Sample of assignment – reasoning the Euro crisis

  1. What is the Euro crisis and discuss the factors that have brought about the Euro crisis?

Euro crisis

Proposed by Minescu (2011) the euro crisis is a term to describe the situation of EU member countries which are struggling to pay their debts built in recent period of time. This crisis blew up in Greece and then spread many European countries. Many countries such as Greece, Ireland, Portugal and other EU member all failed to promote their economy in a expected growth rate to expand their capacity to repay the debts they borrowed before. Although these countries were seemed as the ones which suffer immediate risks, the actual consequences of this crisis are far-reaching than only a few countries, which not only impact the EU countries a lot but also have further side influences on the whole world. As the euro crisis has such a influence for the economy of the whole world, the causes of this crisis are also important for us to pay great attention.

Increasing of debt levels

The first cause of this crisis described by Minescu (2011) is the sovereign debt problems in the PIIIGS countries such as Portugal, Ireland, Iceland, Italy, Greece and Spain, which are all possessed by large debt burdens. According to the forecast of IMF, it predicts that the debt level of the PIIIGS countries may even reach 100% in next year in the aspect of their economic output as table 1.0 shows. Although in the normal period, if the interest rate is low and the earnings and tax income are increased due to the economy growth, the level of debt in these countries may be sustainable and payable. But unfortunately, the 2008 to 2009 financial crisis had a strong attack on the European economy and its developing speed, the significant increased interest rate in the PIIIGS countries and other related factors lag the developing of the economy of this area and make these countries struggle to pay back their debts.

Table 1.0 the debt level forecast in 2012

figure 1.0

Source: IMF

Side effects of the common monetary policy

Wignall and Slovik (2011) told us that Euro is the common currency among EU member countries, which denotes all of the member countries have no choice but to adopt the same monetary standard related to euro that the standard exchange rate, inflation rate. And in the meanwhile, the issue right and control right on euro are all controlled by ECB, which shows there is no single country able to own the right to depreciate or appreciate the euro since they join in EU. Not like the USA, it is able to depreciate its currency to alleviate the pressure brought by the economy recession to protect the healthy development of its export trade and economy. These EU member countries, such as Greece, they can’t resort to depreciating their currency to stable its embarrassing economy situation, because only ECB has the right to carry out the monetary policies. So these EU countries may only use other means to calm down the economy panic rather than the monetary measures, which may not as effective as the monetary ones (Becker & Sebastian 2009).

Internal mismanagement

The euro crisis isn’t an accident but it is caused by some mismanagement practices of the member countries respectively.

I. Greece

As the first EU member to receive the help from EU and the IMF, Greece has the worst debt level. The survey from the Economist (2010) noticed Greece had a high level of public debt reaching even at 100% of its GDP when it joined in the euro at the beginning. And joining the common currency system has also promoted many favorable terms of Greece to refinance its government debt. At the same time the great developing speed of other EU members assist the process of Greece’s economy together, which covered the weakness of the public finance for Greece. This situation made the government debt situation of Greece becomes worse and worse. For example, the deficit in current account reached 14.6% out of GDP in 2008 and the debt level of its government reached 115% out of GDP in 2009.

Worse still, in the capital raising aspect, Greece had been depending on too much on the consumer expending and foreign investment, which further intensify the conflicts of high government spending and lowing government savings. Nelson et al. (2010) explained to us further that besides the mentioned causes, the little right to depreciate the currency and low level of economic competitiveness due to extra-employment and payment in the public sectors finally made the debt crisis occurring in Greece firstly.

II. Portugal

As one of the follower of the debt crisis after Greece, Portugal owns its special factors. From the Economist (2010), it denotes the major reasons caused the debt crisis of Portugal were the high level of budget deficit and large amount of the government debt, which was different from Greece. Before entering the common monetary system, Portugal had enjoyed a fast growth speed in its economy. But when entering the euro, it has begun to loss its competitiveness due to its wage levels.

Moreover, the Economist (2010) claimed that the further development and enlargement of the size of EU members also diverts a large amount of foreign direct invest from Portugal to other new member countries. The economy dilemma roused by these factors finally pushed Portugal into the euro crisis.

III. Spain

As the victim of euro crisis, Spain has its own problems even its debt level wasn’t as large as Greece. The Economist (2011) also explained the reasons of Spain which lay in its national bank system and housing market. The improper loans issued by Spanish banks to these property developers, which even equals 31% of its GDP and the large amount of bad loans had destroyed the economy.

And from the explanation of the Deutsche Bank (2011), besides the above problem, there was also a bad influence of the high level of unemployment rate in the healthy development of its economy. All of these factors also made Spain have to face the debt crisis.

Pressures for financial system

Another factor causing the euro crisis is the financial system in the region. Whenever in the debt crisis period or before the debt crisis period, there is a mismanagement of the financial system such as the banking system. In the credit policy aspect, many member countries banks had adopted a rather loosing policy to issue large amounts of loans to house consumers and ignored the actual purchasing power and loan payment capacity of these borrowers. In this situation, there was a common phenomenon that the bank loans often exceeded the deposits, which made many banks even some strong banks become passive when a large amount of capital required by the country to meet the debt challenge. As this situation was very common in the EU countries, the financial capability of EU countries to solve the debt problem became comparative weak which further push the debt crisis to come into being.

Capital flowing away

A large amount of the capital is the most effective means for EU to calm down the debt problem. But as the bad economy situation, the unstable financial capacity of the banks, slow or even negative economy development rate in some countries made may investors particularly some foreign investors flee away from the euro market, which further deteriorate the financial stability of EU and made the debt problem become more and more difficult to solve. This is also the factor causing the euro crisis.

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