In my first post on Eurozone i highlighted the creation of the block, its merits and constraints.
Now lets turn our attention to the first major challenge before the Eurozone and its implications.
All of us are aware of the Financial crisis of 2008-09 that saw collapse of Lehmann Brothers, bail out of AIG and bailout of other big Financial institutions. Europe or for that matter the Eurozone was not immune from it. It was hit very badly with some countries on the verge of collapse and others badly wounded. But how come things come to such a state.
The seeds of the crisis were sown back in the hay days of early 2000’s. A period of easy financing encouraged many people to indulge in risk taking behaviours both by the private firms and by Governments. The Maastricht treaty which led to creation of Eurozone had led down some guidelines for member states in areas of fiscal deficit but they were never followed. The laid back attitude of countries (read structural problems) especially in the peripheral areas of Europe forced the Governments in these countries to breach those sacrosanct lines which had unintended consequences. The banking system being in the forefront of the credit system was hit badly with several Governments and other institutions of European Union bailing out banks. This transfer of risk from the banking system to the Governments risked sovereign default crisis in many countries such as Greece, Ireland, Portugal & Cyprus where the debt to GDP ratio had reached levels not seen in many countries ( > 100%). In Other countries such a Spain the crisis was contained at the Banking level .
As mentioned before Eurozone has a single monetary union but not a fiscal union which made matters complicated for states in terms of raising taxes and other sources of revenue. The ECB played its role by lowering interest rates and allowing cheap loans to European banks. The monetary policies of ECB had an unequal effect on member states. States in the North such as Germany benefited where as in the South many members could not take advantage of it. But nevertheless the weaker nations benefited for being part of a block as they were indirectly bailed out by richer nations in the block.
Some economists were of the view that leaving the Eurozone and creating own currency would be a better option for weaker member states than draft tougher laws on labour reforms, fiscal policy etc. This is debatable as the Euro denominated debt would make the exiting countries insolvent very soon unless other forces come to the rescue.
As expected the economic crisis had the strongest effect on the job market and in countries in peripheral areas the unemployment rate rose to 25%. The economic slowdown reduced economic activity, demand and pushed Europe towards an era of deflation. This was visible from historic low yields on Government bonds. This crisis also led to regime change in many countries and many Governments truly vulnerable and shaky.
Ultimately the last man towards whom everyone was looking for solution, Mario Draghi the ECB president had to step in for the rescue. Quantitative easing was launched with money injected into the system with a mandate to increase inflation expectation to 2%.
The coming few months or years will show whether he succeeds or not.
In my next blog i will travel to the ancient capital of civilisation Athens (though many won’t believe) given the current state of affairs. I will meanwhile check for a Greek restaurant in town !
Muses 