The European Debt Crisis: Impact, Solutions, and Future of Euro

This report provides a comprehensive analysis of the European debt crisis, examining its main forces, consequences, and potential solutions. It explores the increasing household and government debt levels, excessive social welfare spending, and trade imbalances as key contributing factors. The report details the impact of the crisis on various economies, including the downturn in the economy and the decrease in European house prices. It also discusses proposed solutions such as currency devaluation, internal devaluation, debt consolidation, and monetary easing. Furthermore, the report identifies the winners and losers of the crisis and explores measures for preventing similar crises in the future, including collective bond issuance and pre-emption strategies. Finally, it offers insights into the future of the Euro, considering potential scenarios and challenges for the currency and its member states.

THE EUROPEAN
DEBT CRISIS

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
Main forces of European debt crisis............................................................................................1
Consequences of crisis................................................................................................................2
Solutions for crisis......................................................................................................................3
Losers and winners of crisis........................................................................................................4
Measures for preventing from similar crisis...............................................................................5
Future of Euro.............................................................................................................................6
REFERENCES................................................................................................................................8

INTRODUCTION
European debt crisis is referred as the most serious financial crisis since 1930 by head of
Bank of England. This term reflects the struggle of Europe in context of paying debts which was
built in recent decades. The countries which were involved in this crisis are Italy, Portugal,
Spain, Greece and Ireland as they were failed to generate economic growth which should be able
to pay liabilities to bondholders which was guaranteed. These five countries were in very
immediate danger for creating default in the era of 2010 – 2011.
MAIN BODY
Main forces of European debt crisis
Increasing household and debt level of government is the main cause of crisis. In this,
members of European Union signed a treaty where deficit spending and debt level was set to a
limit known as Maastricht treaty. Excessive social welfare spending was known as the major
reason of debt crisis (Broto and Perez-Quiros, 2015). The debt level was increased because of
package of large bailouts given to financial sector and after that, global economic was slowdown.
In the same series, there was rise in government debt in context of GDP. So, all fiscal deficits
were stressed in euro area which were shrinking or stable from early 1990. There was presence
of excessive lending via banks not spending created this crisis. There are different complicated
derivatives which turned this crisis very worse which is termed as credit default swaps which is
an insurance like derivative instrument is labelled once as market was distressed by small CDS
market and drive rate of bond interest rate of various sovereign nations.
Trade imbalances created variation in labour cost which had framedall southern nations
very less competitive and raised imbalance in trade. The nations of EU have enhanced the labour
cost more than Germany. Competitiveness was lost as those nations increased wages but not
productivity. As labour cost was restrained by Germany as it was and debatable factor in this and
it is cause for low employment rate which is considered as very important factor. It is indicated
by economic evidence that it has major role in trade deficits in t level of public debt. The interest
spread and current account deficit has a strong relationship as it is not a debt crisis; in real, it is
balance of payment crisis.
There was structural contradiction in Euro system which was the major cause of this
crisis. There was presence of monetary union with absence of fiscal union which includes
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pension, taxation or any functions of treasury. They have to follow same fiscal path but for
enforcing, they do not have common treasury. They did not have banking union as there was not
any wide approach for bank deposit insurance, bank oversight, etc. There was fear of increasing
default in bond yields but this is very expensive for paying interest on debt (Hallett and Oliva,
2015). As high debt tends to increase high interest rate costs which is very difficult to pay. They
can even apply Treasure Euro Dollar spread which is difference between interest rate on short
term US government debt and on interbank loans for paying its debt.
Consequences of crisis
This crisis has impacted the whole economy as there was huge loss to bank as many
commercial banks had lost money in bad debts exposure in United States such as subprime
mortgage bundles. This has created downturn in economy or major recession by decreasing bank
lending and investment. It has also led to decrement in the prices of European houses which had
raised losses in context of European banks (Strategic consequences, 2018).
