EURO Zone Crisis

International Trade
Prof. Vicenzo Quadrini

Feb 27, 2014

Deshbhratar Sandeep
Seungjik Yang
Sung Jin Ryu
Taro Arakawa

http://www.youtube.com/watch?v=I5QwKEwo4Bc

EURO ZONE CRISIS

Incentives of governments to borrow increase both when financial
markets become internationally integrated and when inequality rises.
If debt crises are more likely to arise when the stock of public debt is
higher, then the growth in government borrowing induced by capital
markets liberalization and increased income inequality may
contribute to trigger a sovereign debt crisis.
- ???

http://www.youtube.com/watch?v=I5QwKEwo4Bc

Contents

1 Euro Formation
2 Causes
3 Measures
4 Challenges/ Future

1 Euro Formation

Euro Formation
The EUROZONE
Officially called Euro Area
Introduced in 1999
Single currency shared by 18 of the
European Union's member states

Euro Formation
Early Stage
When it was launched on 1 January 1999, the euro became the
new official currency of 11 Member States

Euro adoption
2014: Latvia
2011: Estonia
2009: Slovakia
2008: Cyprus, Malta
2007: Slovenia
2002: Introduction of euro banknotes and coins
2001: Greece
1999: Belgium, Germany, Ireland, Spain, France, Italy, Luxembourg,
the Netherlands, Austria, Portugal and Finland

Euro Formation
Enlargement
Ten countries (Bulgaria, Croatia, Czech
Republic, Denmark, Hungary, Lithuania,
Poland, Romania, Sweden, and the United
Kingdom) of the EU do not use the euro
Lithuania is due to adopt the euro from 1
January 2015

Denmark and UK are legally exempt from

joining the eurozone

Euro Formation
Comparison of eurozone
with other economies
Population

GDP

% world

Exports

Imports

Eurozone

317 million

8.4 trillion

14.6% 21.7% GDP 20.9% GDP

EU (27)

494 million

11.9 trillion

21.0% 14.3% GDP 15.0% GDP

United
States

300 million

11.2 trillion

19.7% 10.8% GDP 16.6% GDP

Japan

128 million

3.5 trillion

6.3% 16.8% GDP 15.3% GDP

Euro Formation

Comparison of Economies

2 Causes

Causes
Extension of 2008 global financial crisis

Starting from Greece in 2010, the financial crisis spread rapidly to

Southern Europe, and finally to whole European countries

Greece

Southern
Europe

Whole
Europe

Causes
PIGS (Portugal Ireland Greece - Spain)
Excessive sovereign debt

Government budget deficit

High unemployment

Including
Italy

PIIGS

Causes
Deterioration of Economic Growth
Why??

Causes
Deterioration of Economic Growth
Banking
Crisis

Loss in securities
investment/
collapse in real
estate bubble

Financial
Crisis

Sovereign
Debt
Crisis

Bailout on bank /
deteriorated current
account / negligence on
financial management

Insolvency of financial institutions caused by

Global Financial crisis and following financial
crisis led to Euro-zone crisis

Causes

Economic recession, drop in tax revenue, deterioration of

fiscal sustainability by Global Financial Crisis

Major European banks was placed in bankruptcy by credit

crunch

Large scale cash infusion to prevent bankruptcy of banks

Increase in Financial deficit
% of GDP

2007

2009

0.7%

6.3%

Causes
The vulnerability of financial management

Some Southern European countries are financially

Vulnerable countries (PIIGS)

Tax basis is weak due to the underground economy

Government expenditure and welfare expenditure made
things worse

Average of
OECD

Greece

Causes
Institutional imbalance by European single currency
European Central Bank(ECB) is responsible for monetary
policy

Meanwhile, fiscal policy is carried out by each country

Introduction of single currency without fiscal consolidation

made imbalance among European countries worse

Not-working Currency mechanism

Causes
From Global Crisis to Euro-zone Crisis
Sub-prime
mortgage in
2008
World
economic
recession
transmitted
to real
economy

Crisis of European
financial institutions

Large scale
reflation /
Deterioration in
financial
sustainability

Drastic increase in
Sovereign Debt

Fund collection
from in-doubt
countries

Countries (PIIGS)
with encountered
bankruptcy

Causes

Portugal

Italy

Country
Greece
Spain
Portugal

Ireland

Greece

Spain

Major cause
High fiscal deficit and high debt/GDP ratio
Property and construction sector funded by
foreign flows
High CAD (Current Account Deficit)

Banking

Causes

Causes

Causes

3 Measures

Measures
How to reach settlement (Assistance to an individual country)
1. Fiscal Austerity

2. Debt Waiver

3. Official Assistance

Measures
1. First Stage (May 2010) *Example of Greece

Reduction of fiscal deficit of GDP

13.6% (2009)
8.1% (2010)
3 % (2014)
by raising tax, pension system reform,
pay cut for government servant, etc

Nothing

A 110 billion bailout by EU and IMF

Fiscal Austerity

Debt Waiver
Official Support

Measures
2. Second Stage (March 2012) *Example of Greece
Reduction of debt of GDP
120% (2020)
Fiscal Austerity
by pay cut of politicians, raising tax,
etc

Debt Waiver

Voluntary 50% Write-off of Greek

debt by private investors (equivalent
of 100 billion)

