euro crisis?

Alexander Consulting EnterpriseAlexander Consulting Enterprise 04/20/2304/20/23

Euro Crisis?


EMU

1.What is EMU?Acronym for Economic and Monetary Union

2. How Does it Work?All national currencies of member states convert into the EURO atan irrevocably fixed rate. The EURO will float freely against other main currencies (yen, $). National banknotes will cease to be legal on 1 July 2002.

3. What is the role of the ECB?The Governing Council of the European Central Bank (ECB) consistsof six executive board members responsible for current business andthe 11 ministers of the National Central banks. The ECB isresponsible for the money supply in Euroland.


The exchange rate weapon is ruled out. There is no redistribution effect of federal taxes (For example: If one part of the U.S. moves into recession, its tax payments (linked to income and sales) will fall and federal benefit payments will rise). Adjustments in the EMU will have to take place through:- Relocation of workers- Relocation of businesses- Change of wages- Transfer payments between EMU member states

4. Does the EMU lead to a loss of sovereignty of its member states?

A nation’s currency symbolizes national autonomy. Monetary policyis a powerful economic instrument, that has an impact on inflation, interest rates, governmental debt, short term unemployment, and economic cycle

5. What happens if the economic cycles in different EMU member states are out of synch?


Greek Crisis

Greece joins currency union in 2001

Low interest rates, low inflation, access to capoital markets

Economic boom financed with cheap money

No currency devaluation to counteract increasing ULC

Domestic businesses are increasingly loosing competitiveness

1. Timeline of the Crisis

Hay fire of cheap money is burnt out. Economy is not competitive


Increasing Loss of CompetitivenessHarmonised competitiveness indicators based on unit labour costs indices for the total economy: 2009 Q4 (period averages; index 1999 Q1=100)

The purpose of harmonised competitiveness indicators (HCIs) is to provide consistent and comparable measures of euro area countries' price and cost competitiveness that are also consistent with the real effective exchange rates (EERs) of the euro. The HCIs are constructed using the same methodology and data sources that are used for the euro EERs. While the HCI of a specific country takes into account both intra and extra-euro area trade, however, the euro EERs are based on extra-euro area trade only.

Euro area

BE DE IE GR ES FR IT CY LU MT NL AT PT SI SK FI

1. Period average 108.1 107 89.6 125.3 112.6 113.3 104.5 113.1 112.8 117.7 109.8 112.7 95.1 · 107.7 176.7 105.7

2. Percentage change versus previous period

1.4 1.2 0.5 2.4 -1.0 1.1 0.8 -0.4 1.7 2.0 1.4 0.3 0.3 · -0.2 -1.8 0.6

3. Percentage change versus previous year

6.3 2.4 3.8 -0.3 4.5 0.2 2.3 2.3 3.9 2.9 4.2 4.5 3.4 · 4.3 3.1 4.8

4. Percentage change since 1998 Q4

4.0 5.9 -13.0 17.4 12.9 12.9 3.8 10.9 10.9 14.7 9.9 10.4 -5.2 · 7.6 78.7 3.9

http://www.ecb.int/stats/exchange/hci/html/hci_ulct_2009-10.en.html

2012 numbers: http://www.ecb.int/stats/exchange/hci/html/hci_ulct_2012-10.en.html


Governmental spending to counteract increasing unemployment, low consumption, and failing companies

Public debt explodes

Investors slowly start to react and buy less Greek bonds and increasingly take out Credit Default Swaps to get insurance against default

Price of bonds falls and interest rate increases.

“Bad” speculators refuse to buy bonds despite skyrocketing interest rates. Price of Credit Default Swaps goes through the roof and markets start to

freeze

EU and IMF commit € 750 billion to bail Greece out. EZB buys bonds

1. Timeline of the Crisis cont.

Hay fire of cheap money is burnt out. Economy is not competitive


2. Potential Solutions

1. Quasi Permanent Transfer Payments(Model East Germany) Greek economy does not become competitive. Long-term transfer payments (€ 60 billion per year?) are necessary to keep up the standard of living.

2. Structural ReformsThis is the favorite model by European politicians. Debt relief coupled with severe structural reforms to make the Greek economy more competitive. This would lead to a drastic decrease of the standard of living for years to come.


3. Exit the Currency UnionInvestors of Greek bonds get a haircut. New currency will be heavily devaluated.

Economy becomes competitive. Exports, tourism, and production for domestic consumption increase.

Access to international capital markets is obstructed. High interest rates. Drastic increase of import prices. Temporary decrease of standard of living. Danger of inflation.

4. ?

2. Potential Solutions cont.

euro crisis?

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