What Were The Main Causes of The Eurozone Debt Crisis of 2010/2011 - Essay Example

?What Were The Main Causes of The Eurozone Debt Crisis of and What Have Been The Significant Policy Responses To That Crisis? Table of Contents Introduction 3 A Brief Idea of the Impact of Eurozone Debt Crisis 4 A Brief Analysis of the Causes of the Eurozone Debt Crisis 6 A Brief Overview of the Significant Policy Responses towards Eurozone Debt Crisis 9 Conclusion 11 References 12 Introduction The conception of debt crisis can fundamentally be defined as a massive public debt that is not repayable by any particular nation or a national government and ultimately seeks for financial aid from other countries or any financial institutions (Pescatori and Sy 2004). It has been apparent from the working paper of International Monetary Fund (IMF) that since early 2010, the Eurozone had faced significant effects from the recent debt crisis. The countries belonging to Eurozone that have subsequently faced the major debt crisis included Greece, Portugal as well as Ireland. Among these three Eurozone countries, particularly Greece has been viewed to be the main sufferer of the resulting debt crisis that took place in the Eurozone. It has been reported that Greece possessed the highest level of public debt along with significant budget deficits in the year 2010. In this connection, the sufferer countries belonging to Eurozone i.e. Portugal, Greece and Ireland eventually turned to other European nations as well as the International Monetary Fund (IMF) for financial assistance with the intention to avoid default on their huge public debt. However, Greece was the first Eurozone member to realise strong market pressure and also the first nation to turn up with other European nations along with IMF for financial support and assistance. Thus, from the above facts, it can be stated that among the Eurozone countries or members that faced the debt crisis, the market condition, especially of Greece, was quite deteriorated through increased public debts that ultimately made the country to emphasise on accepting financial support from other European nations and from the IMF (Pescatori and Sy 2004). With due consideration to these facts, the discussion in this paper will perpetually portray the various significant impacts of the debt crisis that took place in Eurozone upon various grounds, important causes for the debt crisis and the momentous policy responses towards the crisis. A Brief Idea of the Impact of Eurozone Debt Crisis The wide emergence of the debt crisis of Eurozone imposed noteworthy impact upon several grounds that largely include political and economic factors among others. From the perspective of the political grounds, certain number of members belonging to various political parties showed utmost importance towards the involvement of International Monetary Fund (IMF) during the crisis that was faced by the Eurozone countries. In this connection, in the year 2010, the then government passed the legislation for the purpose of limiting the active financial assistance of IMF to the advanced economies. In terms of the economic factors, the debt crisis that occurred in the Eurozone countries, especially in Greece, Portugal and Ireland, posed momentous impact upon the economy of United States as well. The debt crisis of the Eurozone countries might be regarded as a strong financial issue due to the fact that the debt crisis could hamper the exports of United States making the currency value of Eurozone countries (i.e. Euro) to decrease in value against the US currency (i.e. Dollar). It is obvious to the fact that the emergence of the debt crisis could largely increase different kinds of financial risks that can pose large impact upon the financial markets of United States (Nelson, Belkin and Mix 2011). Furthermore, the Eurozone debt crisis imposed major effect upon the exposure of the banks belonging to United States. Noticeably, the banks of the United States possessed little exposure to one of the debt crises which affected Eurozone country, Greece, but significantly held certain greater financial exposures that generally include guarantees, credit commitments and securities as well as derivative contracts among others. In this context, the debt crisis of Eurozone might not hamper the various financial institutions of the Eurozone nations by a large extent; however, it can largely affect the various financial exposures of the United States (Nelson, Belkin and Mix 2011). Additionally, the crisis also possessed certain broader effects particularly towards the developing nations belonging to European Union. It is in this context that the crisis related with the Eurozone countries rendered direct pressure upon several banks belonging to Europe that compelled the banks to hold more capital and lend less. As a result, the banks realised a slower growth in their various working functions as well as it had to witness the issue of deleveraging (Massa, Keane and Kennan 2011). Moreover, this particular Eurozone debt crisis affected the several developing countries regarding the aspect of investment and business trade linkages. The debt crisis eventually lowered the confidence level of the financial institutions that largely affected their working activities in relation to the aspect of investments. In addition, the transformations in the financial market due to the debt crisis further delayed the investments along with dropping of the portfolio flows in the European developing countries (Hofmann & Schneider 2010). The depreciation of the Euro currency due to the result of debt crisis eventually affected the competitiveness of the developing nations involved with the European Union along with affecting the overall business trade and services at large. In