Official Support A 130 billion bailout by EU and IMF

Measures
How to reach settlement (Preparation for a next crisis)
In addition to individual assistance to countries
such as Greece, Ireland, and Portugal,
1. Rescue funding programs

2. Legislative measures

3. Improvement of the health of banks

Measures
1. Rescue funding programs

May 2010

July 2011

May 2012

European Financial Stabilization Mechanism

(EFSM) 60 billion
European Financial Stability Facility (EFSF)
440 billion

European Stability Mechanism (ESM) 500

billion

Rise in lending capacity from 500 to 700

billion

Measures
2. Legislative measures (Fiscal Policy Agreement)
Six-Pack in effect
1) Strengthening of budgetary surveillance

2) Enforcement of budgetary surveillance in EURO zone

3) Speeding up the implementation of the excessive
deficit
Dec. 2011 4) Requirements for the fiscal framework
5) Prevention and correction of macroeconomic
imbalance
6) Enforcement to correct excessive macroeconomic
imbalance in EURO zone
Fiscal Compact in effect
Including rules such as balanced public finance
Jan. 2013 to national legislative (if possible, constitution)

Measures
3. Improvement of the health of banks

EBA
(European Banking
Authority)

ECB
(European Central
Bank)

Implementation of Stress Test

Set a target of capital ratio (Tier 1 ratio) : 9% by
June 2012

Bond Purchase
Long-term Refinancing Operation

Measures
3. Improvement of the health of banks
Bond Purchase by ECB
25

250

20

200

15

150

balance
10

100

50

weekly purchase

(Source) ECB

Measures
3. Improvement of the health of banks
Lending outstanding of ECB to Banks
1400

1200

1000

800

Long-Term Operation

600

Short-Term Operation

400

200

0
2
0
0
7

2
0
0
8

2
0
0
9

2
0
1
0

2
0
1
1

2
0
1
2

(Source) ECB

Measures
3. Improvement of the health of banks
Trends of Euribor
2.5

1.5
1 month
3 months
12 months

0.5

0
1

2010

10 11 12

2011

10 11 12

2
2012

(Source) ECB

4 Challenges / Future

Banking-Challenges
The Crisis started in the banking
sector in US and hit the banking
sector in Europe
Use of derivatives rose from 2
times world GDP in 1998 to 12
times world GDP

Growth of Capital Markets

banking led to re-hypothecation
of the same collateral multiple
times
Countries with large capital
market banks heavily exposed to
Sovereign debt of EU economies

Universal/ Global Banking Size

Banking-Challenges

Banking-Challenges

Banking reforms
Recapitalization of banks based on proper cleaning up of
balance sheets where necessary
Clear distinction between traditional and capital markets
banking
Basel II underestimated the risks that banks were exposed to
Basel III implementation to help strengthen bank liquidity and
reduce bank leverage
Consistent and transparent accounting by the banks
Banks should rely more on traditional deposits vs the
wholesale funding to improve sustainability

Banking reforms
Basel III is the global regulatory standard (agreed upon by the
members of the Basel Committee on Banking Supervision) on
bank capital adequacy, stress testing and market liquidity risk.
Basel I and Basel II are the earlier versions of the same, and
were less stringent

Basel III released in December, 2010 is the third in the series

of Basel Accords.
Basel III seeks to improve the banking sector's ability to deal
with financial and economic stress, improve risk management
and strengthen the banks' transparency.

Banking reforms
Requirements

Under Basel II

Under Basel III

8%

10.50%

2%

4.50% to 7.00%

4%
2%

6.00%
5.00%

None

2.50%

None
None

3.00%
0% to 2.50%

Minimum Liquidity Coverage Ratio

None

TBD (2015)

Minimum Net Stable Funding Ratio

None

TBD (2018)

Leverage Ratio-Systemically
important Financial Institutions
Charge

None

6%

Minimum Ratio of Total Capital To

Risk Weighted Assets (RWAs)
Minimum Ratio of Common Equity
to RWAs
Tier I capital to RWAs
Core Tier I capital to RWAs
Capital Conservation Buffers to
RWAs
Leverage Ratio
Countercyclical Buffer

Quantitative Easing-Taper
Increased volatility-falling prices in interest rate sensitive
assets

Government debt service cost could rise substantially by upto

20%
Household debt service cost could rise significantly
Corporate profits will be under stress with increasing interest
burden
Capital outflows from the Eurozone to the US with a possible
depreciation of Euro
Investors in bond market could face large losses

Quantitative Easing-Ultra Low Rates

Banks & Insurance
companies to
experience
continued erosion
in profitability with
a compression in
net interest
margins

Defined benefitpension schemes

would struggle to
deliver on their
commitment to
retirees
Increasing use of
leverage with the
return of assetprice bubbles

What Lies Ahead ?

Austerity fiscal consolidation and privatization

Fiscal Union allow ECB to float Euro Bonds

Debt Mutualization- the crisis hit countries transfer debt to the
rich countries
Fracturing of the Eurozone

What I object to the current government intervention in so called

solving the crisis, they havent solved anything. They have just
postponed it
- Marc Faber

The bottom line is that unconventional monetary policies that

move away from repairing markets or institutions to changing
prices and inflationary expectations seem to be a step into the
dark.
- Raghuram Rajan

The economic contraction is more severe after a prolonged period

of credit expansion.
-Prof . Vincenzo Quadrini, USC

Thank you!!