Introduction The Eurozone crisis also known as Euro crisis is an ongoing crisis since late 2009 after the great recession of 2009 affecting the Eurozone countries. This was after a New Greek government revealed of the previous government misleading reports on government budget data higher than expected deficit levels. The result was devastating eroding the investors’ confidence hence the bond spreads rose to unsustainable levels. Moreover, the countries fiscal position and debt levels of some member countries escalated to unsustainable levels (Vittori, 2013).As the threat of debt default by the government rose, the Greece government in May 2010 received loans from other Eurozone governments and the IMF to save the situation. Investors in Ireland and Portugal increasingly became nervous of the public finances as the bond spreads rose. This forced the two governments to seek for European-IMF financial aid packages received in December 2010 and May 2011 respectively. In their effort to respond to the crisis and prevent its spread, European leaders and institutions have put in place a set of unprecedented policy measures particularly in Spain and Italy as the third and fourth largest economies in the Eurozone. The effort so far has not managed to regain the markets confidence due to the many cycles over the time. The economic has as well been politicized amounting to a political crisis. The Eurozone countries facing the intense market pressure have experienced protests against the deficit cutting measures. In the economically stronger countries, their efforts of providing financial assistance to the weaker economies have faced resentment. This is due to the notion that they have failed to implement appropriate policy measures expecting for bail out. These together with the disagreement among the key policymakers over the appropriate policy response and the slow, complex EU policy-making process have exacerbated market anxiety.Causes of the crisis The crisis was caused by independent but interrelated factors originating in Eurozone. According to many analysts, the crisis was caused by a set of common challenges facing some Eurozone as well as specific factors to a country. The capital inflow and following buildup of both private and public debts through the last ten years into European nations were a major factor to the present predicament. As the In their preparation to implement the euro and changeover from state legal tender to the euro, Eurozone nation’s bond spread fell drastically converging to the interest rates paid by the traditionally stronger core Eurozone economies. This saw both the private and public components in the periphery countries take the benefit of admission to innovative, economical credit neglecting the productive investment. Consequently, there were insufficient resources to settle up the obligation which started rising (Singala & Kumar, 2012). In several nations like Greece, the debt was intense in the public segment as a result of public finance mismanagement. Meanwhile, further nations like Ireland and Spain the obligation accrued more in the private segment as a result of vital hitches in real estate business and banking.
The untenable attribute of the amount outstanding was very evident during the universal financial catastrophe in 2009 after investment markets weakened, and this proved difficult for the various economic players to repay their liability. Furthermore, the economic calamity and the subsequent downturn strained public funds leading to government deficits with spending increasing taxes and revenues. In some extreme cases like Ireland, the command assumed the private segment obligation by guaranteeing them. Some governments almost default their debts.Capital inflow also fueled domestic demand. This led to high levels of growth in some countries together with inflation what is termed as growth and competitiveness crisis. The increasing prices in the periphery reduced competitiveness against other Eurozone countries, like German, which had pursued policies such as wage restraint keeping the prices relatively low while cushioning export. As a result, the periphery countries incurred trade deficits, which were linked to borrowing and especially from banks in the Eurozone core especially German banks (Vittori, 2013). Eurozone membership constrained the periphery governments’ ability to respond to the growing trade deficits. The membership never allowed them to devalue their currency in order to reduce their trade deficit by bolstering export to other Eurozone countries and stem imports. Likewise, the periphery countries could have raised interest rates to slow economic growth in response to potentially over-heating economy. The Eurozone membership limited the individual member states ability to apply either of the policy option individually. Although capital inflows contributed to the debt build-up in the periphery, factor specific to the particular country also contributed to the current catastrophe. Greece is indicted of having deprived public funds management with rampant tax evasion and high government spending on salaries and reimbursement, etcetera.
