Euro - Essay Example

Roots Cause of the Current Euro Crisis Roots Cause of the Current Euro Crisis Euro crisis is now moving into dangerous waters and experts fear that the euro debt crisis will plunge into the world stock markets and will result in a global financial and economic crisis. Euro crisis could eventually lead to the crash of the global markets. It is also believed by many that the current crisis could possibly break up the Euro. The whole world is closely watching the developments in the EU and how the members are acting in order to come out of the crisis.

This paper is aimed at analysing the root causes that has resulted in the crisis in the first place. One of the main causes for the current crisis is the failure of the one-size-fits-all monetary policy. The monetary policy of ECB is not area wise targeted but rather focused on the core economies of French and Germany. This is mainly because of the disproportionate size of these economies in the union. Therefore, the single currency policy has stabilized these core economies but has completely thrown the other economies of balance.

One-size-fits-all monetary policy has fuelled the economic balance that is witnessed today (Beckworth, 2011). Another reason why the single currency fails in the Euro area is the fixed interest rates throughout the region. What this means is that the interest rates can be positive, negative or even zero depending on the inflation in the region. High inflation would mean negative of zero interest and low inflation results in positive interest rates. This is exactly what happened in European Union.

ECB had to loosen the monetary conditions in order to avoid stagnation and deflation in Germany (which was facing relatively tighter monetary conditions). As interest rates were the same throughout the region, the interest rates in the periphery economies were very low. These lower interest rates throughout Europe are the main “contributor to the bubble in the peripheral economies” (Hoffmann, 2011). In a currency area due to the capital market and financial integration, other countries are also drawn when a bubble bursts in one country.

This is one of the major causes for the crisis in Europe today. One of the most important factors to be considered here is the fact that the European Union does not fulfil the conditions necessary to be form an Optimum Currency Area (OCA). The cultural and linguistic differences in the Euro area result in complete lack of labour mobility which is one of the requisites for an area to be considered an OCA. Also a centralised fiscal transfer mechanism which is an essential risk sharing system in an OCA is absent.

The business cycles in the different countries in the EU are not similar and this means that the degree of effect on the national economies by a shock is different. The failure of EU as an OCA is an important factor that has resulted in the failure of the single monetary policy and in turn given rise the current crisis. The Stability and Growth Pact was in place to ensure fiscal discipline in the EU. But most of the member failed to follow the rules laid down in the pact and this can be viewed as another reason for the crisis.

According to the pact, national debt should be lower than 60% of the GDP and the budget deficit annually should not be more than 3% of the GDP. But most of the member countries did not follow this and found ways to bypass these rules. It also has to be noticed that pact has been made very flexible which helped the members to bypass it. When Greece ran out of money, EU came to its aid. But according to the rules, a country must not be subsidized by other countries to meet its expenditures. But this rule was also broken.

Therefore, the root causes for the current euro crisis are the one-size-fits-all monetary policy, EU not being an OCA and the flexibility of the Stability and Growth Pact. References Beckworth, D. (2011). ECB Monetary Policy: One Size Doesnt Fit All. [Online]. Available at: http://seekingalpha.com/article/261554-ecb-monetary-policy-one-size-doesn-t-fit-all. Accessed on 9Nov, 2011. Garganas, N.C. (2007). Does one size fit all? Monetary policy and integration in the euro area. [Online]. Available at: http://www.bis.org/review/r071107c.pdf. Accessed on 9Nov, 2011.

Hoffmann, A. (2011). Does one size fit all?. [Online]. Available at: http://thinkmarkets.wordpress.com/2011/03/23/does-one-size-fit-all-2/. Accessed on 9Nov, 2011. Rowley, E. (2011). Euro crisis could cause global markets to crash. Available at: http://www.telegraph.co.uk/finance/economics/8641483/Euro-crisis-could-cause-global-markets-to-crash.html. Accessed on 9Nov, 2011.