Illustration 1: Economic growth slowdown
(Source: Euro Debt Crisis, 2016)
There was a major reason for sudden increase in government debt by recession. All the
government finances were deteriorated as there was negative growth and tax was received in
very less quantity by government. It can be linked to unemployment benefits which were in high
number fewer people were working so less income tax and less spending of people so give less
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VAT and less company profits will give less corporation tax. Debt rose to ratio of GDP as it is
considered as the most useful guide to different level of debt which is a manageable debt. If there
is decrement in GDP and rise in debt, then it will rise in a rapid manner. Due to this crisis, bond
market of nations which were affected performed in worse manner as yield rise reflects fall in
price. On the same side, US treasuries yield fell at very low level historically and it gave very
low level for reflecting investors. This crisis has made worse to Brussels commission and
Germany was criticised for not stimulating more demand in Eurozone as it had given help to
Southern Europeans for increasing their level when public spending has been slashed.
Solutions for crisis
EU faces many problems during crisis such as high unemployment, huge current account
deficit because of less competitiveness, stagnant economic growth and very high government
borrowing. The first measure for overcoming on this crisis is to devalue currency as it will lead
to gain competitiveness and decrease budget deficit with unemployment and it will help
economy for recovering (European debt, 2018.). For decreasing the budget deficit, economic
recovery is termed as an important ingredient. So, option for devaluation must not be considered.
If Euro will be left by countries then it will directly damage and it will tend to give rapid flow of
capital outside country because of these mentioned consequence. Internal devaluation is faced by
Greece and Portugal for restoring competitiveness by decreasing inflation, cost and wages but
this is not considered to be appropriate due to causation of high unemployment and lowering
growth.
In the same series of solution, debt has been consolidated of countries like Greece and
Italy. EU has requirement of partial debt default as there is no chance of repayment for Greece so
it should allow Greece for default and gives full concentration on Italy as it has capability to pay
debt with various constraints such as shortage of money and all. The importance of economic
growth has been determined by EU and ECB, so they are recommended for spending cuts and
austerity but this will lead to occur negative spiral of less growth, lower tax revenues and high
unemployment. Monetary easing is referred as best solution as its main target for high inflation
and quantitative easing. Monetary stimulus should be provided to peripheral countries when they
face deflationary pressures. Only worse thing is wrong attitude about inflation with ECB. There
should be implementation of supply side policies as they will improve efficiency and
competitiveness especially for Greece and Portugal.
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Losers and winners of crisis
There are various players for complicating matters for solving European debt crisis as
everyone has there stake in crisis's outcome. Every individual nation has significant role in crisis
but huge contribution is of Greece (de la Porte and Heins, 2016). It has not stimulated alone in
crisis for confronting Europe. The countries which were in danger for defaulting on sovereign
debt are Portugal, Italy, Greece and Spain. All these countries collectively practised the largest
appetite foe debt to government. As per International Monetary fund, debt level of project at end
of 2011 was :
Country Debt to GDP GDP
France 86.90% 1.99 trillion
Germany 82.60% 2.57 trillion
Italy 121.10% 1.59 trillion
Spain 67.40% 1.09 trillion
United kingdom 84.80% 1.53 trillion
The workers were squeezed by German employers and export of company has built
success for raising inequality in German society. The main conflict which was between big
business and workers which was undertaken by EU as employers abused the environment of post
crisis for lowering wages and zero hour contract was increased which also undermine trade union
with collective bargaining rights and profit was preserved. The harsh imposition of cuts, the
workers were not settled as they were victim of crisis. From many years they were establishing
support from neighbourhood group and community clinics which gave facility of health care for
this official system which was pushed out.
Greece was not in pressure for outcome of current stand-off. The finance minister of
Europe has to think in very conscious state of mind about bankrupting Greece. It will wreak the
havoc with finances of Eurozone as ability of Greece for demonstrating an alternative to austerity
outside euro. The discount rate where aggregate of future cash flow from coupon or principal is
equal to recent price of bond is referred as yield to maturity (EU for avoiding economic crisis,
2018). The citizens of countries which are debt ridden might follow this example and whole
project of austerity might fall apart.
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Measures for preventing from similar crisis
Government should collectively issue bond instead of issuing their own national bond.
This will lead to addressing problem of liquidity many small financial markets. It will decrease
borrowing costs. There should be inherent contradiction between monetary and economic union
with absence of political union. The strategy of pre-emption should be imposed where in goods
or shares should be purchased by one party before that specific opportunity is gone to others. The
crisis of sovereign must lead to others in certain manner such as investors suddenly pass their
attention to next link which is weakest (Credit default swaps, 2018.). It will be creating no
shortage in economy which is experiencing severe fiscal pressures. As this was conquerable in
case of Greece or Ireland but on contrary side it will be imposing huge challenge with large
member states like Italy or Spain.