this context, a weaker currency would have a substantial affect upon the trade in services as the tourists of Europe seems to travel to different economies that might diminish their purchasing control which ultimately can possess a strong affect on the entire European economy (Pescatori and Sy 2004). A Brief Analysis of the Causes of the Eurozone Debt Crisis According to the European Commission, the different reasons for the emergence of the debt crisis of Eurozone in 2010-2011 could be significantly related with the Asian Crisis which occurred in late 1990’s along with the crisis that was faced by the Nordic nations in the same era. The European Commission noted that the different reasons of the debt crisis of Eurozone along with the crisis that was faced by the Asian and Nordic countries were largely due to certain momentous facets. The important factors included rapid credit growth through longer periods, strong leveraging issues, accessibility of low risk premiums, plentiful accessibility of liquidity, increasing price of the assets and the progression of bubbles in the sector of the real estates (Minescu 2011). Apart from the various causes for the emergence of the debt related crisis of Eurozone that are mentioned above, the other contributory factors of the crisis can be regarded as the issue of household mortgages. It has been observed that due to the emergence of the crisis, the level of the household debt raised significantly in relation to the disposable earnings of the households. Thus, this particular issue relating to the household mortgages ultimately increased the extent of household credit playing a vital part towards the occurrence of the Eurozone debt crisis (Valiante 2011). In this context it has been apparent that one of the Eurozone members i.e. Greece had contributed largely upon the emergence of the debt crisis. In this connection, the considerable level of the public debt and the high budget deficit of Greece eventually paved the way towards the rise of the crisis. Thus, it can be stated that the two noteworthy issues, such as the large deficiency in the economic budget along with the extensive level of public debt were considered as the chief causes of the debt crisis of Eurozone. Noticeably, as the Eurozone member, when Greece joined the European Union in the year 2001, the nation already possessed a public debt in excess of 100% of Gross Domestic Product (GDP). In this context, the government debt of Greece reached upto 115% of GDP in the year 2009; whereas, the deficit in relation to current account belonging to Greece was recorded as 14.6% of GDP in the year 2008 (Valiante 2011). Along with the issue of public and government debt as well as deficit in the current account, there also lay certain additional reasons for the debt crisis in Greece and other parts of European Nations. The other reasons include increased government spending, feeble revenue collections, frail enforcement of the various rules and regulations of the European Union regarding debts and other financial aspects. Moreover, Greece also faced certain decisive restrictions such as the unfeasibility of currency devaluations owing to its membership into the Eurozone and the deficiency in the competiveness of its economy as a consequence of its overpayment, especially made in the public sector (Valiante 2011). In relation to the debt crisis of Eurozone, Portugal also viewed as the probable victim of the debt crisis immediately followed by Greece. The major weaknesses of Portugal as the Eurozone member that contributed largely to the emergence of the debt crisis was very much alike to that of Greece which included the issue of large public debt and an extensive budget deficit. Though these weaknesses that were possessed by Portugal were quite similar to that of Greece, but still there could be observed certain diverse situations between two countries. In this connection, Portugal was recognised to enjoy speedy financial growth earlier than joining the European Union in the year 1999, but was also found to lack in terms of competiveness, especially in terms of wages in its employment market. The decade of 1990’s was largely viewed as a lost decade for the country and as a result, the country was not able to control its total requirement of public finances due to the issue of remaining competiveness in its employment market. Additionally, the trend of Foreign Direct Investment (FDI) was also considered as one of the vital causes for the emergence of the debt crisis. Due to the lacuna of the economy in managing the public finances, the investors gradually showed lower concentration to make their valuable investments particularly in Portugal (Pescatori and Sy 2004). The other consequences of not effectively managing the public finances ultimately led towards the recession that lowered the tax revenues as well as raised the welfare costs substantially. The other causes of the debt crisis generally include lack of a centralised fiscal system along with greater level of labour mobility. Additionally, the valued position of the actual international investments that largely signifies the broader differences between the external financial liabilities as well as assets of the Eurozone countries comprising Ireland, Greece and Portugal among others are significantly weak that ultimately contributed towards the occurrence of the debt crisis. As a result, the government of the respective countries belonging to Eurozone were recognised to rely deeply upon the external monetary support from various other European countries along with the different financial organisations like International Monetary Fund (IMF) (Dun & Bradstreet Limited 2010). Thus, it can be stated that the various momentous causes for the emergence of debt crisis in