Euro Debt Crisis

By: Abhilash.P.V

The Euro-Zone The EUROZONE officially called the euro area, is a monetary union of 19 of the 28 European Union (EU) member states which have adopted the euro (€) as their common currency and sole legal tender. 

The EUROZONE consists of : Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Formation Of The EUROZONE

There were a lot of tariffs, trade Barriers, restrictions on trade in various European countries prior to 1945. Also, there was fee on currency exchange .

However, after the World War II, which devastated Europe, several trade barriers were gradually removed to recover from the impact. The removal of the BERLIN WALL resulted in the formation of THE EUROZONE , with a common currency EURO and a Monetary Body – THE EUROPEAN CENTRAL BANK.

The Euro The EURO is the Currency of 19

EUROPEAN Countries . It came into use on 1st January,

1999. It was approved by all the

countries through the Maastricht Treaty. The main aim for the unification of the currency as Euro was to promote exchange.

It is the breakdown in the value of Euro. The European debt crisis (often also referred to as the Euro zone

crisis or the European sovereign debt crisis) is a multi-year debt crisis that has been taking place in several euro zone member states since the end of 2009. These states (Greece, Portugal, Ireland, Spain, Cyprus) were unable to repay or refinance their government debt or to bail out over-indebted banks under their national supervision without the assistance of third parties like the ECB, or the IMF.

The European debt crisis erupted in the wake of the Great Recession around late 2009, and was characterized by an environment of overly high government structural deficits and accelerating debt levels. 

THE EUROZONE CRISIS

The Euro Debt crisis – In depth

The euro zone countries abolished their monetary policies( interest rates, borrowing capacity) and gave the control of the same to the ECB.

However the countries retained their fiscal policies(taxes, government expenditure)

As a result, small countries could now borrow greater sums of money from European banks at lower interest rates.

This had a negative impact in countries like Greece, where people don’t pay appropriate taxes. Government increased their spending/expenditure.

Now , this country was spending more than what it collected as taxes through borrowings[Deficit Spending]

Deficit Spending Programmes included more jobs, higher pension and retirement Benefits.

They were able to repay these debts with further borrowings from financial institutions of other European Countries .

This result in an inter-twined European borrowing circle.

The major countries involved in similar borrowing cycles:

Spain, Portugal, Ireland and Cyprus.

However with the US Recession crisis of 2008, borrowing came to a halt. Small Economies like Greece and Cyprus could not function, as it didn't

have any money to undertake development programmes and couldn’t borrow any money to repay its existing loans or debts.

As the economies were tightly inter-twined, with Greece’s collapse, other economies began to collapse- Spain, Portugal, Ireland And France.

However, one of the countries had to take up the responsibility to repay the debts to avoid the collapse of the European Union, that country being the European Superpower , GERMANY

Germany reluctantly agreed but also put forward certain AUSTERITY MEASURES

Austerity measures means cutting down Government Spending, Borrowing Less and paying more debts.

But, when the Government spent less, people of the nation Earned Lesser Income and Protested which led to widespread RIOTS.

When the defaulting countries could not repay Germany, the whole of the European Union crashed. Germany’s Creditors could not be repaid as Germany did not have sufficient income. For this Brief period of 3-4 years, the whole world went into recession.

Causes OF European Crisis• Monetary Policy :Membership in the Euro zone established a

single monetary policy, preventing individual member states from acting independently. In particular they cannot create Euros in order to pay creditors and eliminate their risk of default. Since they share the same currency as their (euro zone) trading partners, they cannot devalue their currency to make their exports cheaper, which in principle would lead to an improved balance of trade, increased GDP and higher tax revenues in nominal terms.

• The Recession of USA: However with the US Recession crisis of 2008, borrowing came to a halt. Small Economies like Greece and Cyprus could not function, as it didn't have any money to undertake development programmes and couldn’t borrow any money to repay its existing loans or debts.

Different Fiscal Rules: In the Euro zone system, the countries are required to follow a similar fiscal path, but they do not have common treasury to enforce it. That is, countries with the same monetary system have freedom in fiscal policies in taxation and expenditure. So, even though there are some agreements on monetary policy through the European Central Bank, countries may not be able to or would simply choose not to follow it. This feature brought fiscal free riding of peripheral economies, especially represented by Greece, as it is hard to control and regulate national financial institutions.

Excessive Borrowing: Countries Like Greece started lot of deficit spending programmes such as retirement pensions, more number of jobs . The amount spent was much higher than the amount they received as taxes. Therefore, the debts continuously increased.

Loss of confidence : When countries like Greece started defaulting its creditors, financial institutions lost their trust on the Euro-Zone Countries. This enhanced the crisis.

Fiscal policies

Excessive Borrowings

Recession in The United States Of America

Possible SolutionFiscal Union: A fiscal union can be established

in Europe which prevents excessive Borrowings , Cuts Down Governtment Expenditure, formulates rules and regulation on tax.

Austerity Measures have to be followed to handle the crisis initially. This will help the defaulting countries raise funds to repay their debts and will ensure that such a situation doesn’t show up again.

Payment of Taxes: Citizens should pay appropriate taxes based on his/her income to the Government.