The indirect cost must be imposed for fiscal crisis in neighbourhood which is demanding
more exports. The repercussions must be dramatic and it will lead to breakup if default of
sovereign debt. In case of inflexible economy default within currency union is considered as
plausible instead of leaving it. The member state must decide that they are having default and
must cut themselves for temporary basis from various sources of capital and it will be devalued.
It will lead to ensuring and restoring competitiveness and economy will grow as soon as possible
in import of long term inflation perspective. If any one country will boycott itself then whole
efforts and pressure will be on other in intense form. If cost will be hold down then
competitiveness will be improved nut it will lead to expense of very low domestic demand. The
yield spread replicates variation between quoted rate of return of various investments but has
similar maturity with risk premium for single product of investment for other. Different bailout
programs were stated by European zone which were provided by jointly IMF for lowering yield
of monetary transactions (Key players in European debt crisis, 2018).
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Illustration 2: Long-term yield spread over German government bonds (1990-Feb 2017)
(Source: European Soverign debt problem, 20180
Future of Euro
The European central bank, government leaders, International Monetary fund and head of
bank will be putting huge effort for stabilising and transforming the situation in very concise and
well anticipated steps. There main objective will be reduction of debt burden of Greece or to
manage in such a way that it should take exit from Euro. But this will lead to huge risk and cost
to other EU nations, specific crisis bailout which will return and it will be very expensive. Euro
currency will survive but with fewer members as it have today. It will be splitting currency in
very effective manner with smaller group and it will face huge problems from common interest
rate and exchanges (How to avoid Eurozone Debt crisis, 2018). Germany is a very dominant
economy in the European Union so in this context rate of interest policy is set. In the economy
like Germany and France will face various stages of boom and bust cycles with smaller economy
and various requirements. These people are not happy with failure of government of Greek for
managing budget, taxes, dealing with corruption and to maintain there country in very stable
position.
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From the above report it has been concluded that various measure like bailout programs
are efficient for conquering with such type of similar crisis. And future of Euro is secure
according to this brief analysis.
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REFERENCES
Books and Journals
Broto, C. and Perez-Quiros, G., 2015. Disentangling contagion among Sovereign CDS spreads
during the European debt crisis. Journal of Empirical Finance. 32. pp.165-179.
de la Porte, C. and Heins, E., 2016. A new era of European integration? Governance of labour
market and social policy since the sovereign debt crisis. In The sovereign debt crisis, the
EU and welfare state reform (pp. 15-41). Palgrave Macmillan, London.
Hallett, A. H. and Oliva, J. C. M., 2015. The importance of trade and capital imbalances in the
European debt crisis. Journal of Policy Modeling. 37(2). pp.229-252.
ONLINE
Credit default swaps. 2018. [Online]. Available through
:<https://www.huffingtonpost.in/entry/credit-default-swaps-europe_n_1458842>.
EU for avoiding economic crisis. 2018. [Online]. Available through
:<https://www.weforum.org/agenda/2015/09/what-can-the-eu-do-to-avoid-future-
economic-crises/>.
Euro Debt Crisis. 2016. [Online]. Available through
:<https://www.economicshelp.org/blog/3806/economics/euro-debt-crisis-explained/>.
European debt. 2018. [Online]. Available through
:<https://piie.com/commentary/testimonies/european-debt-and-financial-crisis-origins-
options>.
European Soverign debt problem. 2018. [Online]. Available through
:<https://www.cbsnews.com/news/europes-sovereign-debt-problem-causes-and-solutions/>.
How to avoid Eurozone Debt crisis. 2018. [Online]. Available through :<http://www.cer.eu/in-
the-press/how-avoid-eurozone-debt-crisis>.
Key players in European debt crisis. 2018. [Online]. Available through
:<https://blogs.cfainstitute.org/investor/2011/12/01/key-players-in-the-european-
sovereign-debt-crisis/#Key-Players>.
Strategic consequences. 2018. [Online]. Available through
:<http://www.cer.eu/in-the-press/strategic-consequences-euro-crisis>.
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