Ireland the Celtic Tiger had an oversized banking system resulting from its economic success. The government guarantee of Irish banks escalated the budget deficit by over thirty percent in 2010 increasing the public obligation levels to above forty percent for the years of 2009 and 2010. Portugal’s economy experienced no effective competition hence it was the most sluggish economy in the EU for the boom period previous to the global economic predicament. In Spain, the country ran a surplus budget in the middle of 2000’s with relatively little public obligation levels as a result of capital inflows the real estate bubble was fueled to unsustainable levels. Italy on the other has had an extensive record of high public amount overdue. The boom period before the economic crisis saw the debt level exceed 100% of GDP increasing its vulnerability to tight economic conditions (Vittori, 2013).Economic Challenges Facing the Eurozone The major problem facing the Eurozone is the high levels of public debts and government deficits in some Eurozone countries-Portugal, Ireland and Portugal. Consequently, the governments have had to borrow from the leading economies and IMF. Of most concern are the Spain and Italy high debt levels and high interest rates raising doubt over the countries public debt sustainability (Rogers, 2012). Another concern is the weaknesses in the Eurozone banking system. This is as a result of the many Eurozone banks holding periphery bonds, which analysts consider as risky as many do not have sufficient capital to absorb losses in case one or more Eurozone government restructure their debt or default. This has triggered capital flight from banks in some Eurozone countries resulting into financial crisis (Rogers, 2012). Lack of economic growth has made it difficult for Eurozone countries especially the periphery to repay their debts. According to the IMF report in April 2012, the Eurozone was to dip back into recession in 2012 contracting by 0.3% before resuming modest in 2013. The economic outlook of some countries is worse. Greece’s economy has contracted by nearly 20% for the period between 2007 and 2012. Of the periphery countries, only Ireland experienced a growth of 0.5 in 2012 with others facing recession ((IMF, 2012). Persistence trade deficits in the periphery countries have made it difficult to pursue export-led growth as a response measure. This has forced them to undertake structural reforms in an effort to make their economies competitive and bolster exports in the long run. According to analysts report the Eurozone core have taken few policy measures to boost demand and raise prices a move that will help increase imports from the periphery countries. Lastly and vital are the problems in the Eurozone structure. Although Eurozone has a common monetary policy and currency, they lack a fiscal union. As a result, it does not have a centralized budget authority or fiscal transfer system across member states. If the union could have a close fiscal union, a central budget authority could control spending in the different Eurozone affiliate states and employ fiscal transfers to smooth out shocks in the zone. This remains both economic and political concern and member states have paid focus on it (Vittori, 2013).Policy Responses Various policy measures have been employed since the start of the crisis in an effort to stop or at least contain the crisis. One of the major policy responses has been the provision of financial assistance to countries and banks in crisis. This is through the Eurozone governments rescue facilities to governments and banks. European Financial Stability Facility (EFSF) was temporarily established to provide direct loans to Eurozone governments, banks or purchase government bonds from the secondary markets. The organization aims at forming a permanent rescue fund by the name European Stabilization Mechanism (ESM). Crisis affected countries are pursuing substantial economic reforms in order to comply with donor a financial assistance provider requirements. This is in an effort to reach the benchmarks set on fiscal austerity and structural reforms. The IMF together with European Commission representatives and the European Central Bank (ECB) have been helping the crisis hit countries design and monitor implementation of the reform programs (Rogers, 2012).
The ECB has been purchasing the Eurozone government bonds on secondary markets in an effort to stabilize bond yields. It has also been in the front line in implementing the reforms associated with financial assistance packages. More so it has provided unprecedented flexibility in its short term refinancing operations throughout the crisis. Lastly it has cut the interest rates to the lowest level to revive the Eurozone economy. Internationally the IMF has pledged to increase its financial resources in order to fight the crisis. The United States among other countries through its Federal reserve has re-established temporary reciprocal currency agreement-swap line-with the aim of increasing the dollar access (IMF, 2011). In conclusion, little has been achieved in addressing the crisis. The root causes of the crisis such as fundamental problems in the Eurozone architecture, trade imbalances in the Eurozone and lack of competitiveness in the periphery countries. Additionally the austerity policy response measures have sacrificed growth consequently undermining the recovery from the crisis. There is the need to improve on the policy making process increasing on efficiency.
Impact of exchange rate
The Euro exchange rate volatility during the European debt crisis has been a result of uncontrolled public debate emanating from the policy makers. This calls for application of the macroeconomic fundamentals in policy actions by the policy makers.
At the country level, the ECB has been voluntarily been affecting the exchange rate and its volatility through its actions. This has helped to lower the volatility and consequently economic uncertainty and brought some sanity in the market. This is through the monetary and fiscal policies regulations applied interchangeably. To achieve high growth levels in the long-term there is the need for macroeconomic stability especially the inflation rate.
In the light of prevailing situation, there is need to implement structural reforms in order to eliminate cross country economic differences and adopt strict financial policies in financial sector management. This is guided by the principle that economic performance is the major pillar of a stable exchange rate. Additionally, there is need to eliminate public and private sector imbalances a thing the ECB have been working on. This is not forgetting the extra role of ECB of contributing to the global economy governance on top of guarding the euro.
References
Guillén, A. (2012). Europe: The Crisis within a Crisis. International Journal of Political Economy, 42(2), 41-68.
International Monetary Fund (IMF), “IMF Outlines Joint Support Plan with EU for Portugal” May 6, 2011.
International Monetary Fund (IMF), World Economic Outlook, April 2012.
Rogers, C. (2012). The IMF and European Economies: Crisis and Conditionality. Houndmills, Basingstoke, Hampshire: Palgrave Macmillan.
Singala, S., & Kumar, N. (2012). The Global Financial Crises with a Focus on the European Sovereign Debt Crisis. ASCI Journal Of Management, 42(1), 20-36.
Vittori, D. (2013). A political crisis in an economic tempest (January 2008 - December 2012). Eastern Journal of European Studies, 4(1), 105-126.
