countries such as Greece, Ireland, Italy, Portugal and
Spain (G, I, I, P, S). In sum, this countries failed to generate enough economic growth
to make their ability to pay back bondholders the guarantee it was intended to be.
Consequently, these five, debt to GDP in 2013 Q1 can be seen on the Figure 1, were
seen as being the countries in immediate danger of a possible default, so the crisis has
far-reaching consequences that extend beyond their borders to the world as a whole.
We see unsustainable fiscal policies of countries in Europe and around tho globe.
Moreover, when growth slows, so do tax revenues that resulted to making high budget
deficits unsustainable. For example, on the one hand Greece’s debts were so large that
they actually exceed the size of the nation’s entire economy, and on other hand the
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country could no longer hide the problem. If we focus on implications for investors,
they responded by demanding higher yields on Greece’s bonds, which raised the cost
of the country’s debt burden.
Figure 1 Government debt to GDP ratio, 2013 Q1 in percentage
Source: Author´s, according to data from Eurostat, 2013 Q1
However, the European Union responded slowly due to requierements the
consent of all 17 nations in the union. In spring, 2010, when the European Union and
International Monetary Fund disbursed 110 billion euros to Greece. Particularly,
Greece required a second bailout in mid-2011, Ireland and Portugal also received
bailouts, in November 2010 and May 2011, respectively. So the Eurozone member
states also created the European Financial Stability Facility (EFSF) to provide
emergency lending to countries in financial difficulty.
If we look at action from European Central Bank, ECB announced a plan, in
August 2011, that included purchasing government bonds if necessary in order to keep
yields from spiraling to a level that countries such as Italy and Spain could no longer
afford. So in December 2011, the ECB made €489 in credit available to the region’s
troubled banks at ultra-low rates, then followed with a second round in February
2012, that has been called as Long Term Refinancing Operation (LTRO). As
a conclusion, the EU's bailout mechanism is increased to €1 trillion.
Generally, financial instituions hold on to their reserves rather than extend
loans. Slower loan growth, in turn, could weigh on economic growth and make the crisis
worse. As a result, the ECB sought to boost the banks' balance sheets to help forestall this
potential issue. However, each investor´s reaction pay attention on news from
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Europe, moreover European bank stocks and the European markets. They performed
much worse than their global counterparts during the times when the crisis was on
center stage. The bond markets of the affected nations also performed poorly, as
rising yields means that prices are falling. At the same time, yields on U.S. Treasuries
fell to historically low levels in a reflection of investors’ flight to safety.
The political implications of the crisis are especially cutting expenses to reduce
the gap between revenues and expenditure. Second, the possibility that one or more
European countries would be abanddon for the euro. On one hand, leaving the euro
would allow a country to pursue its own independent policy rather than being subject to
the common policy for the 17 nations using the currency. But on the other hand, it
would be an event of unprecedented magnitude for the global economy and financial
markets. This concern contributed to periodic weakness in the euro relative to other
major global currencies during the crisis period.
2 LITERATUREREVIEW
opic European Debt Crisis has generated attention in the literature for
several years prior to 2010, what I summarize below.
Particularly, when the government tries to reduce private debt, this results in
an increase of public debt. So on the one hand the debt crisis has a significant impact on
the Eurozone, as it constantly raises new issues as to its viability and on the other
hand the future of the Euro as a common currency as described Blundell-Wingall,
Slovic (2010, p.4).
The real consequences associated with the banking crisis (higher
unemployment) describe in general, changes of the current account balance of
whatever sign are not necessarily an indication of imbalances. Viewed in this light, they
may simply reflect intertemporal saving as well as consumption and investment
preferences of private enterprises, households and governments presented by
Obstfeld and Rogoff (1994). Moreover, rising prices and unit labour costs and strong
investment could be due to a catch-up of periphery countries within the euro area.
Candelon, Palm (2009, p.3) noticed it may affect government tax revenues,
which will shrink, and on the other hand government spending, which will rise,
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through social security (unemployment benefits) and through measures designed to
stimulate global demand. Nevertheless, this automatic stabilizer mechanism deepens
the budget deficit and increases the debt. As a consequence, this restrictive fiscal policy
could increase the probability of default for households, increasing the amount on non-
performing loans, again putting tensions on the banks' balance sheet.
Hofmann (2012, p. 2-3) pointed out that a country with unsustainable debt
exercises emergency measures to regain sustainability. The goal of economic growth
requires measures to increase a country’s competitiveness, that include austerity, default
and restructuring, as well as inflation coupled with depreciation of the currency. On the
other hand monetary depreciation caused by expansionary monetary policy,
potentially coupled with Quantitative Easing, is the easiest way out. As a result, that
may raise the country’s competitiveness through boosting exports and potentially
attracting capital lured by cheap production cost. Viewed in this light, a country in a
currency union lacks the power to control and enforce these measures. In sum,
depreciation of the Euro is simply impossible without detrimentally affecting all of
the 17 Euro zone countries that are intractably linked by the same currency.
