Integration - Sovereign Debt Problem in Greece and Reviving the Eurozone

What problems did the 2008 crisis cause and how did the ECB / EU solve them

Liquidity - banks didnt have enough cash to carry out transactions and assets werent as liquidable.

• ECB helped by 3 year low insterest Repos.

  • Repos - Repurchase Agreement - CB buys securities (collateral) and other party agrees to buy them back at a later date at a higher price.

Sovereign insolvency - lenders fear govs wont be able to repay bonds when they mature, threatening default.

• EU held via conditional loans (with IMF): European Stability Mechanism (ESM)

What is the European Financial Stability Fund

Whats the ESM and how has it been used already?

What did the ESM mean by Conditional Loans

How did it effect countries such as Spain, PIG countries and Cyprus.

2010 Financial Fund:

• Temp until 2013 to help rescue weak governments | Got investors to invest in a pool of money to be invested into other financial responbibilities | lent to Portugal, Ireland and Greece (PIG).

European Stability Mechanism: (OCT 2012)

• Based on IMF model of conditional loands. | Permanent intergovernmental (non-EU) institution | can lend up t0 500 bil euros.

  • 20 Shareholders | Already lent just under 300 billion.

• Loans and support are conditional: PIG significant fiscal consolidation to reduce budget deficits and structural reform as labour costs had fallen.

• Ireland, Spain and Portugal able to return to the bond market at acceptable rates and exited ESM by 2013.

• Greece and Cyprus still in - hardship and unemployment.

What went wrong for IISPG (Ireland, Italy, Spain, Portugal, Greece)

• According to De Grauwe

• According to Dadush and Stancil

• All behaved well except for Greece - Keynsian responses to a downturn.

• With Euro low IR and high confidence = demand surge in IISPG, one-size-fits-all policy was ineffective as monetary authorities failed to control credit expansion, increase in private debt especially in Greece, Ireland and Spain.

• Lower euro IR and increased revenue for unstainable domestic surge = increased gov. spending

• Public spending/person 1997-2007 up by 76% in IISPG but only +34% in North EuroZone.

• Lost competitiveness as unit labour costs +32% but +12% in N (cause of demand surge not cisis)

• Crisis ecposed flaws of IISPG post euro growth model

Should Greece stay in the EZ?

• Performance pre-crisis | Effect of Crisis | Rescue packages

• Economy buoyant pre-crisis, 2006-7 Growth rate of +4.2% | BUT persistent Budget deficit and >100% public debt.

• Crisis - total debt up 130%, annual deficit f 16%

  • Fears over solvency led to rapid rise of IR on gov borrowing.

• First Rescue package from Troika 2010 w/ 110 bil. euro | Second package 2012 w/ 173 bil. euros

• Loans condition on budget reforms: increase tax and lower spending.

• GDP fell 25% 2007-13, debt ratio to 175% | Severe deflation wages down -12%, price -0.4%.

• Greece insolvent: much of Eurozone loans have to be written off by delayed to a) keep pressure on gov to reform (Pensions, labour, VAT) and to avoid contagious fear of Eurozone breakup.

IISPG without the G

From 2009 many countries under budgetary stress

• Ireland extreme - deficit 32% GDP.

EZ / IMF gave loans to Ireland (67.5 bil), Portugal (52 bil), Cyprus and Spain to support banks.

At price of sever austerity programmes leading to falling GDP and rising unemployemnt - IMF concern it may be slef-defeating.

Soverign debt >120% GDP regarded as unstainable but OMT (Outright Monetary Transaction See: Lecture12) helped by reducing IR.

What were the different approaches the Eurozone could use to revive the growth of the currency union.

Nominal Targetting

Forward Guidence

Budgetary Austerity

What is nominal targetting

• What are some critisisms to this approach

Target nominal GDP growth (e.g. inflation 2-3% + output growth 2-3%)

Pursues full employment and low inflation

Allow a catch up period after a recession (even if Inflation increases)

Change expectations - confidence, certainity = inc. growth

Create more room for expansionary fiscal policy

• Needed in EZ as MP is determined by the ECB and not tailored to local areas within the EZ.

BUT: reflective of the attitudes in GER around the hyperinflation crisis.

What is Forward Guidance

Where was it already being used

Central Banks communicate plans for monetary policy such as interest rates - aims to improve expectations and certainty, guides behaviour in markets.

Already done in the UK and US

What is Budgetary Austerity

How is it enforced

Criticism of the approach

Due to many countries with: high borrowing, national debt and increasing costs of servicing debt they could spiral and defaul. Instead should: Reduce spending and increase taxes

• Enforced through Six Pack, European Semester, Fiscal Compact.

But Likely to reduce growth and increase debt:GDP ratio.

• When: IR close to 0, lots of construction unemployment and lots of infrastructure jobs with large efficiency payoffs - austerity measures would cause the EZ more harm then good.