the euro effect

8/7/2019 THE EURO EFFECT

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ITS EFFECTS ON COUNTRIESSUBMITTED BY :-GAURANG

ARJUNAMLAN

HIMANSHUPANKHURI

RAVI BANWANIHARSHIT AHUJA

RAHUL VYAS


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The story begins with the Spanish real estatebubble. This brought massive inflows ofcapital; within Europe, Germany moved into

huge current account surplus while Spain andother peripheral countries moved into hugedeficit.


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Transmission from the United States

Housing Price Bubble and Collapse

Financial Market Freeze and Collapse

Policy Response

Support for Financial Sector

Monetary Policy

Fiscal Policy

Effect of the Euro Currency Zone

Greeces Problems


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US Housing Bubble created by

Low interest rates

Lax regulation of sub-prime mortgages with

adjustable rates, two year teaser rates Securitization of mortgages, sold to unwary

buyers as highly rated

US Bubble popped when

Interest rates rose in 2006, housing prices fell Subprime mortgages and securities defaulted


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http://mjperry.blogspot.com/2009/04/house-price-indexes-usa-vs-europe.html


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US Housing Prices peaked in late 2006

European Housing Prices peaked a year later

Financial Crisis struck Europe & US at same

time, August 2007, after Bear, Stearns,Fannie Mae & Freddie Mac taken over withUS Government assistance in April and July of2007

International credit markets froze up inAugust 2007 when subprime based hedgefunds collapsed in Europe and US. No longerable to borrow short-term funds, banks facedmuch higher risk premia


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When investors dump government bonds,they also raise interest rate in thesesbonds and force the government toreduce its budget deficit. This is likely to

reduce downturn; hence increase indeficits thus by selling country bonds theyalso increase riskiness of governmentbonds.


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The essence of the problem is that investorswho sell government bonds of one country donot take into account the spillover effects on

other country bonds. The problem ofcontagion is high in euro-zone because of theintensive trade between its members.

By forcing early exit strategy in one member

state they also force other member states todo so


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ECB injected liquidity into European banksunable to obtain short-term funds in market.

Federal Reserve used Euro-dollar swaps to

make dollars available to ECB to lend tobanks.

ECB did not lower interest rates untilOctober 2008 because of its focus on

inflation. Euro fell against the dollar due to safe

haven flight to US Treasury securities.


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Sources: ECB, Federal Reserve Bank of New York


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TARP(TROUBLED ASSET RELIEVED PROGRAM)and Federal Reserve programs in US

National programs in European countries,

due to absence of Euro zone-wide regulator. Beggar-thy-neighbor effect, as first Ireland

gave deposit guarantees, then UK, thenNetherlands, to avoid bank deposit flight.


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Automatic Stabilizers of falling taxes, risingwelfare and unemployment payments kick inas incomes fall and unemployment rises.

Discretionary Fiscal Stimulus enacted in mostcountries, depending on their fiscalpositions.

European countries limited by Stability and

Growth Pact to 3% fiscal deficits, except intime of exceptional economic distress.


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Previous economic crises in Europe have ledto large devaluations of currencies.

Within eurozone, single currency prevents

devaluation , provides automatic financialsupport through capital markets.

Non-euro currencies depreciated sharply in2008, British pound sterling, Swedish kronor,

Polish zloty, Hungarian forint.


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Since joining the euro, Greece has had higherinflation than other Eurozone members.

Greece has also increased debt faster than others to

finance generous public sector pay, welfare, andretirement benefits, while collecting a lower sharein taxes due to widespread tax evasion.

As a result, Greek goods have become increasingly

expensive and uncompetitive, causing loss of marketshare and further reducing revenues.


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Greek debt/GDP ratio reached 113% and deficit/GDPratio reached 12.7% in 2009.

Foreign bondholders became doubtful that Greece

could continue to roll over its increasing debt, forcedinterest rates higher.

EU faced choice between Greek default and bailoutwith tough conditions.

IMF and EU agreed to lend Greece up to $146 billionover three years.

Greece to increase sales taxes, reduce public sectorsalaries, pensions, eliminate bonuses.


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On 5 March 2010, the Greek parliament passedthe Economy Protection Bill, expected to save4.8 billion through a number of measuresincluding public sector wage reductions. On 23April 2010, the Greek government requested thatthe EU/IMF bailout package be activated. TheIMF had said it was "prepared to moveexpeditiously on this request. Greece needed

money before 19 May, or it would face a debtroll over of $11.3bn.


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Iceland had to suffer the failure of its banking system and asubsequent economic crisis. Before the crash of the three largestbanks in Iceland, with Glitnir, Landsbanki and Kaupthing, jointlyowing about 14 billion ($19 billion)or 6 times Iceland's GDP. InOctober 2008, the Icelandic parliament passed emergency

legislation to minimize the impact of the financial crisis.The Financial Supervisory Authority of Iceland

used permission granted by the emergency legislation to takeover the domestic operations of the three largest banks.

On 28 October 2008, the Icelandic government raised interest

rates to 18%,(as of August 2010, it was 7%)

a move which was forced in

part by the terms of acquiring a

loan from the IMF


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Ireland borrowed massively to stop its run70 percent of GDP, including $90 billion fromthe European Union Loan, leaving thecountry with more debt-to-GDP than Greece.

By saving the banks, and their creditors, thegovernment bankrupted the country.

Unemployment is 14 percent and output isdown by 10 percent.


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On June the 4th, 2009, several Slovene companies andbanks were planning to issue bonds that year to get freshfunding at more favourable credit terms. The issuing ofcorporate bonds had been rare in Slovenia until then, but

the largest fuel retailer Petrol (PETG.LJ) planned to issue a50 million ($70,920,000) 5 year auction bond later in June2009. In May 2010 Slovenia went heavily into debt payingfor its part of the 110 billion ($145 billion) rescuepackage for Greece. Slovenia had scrapped itsInternational Bond Sale Plan as the economy returned to

positive growth in the October of 2010. The governmenthad planned to borrow as much as 4.39 billion ($5.6billion), compared with 4 billion in 2009. Slovenia alsosold 1.5 billion worth of 10-year bonds in January and 1billion of five-year securities in March


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In 2010, Belgium's public debt was 100% of its GDP - thethird highest in the Euro zone after Greece and Italy andthere were doubts about the financial stability of thebanks. After inconclusive elections in June, by November

the country still had no government and no budget for2011 as parties from the two main language groups in thecountry (Flemish and Walloon) were unable reachagreement on how to deal with the economy. Financialanalysts forecast that Belgium would be next country to behit by the financial crisis as Belgium's borrowing costs

rose. However the government deficit of 5% was relativelymodest and Belgian government 10-year bond yields inNovember 2010 of 3.7% were still below those of Ireland(9.2%), Portugal (7%) and Spain (5.2%)


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Cautious Eurozone response to FinancialCrisis Interest rate policy reaction delayed:

concentration on inflation target

Fiscal policy reaction muted: Stability &Growth Pact

Common currency members avoided largedevaluations and foreign currency debt.

European governments have tried to acttogether, not always successfully.

Limited impact of falling exports due toextensive internal trade relationships.


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the euro effect

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