EUP €


Set of flashcards Details

Flashcards 27
Language English
Category Micro-Economics
Level University
Created / Updated 15.01.2015 / 16.01.2015
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Eurozone - Pro's & Con's

Pros

  • High degree of price stability
  • A better deal for consumers
  • Lower interest rates for borrowers
  • More price transparency
  • Removal of transaction costs
  • No exchange rate fluctuations

 

Cons

  • Dependency
  • Potential macroeconomic imbalance
  • The rigidity of one-size-fits-all interest rates
  • Lack of Strong Federal Government
  • Abolished Independent Monetary Policies
  • You share the problems of the collective countries

Single Currency - Pro's & Con's

  • Advantages:
    • Elimination of transaction costs
    • Ellimination of currency risk
    • Greater price and market transparency
    • Lower borrowing costs due to more efficient financial markets
    • Lower admin costs
  • Disadvantages
    • A country gives up its independent monetary policy.
      • It gives up the possibility to change the exchange rates and the interest rates (internal & external monetary policy)
    • It depends on the integration of the countries.
      • E.g.: Germany - NL => 99% symmetric / Germany - UK => asymmetric

Symmetric shock

(One size fits all problem)

  • If all the EU is facing a shock, the ECB will decide to decrease the interest rates and increase the exchange rates

Asymmetric shock

One size fits all problem

  • When an economic supply or demand shock is different from one region to another, or when the shocks do not move in tandem. | Example: If Germany has a positive total demand shock and France has a negative total demand shock, then these two countries are experiencing asymmetric shocks. 

Stability and Growth Pact (SGP)

The Stability and Growth Pact (SGP) is an agreement, among the 28 Member states of the European Union, to facilitate and maintain the stability of the Economic and Monetary Union (EMU).

Is it realistic?

It is not. Rules are not appropriate to the situation of recession. France & Germany don’t follow it.

Convergence Criteria

The euro convergence criteria (also known as the Maastricht criteria) are the criteria which European Union member states are required to meet to enter the third stage of the Economic and Monetary Union (EMU) and adopt the euro as their currency.

Maastricht Criteria: (1997 Stability and Growth Pact)

  • Inflation: less than 3% GDP
  • Government budget deficit: Less than 3% GDP
  • Government debt: Less than 60% GDP ratio
  • Long-Term Interest rates: No more than 2.0% higher than average Europe.
  • Stable exchange rate: The country who just join, for two consecutive years, and should not have devalued its currency during the last two years

UK, “extra” test:

  • Business cycles must converge
  • Background: “One size fits all” problem
  • Flexible (labour) markets
  • Background: Giving up monetary policy

Maastricht Criteria

  • Inflation: less than 3% GDP
  • Government budget deficit: Less than 3% GDP
  • Government debt: Less than 60% GDP ratio
  • Long-Term Interest rates: No more than 2.0% higher than average Europe.
  • Stable exchange rate: The country who just join, for two consecutive years, and should not have devalued its currency during the last two years

European Crisis

  • The crisis started in 2007
  • Fever chart
    • The top of the fever is somewhere in 2012. Something has changed.
    • It shows the EU is ill (fever = fièvre).
    • Because the investor’s confidence decreased, investors were asking for higher interest rates to compensate.

Crisis 1: Sovereign debt crisis (p1)

The first chart shows the deficit (Fiscal balance).

Before the crisis, countries have positive figures.

2 opportunities to finance a deficit for a country:

  • Print more money (American issue)
  • Borrow money (just on the capital market): it will result in debt.

All those deficits together built the debt.

Because of the higher debt, you have to pay more interests.

--> Vicious circle

What are the main causes for a deficit to increase?

--> Banks in trouble

 

--> Economic growth low à Low wages à Tax revenues will decrease

--> More unemployment à More social benefits have to be paid

Crisis 1: Sovereign debt crisis (p2)

The second graph shows the debt of GDP. For all countries, the debt has increased since 2008.

Before the crisis, countries have positive figures.

2 opportunities to finance a deficit for a country:

  • Print more money (American issue)
  • Borrow money (just on the capital market): it will result in debt.

All those deficits together built the debt.

Because of the higher debt, you have to pay more interests.

--> Vicious circle

What are the main causes for a deficit to increase?

--> Banks in trouble

 

--> Economic growth low à Low wages à Tax revenues will decrease

--> More unemployment à More social benefits have to be paid

Greece

The situation is straightforward --> Mess of the government (always have a high government debt)

Ireland

Before, it was the shining example of the EU.

