The debate between the European Union's Fiscal and Monetary policy and its implications on the overall economy of Euroarea

1. European Crisis
-Conflicts between Monetary and Fiscal Policies
-Pankaj Pandey
T A PAI MANAGEMENT INSTITUTE
Batch of 2014-16

2. EUROZONE
• It is an Economic and Monetary Union (EMU) of 18 European Union
(EU) member states (27 countries altogether) that have adopted Euro
(€) as their common currency.
• Also known as “Euro Area”
• Eurosystem: Monetary authority of Eurozone
• Consists of European Central Bank(ECB) presided by Mario Draghi.
• Central banks of member states

3. • Eurozone hit by recession in 3rd quarter of 2008
• Crisis started from Oct-2009 in Greece.
• The public debt level there rose from 107% in
2007 to 145% of its GDP in 2010.
• Speculated to cross over 170% in 2015.
• Further spread to
PIIGS: Portugal, Italy, Ireland, Greece and Spain.

4. Reasons for Crisis
• Excessive spending by EU member countries.
• Weak actual and potential growth due to ongoing global economic crisis.
• Liquidation of banks in EU.
• This led to large Debt to GDP ratio of the member states, resulting in
Continuous increase in government and private sector liabilities.
• Real Estate bubble

5. Eurozone Monetary Policy
• What they EXPECTED:
• Maintain rate of interest by controlling money supply in the economy
• Seek Economic growth and stability by reducing unemployment and inflation
•What really HAPPENED:
• Prior to formation of EU, smaller countries couldn’t buy as much as they wished. Interest
rates were high (~18%) and there was a limit on borrowing.
• With EU coalition, money supply was controlled by ECB. With reduced interest rates (~3%),
EU members could now borrow huge sum of money.

6. The Effect of Monetary Policy
Smaller
Countries
European
Union
Lower Interest
Rate
Increase in Borrowings
Lenders more
confident of timely
return
Provided more and
more funds to borrow
Smaller countries
accumulated more
debts
Debt repayment with
more borrowed
money
Large Credit Flow
Large Debt
accumulation

7. Eurozone Fiscal Policy
• What they EXPECTED:
• Collect revenue from public by taxation
• Spend money by expenditure in economy to influence the aggregate
demand.
•What really HAPPENED:
• With increased money supply due to increased lending, fiscal profligacy of
both private sector and government took place.
• The Union had to take some Fiscal Reforms.

8. Fiscal Response to Financial Crisis
• Eurozone countries announced Bank Rescue scheme
• Liquidity support by ECB
• Government guaranteed inter-bank lending and new debt issue.
• Seeking public support to the banking sector targeting asset relief (asset removal scheme
- “bad banks”; Asset insurance scheme-tail risk)
• This impacted the Government accounts as a result of fresh liabilities and
potential debts. Its long term implications are debatable.

9. • The Eurozone crisis affected demand, competitiveness and
potential growth of the member countries.
•Two measures possible
• Austerity measures
• Keynesian model (Growth measure, Increased government
spending leading to multiplier effect

10. Keynesian v/s Austerity Measures
– The Big Debate
Austerity Measures
• Short Term:
• Painful and damaging to the ego of the
citizens of the country
• Mid Term:
• Increased taxes and reduced
government spending with low income
level can cause political instability and
public havoc.
• Long Term:
• Existence of EU in doubt.
Keynesian Measures
• Short Term:
• Issue of funding
• Bond Ratings are bad
• Conditions, if borrowing from ECB/IMF
• Mid Term:
• Question of response to growth stimulus.
• Long Term:
• Viability in light of multinational industry
conflicts
• Over Supply
• Price Crashes

11. Latest Update on Eurozone’s Fiscal Policy
• In September, the ECB announced it would buy covered bonds and other assets
for two years in an effort to stimulate the Eurozone economy.(Quantitative
Easing)
• Current Economic status
• Growth Rate: 0.2%
• Rate of inflation: 0.3% (Persistent Stagnation)
• 26-Nov-2014: European Commission President Jean-Claude Juncker has given
details of a €315bn (€16bn from EU Budget and the rest from public) investment
plan to kick-start Europe's economy.
• 4-Dec-2014: ECB has "stepped up" plans for more stimulus measures aimed at
revitalising the Eurozone economy. ECB willing to buy government debts.