2.1 Rationale
ive countries, as I mentioned before, their annual budget deficit was
never low enough to satisfy the eurozone's Maastricht Criteria1. Like
Greece benefited from the power of the euro, which meant lower interest rates and
an inflow of investment capital and loans. If we focus on situation when Greece
leaves euro, first once it converted its euro-based debt to drachmas, it could then
print more currency, so lowering the exchange rate value of its debt. Second, foreign
owners of Greek debt would suffer debilitating losses, and some banks may even go
bankrupt. Third, interest rates on other indebted countries, such as Italy or Ireland,
might go even higher as ratings agencies become concerned they would leave the
euro also. In sum, the value of the euro itself would weaken, helping EU exports but
creating higher prices for imports into the EU. According to this informations from
1 Maastricht Treaty includes five criteria, they are summarised as follows: First, inflation ﴾12 – months
average of yearly rates﴿, second Government Budget Deficit, third government debt to GDP ratio, fourth
exchange rate and last is long-term interest rate ﴾average yields for 10y government bonds in the past year﴿.
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my research, I see impact of debt crisis on this country where are austerity measures
needed. I would like to more focus on this issues in countries of eurozone, as
a conclusion I would like to examine and develop this actual subject, so the research
will extrapolate findings in succession research.
3 METHODOLOGY
esearch is defined by Saunders as: „the systematic collection and
interpretation of information with a clear purpose, to find things out.“
(Saunders et al., 2003). The Research may follow a „Deductive Approach“ by testing
the theoretical propositions with the adoption of suitable testing methods or an
„Inductive Approach“ by collecting relevant empirical data and evolving the necessary
theories based on the data collected.
Data sources can be described as the carriers of data (information). There are
to types of data sources according to Ghauri et al., 1995: First, primary data (field) is
collected specifically for the research project. This will be in form observations.
Second, secondary data (desk) is collected by others. These include academic and non-
academic sources.
4 OUTCOMES
The possible solutions to the Euro Zone Crisis are many. However, two
measures seem inevitable in order to restore financial stability in the Euro Zone.
The first and must obvious solution is to carry further the integration of the
European Union. So far, the Euro Zone is just a trade and monetary union, but
politically there is no integration. That means, as well, that every single country has
its own budget and taxation. This could be partially solved if some transfer
mechanism were implemented, using a development bank that could function as the
Brazilian BNDES (National Social and Economic Development Bank). This would
improve the periphery competitiveness, boost aggregate demand and restore the
economic environment.
Second, due to the crisis and the new interest rates, debt has become too high
on the periphery, different ways to reduce debt have been used around the world.
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To chose the most appropriate one is could be for further research. Either European
Bonds or different way.
5 REFERENCES
Alfaro C.E., Gámez M. M., García R. N. (2003) „Una clasificación socioeconómica de
las regiones europeas mediante Mapas de Kohonen“, Working paper.
University of Castile La Mancha.
Blundell-Wingall, A., Slovic, P. (2010) “The EU Stress Test and Sovereign Debt
Exposures.” OECD Working Papers on Finance, Insurance and Private Pensions,
p. 4
Candelon, B., Palm F.C. (2010) „Banking and Debt Crises in Europe: The Dangerous
Liaisons?“, CESifo working paper Fiscal Policy, Macroeconomics and Growth,
No. 3001, available at: <http://hdl.handle.net/10419/38910>, Sep 10, 2012
Eurostat – newsrelease, euroindicators, 114/2013 - 22 July 2013, available at:
<http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-22072013-AP/EN/2-
22072013-AP-EN.PDF>, Sept 6, 2013, p. 1, 4
Garson, G.D. (1991) „A comparison of neural network and expert systems algorithms
with common multivariate procedures for analysis of social science data“,
Social Science Computer Review 9, 399-434.
Higgins, M., Klitgaard, T. (2012) „Saving Imbalances and the Euro Area, Sovereign
Debt Crisis“ Volume 17, Number 5, available at:
< http://www.newyorkfed.org/research/current_issues/ci17-5.pdf >, Sept 10,
2012
Hofmann, Ch. (August 1, 2012) „The Euro Zone Crisis“, available at SSRN:
< http://ssrn.com/abstract=2121499 >, Sept 10, 2012
Nowotny, E. (2012) „European Monetary Union - lessons from the debt crisis“, BIS
central bankers’ speeches, available at:
< http://www.bis.org/review/r120511b.pdf?frames=0 >, Sept 10, 2012
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Saunders, M., Lewis, P. and Thornhill, A. (2003) „Research Methods for business
students” 3rd ed., Harlow, Essex, FT Prentice Hall
Schäfer, H.B. (May 1, 2012) “The Sovereign Debt Crisis in Europe, Save Banks Not
States“, Available at SSRN: http://dx.doi.org/10.2139/ssrn.2049299 , Sept 10,
2012