the year 2010-2011 of Eurozone generally included inability to manage public finances, increased budget deficits along with extensive increase in the household mortgages which accumulatively resulted in the huge increase of public debt levels. Moreover, the factor of deficiency of its financial market in terms of its competitiveness, deeper reliance upon financial assistances from different European nations as well as international financial institutions and lack of a centralised fiscal system also contributed to the occurrence of Eurozone debt crisis 2010-2011 (Stein 2011). A Brief Overview of the Significant Policy Responses towards Eurozone Debt Crisis The European leaders along with the different world renowned financial institutions that include International Monetary Fund (IMF) along with World Bank largely believed that the vulnerable and the uncontrolled situation of the Eurozone debt crisis could be quite risky and should be avoided to the largest possible extent. The European leaders as well as the above mentioned financial institutions were largely curious regarding the fact that such an uncontrolled and vulnerable situation that contributed deeply towards the emergence of the crisis could pose significant effect upon the selling of the bonds to other Eurozone countries. In relation to the response of the Eurozone debt crisis, it has been recognised that the European leaders as well as the International Monetary Fund (IMF) declared a three-year financial package in the year 2010 that was amounted to approximately $158 billion by forming of loans that would be provided to Greece at the market based interest charges (Nelson, Belkin and Mix 2011). Along with the European leaders and the IMF, the European Central Bank also depicted greater interest towards delivering financial assistance for the purpose of the debt crisis. In this connection, the European Central Bank (ECB) and Federal Reserve (Fed) belonging to United States also played a crucial role while acting in response towards the debt crisis. In response, the ECB, in the month of 2010, declared that they will initiate to acquire the government bonds belonging to Europe, especially with the intention of reducing the extreme level of market pressures that were faced by the Eurozone members or countries (Scott 2011). It has been identified that during the year 2010 and 2011, the ECB procured the government bonds belonging to Europe approximately $112 billion in order to lift up the vulnerable situation that resulted due to the rise of Eurozone debt crisis (Nelson, Belkin and Mix 2011). In addition, the European Central Bank (ECB) has also delivered enhanced as well as resourceful liquidity support, especially towards the private banks located at Greece, along with other countries of the Eurozone. Apart from the financial assistance that was provided by the ECB in response towards the debt crisis, the Federal Reserve of United States also responded significantly by re-establishing impermanent mutual currency arrangements with several central banks with the motive of raising the liquidity of dollar in the worldwide economy (Armingeon & Baccaro 2011). It has been further noticed that in the year 2011, the European leaders once again announced a second monetary supporting package, especially for Greece with a sum total of approximately $157 billion. This particular monetary assistance package was able to assist Greece to deliver sufficient loans in more favourable terms as compared with the initial monetary supporting package that was announced in the year 2010. Instead of providing loans to Greece, the European leaders also delivered deterrent credit lines to the countries feeling intense market pressure and investing towards the recapitalisation of the banks belonging to Eurozone along with purchasing several bonds based upon the secondary business markets (Statistical, Economic and Social Research and Training Centre for Islamic Countries 2011). Thus, it can be stated that the European leaders, International Monetary Fund (IMF), European Central Bank (ECB) and the Federal Reserve (FED) enthusiastically came forward and delivered momentous monetary or fiscal assistance package to different Eurozone nations or members to cope up with the vulnerable situation that was generated from the debt crisis of Eurozone in the year 2010-2011 by a considerable level (Nanto, Sanford and Weiss 2010). Conclusion With reference to the above discussion, it can be stated that there lies immense causes for the emergence of debt crisis in the Eurozone nations which include the factor of extensive growth in the debt levels along with raising deficits in the current accounts among others. It has been recognised that the main source of the Eurozone debt crisis was largely due to the vulnerability of individual financial systems that was possessed by each Eurozone country. For instance, the unsustainable budget deficit in Greece and the large public debt in Portugal contributed significantly towards the debt crisis of Eurozone. The above discussed causes of the debt crisis accumulatively imposed crucial affect upon the economy of the Eurozone based countries. In this regard, many world renowned financial institutions like the International Monetary Fund (IMF) and the Federal Reserve along with other major European leaders provided major financial assistance packages for the Eurozone countries with the purpose of dealing with the debt crisis. Thus, it becomes quite apparent that the various financial organisations along with the prominent European leaders contributed magnificently in order to recover from the adverse situation that resulted due to the debt crisis especially in the Eurozone nations by a considerable extent. 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