Situation cannot be compared with Greece...

Crisis 1: Sovereign debt crisis (summary)

Causes:

  • Lies, damned lies and statistics
  • Expenditures
  • Private debt à public debt
  • Recession

Debt crisis: Cause or result?

The crucial issue : Is a debt crisis a cause or a result ?

For Ireland, it is a result. So reducing the debt is not only the situation. (Because not a cause).

For Greece, it is a cause.

Crisis 2: Current Account crisis (p1)

Graph 1: shows the current account deficit or surplus (in blue), change in the current account deficit (in brown)

Spain: They didn’t have a current account deficit before 1998. Spain started the EU area with a trade balance (no deficit).

Germany: It started with a trade deficit in 1998. But after the introduction of Euro, it turned into a surplus.

Crisis 2: Current Account crisis (p2)

Graph 2: The first point doesn’t mean that every wage is equal in every country.

  • German wages decreased by almost 10% in 10 years.
  • Italian wages increased by almost 20% in 10 years.
  • Spanish wages increased by 12% in 10 years.
    • For the export position of Spanish and Italian companies, that means of a lot.

Crisis 3: Banking crisis

Banks are in trouble. It is maybe due to a lack of supervision.

Banks had too much freedom à result into a mess

Banks had too much freedom à result into a mess

Crisis 4: GDP crisis

à The recession itself

The graph shows the change in 2012 (in blue), the forecast.

Crisis 5: Unemployment crisis (p1)

It is the result of previous problems. But it is also a cause

Crisis 5: Unemployment crisis (p2)

It is the result of previous problems. But it is also a cause

Crisis 6: Political – Institutional

  • Too little, too late?
  • Ability to come to decisions
  • Monetary union without political union
  • Towards a more federal EU?

Euro Crisis – how to solve?

  • Countries: Austerity policy[1]
    • Austerity à Restores Confidence à More growth
    • Austerity à
      • Lower growth à Recession
      • Lower growth à higher deficits
  • EU – measures
  • Economic growth
  • Exit

 

[1] used by governments to reduce budget deficits during adverse economic conditions. These policies may include spending cuts, tax increases, or a mixture of the two

Criteria Government finance

  • Deficit < 3%
  • Debt < 60%

Trust Problem

The relation between the 2 is a matter of trust, confidence.

If the debt increases, at a certain point, investors start to doubt whether the government will be able to pay all the money back. If investors have doubts, they will lose confidence à Government bonds will decrease, interest rates (financing costs) will increase, especially Italy, Spain and Greece.

Moreover: problem of contagion. Because the Greek situation is not very good, investors will have doubts about other countries.

Contagious? So investors will start selling Italian, Spanish… bonds. Investors see a potential danger.

→Solution: Austerity measures

The Austerity debate:

 

Austerity or growth?  Or Austerity and growth?

  • Austerity  --> Restores confidence àMore growth (1st point of view)
  • Austerity --> (2nd point of view: opponent of austerity)
    • Lower growth --> recession
    • Lower growth ->> higher deficits
  • Growth --> (3rd point of view: opponent but another vision)
    • precondition for austerity: growth will solve the problem
    • Growth : increase tax revenues --> decrease expenditures --> decrease deficit
    • Less austerity required

Growth and debt

  1. Growth: Tax Revenues ↑ + Expenditures ↓ = Deficit ↓
  2. Growth: Debt % = Debt / GDP

EU Measures

  • Bail-out:
  • European Stability Mechanism[1] (ESM) – Conditional!
  • Restructuring (Greek) debt
  • Measures taken by ECB
    • Securities Market Program
    • Long Term Refinancing Operations
    • Outright monetary Transactions
  • Fiscal Compact Treaty
  • Banking Union
    • Single supervisor
    • Single resolution authority
    • Joint deposit-insurance scheme
    • Bail-in instead of bail-out
  • Eurobonds?

 

[1] is an international organisation located in Luxembourg which was established on 27 September 2012 as a permanent firewall for the eurozone to safeguard and provide instant access to financial assistance programs for member states of the eurozone in financial difficulty

(Gr)exit - Pro's and Con's

  • Pro
    • Regain monetary independence
      • Depreciations possible
      • Lower interest rates
      • Less need for austerity
  • Con
    • Technically difficult
    • Bank-run + Capital outflow likely
    • Won’t solve structural problems
    • Contagion