Keeping the Interest Rates Low in Order to Help Greece - Research Paper Example

? Reasons Why the European Central Bank (ECB) Should Keep the Interest Rates Low in Order to Help Greece Name of Institution Date of Submission Introduction According to Stein (2011) Greece’s economy was the strongest and fastest developing in the European zone. This was connected to the greatest structural discrepancy in the early mid-2000. In the late 2000s the world was hit seriously by global crisis in which Greece economy was largely affected. The main industries-tourism and shipping were particularly vulnerable in the business cycle. The state made efforts to keep the economy going by spending a lot which consequently increased the country’s debt level in the eurozone. Further efforts were made to reduce the impact of the economic crisis where the Greek State borrowed a loan of €45 billion on 23 April, 2010 from the European Union and the IMF. This was in attempt to cater for its financial requirements for the remaining period of 2010. Their efforts were futile as standard and Poor’s cut the country’s debt rating to junk status a few days after acquiring the loan. The move was in fear of a possible default by the country where the investors were likely to lose 30-50% of their savings. As a result the securities market in the world and the entire euro currency went dipped low in reaction to the S & P downgrade (Stein, 2006). Below is an explanation as to why the European Central Bank must keep the level of interests low with the intention of rescuing Greece. Justification as to why the interest rates must be kept low to help Greece The lowering of the interest rates will give some relief to Greece particularly with its delicate Southern tier. The banks in Greece will eventually borrow heavily from the European Central Bank since the bank will find it difficult to hold more cash in the central bank when borrowing is low. Lending in the private markets will also increase which will enable the households and business free up their cash for more expenditure and investment that can improve the economy of the country. The interest rates of the loans are closely pegged on the formal policy rate hence in one quarter point European Central Bank decrease will eventually reflect into €2.5 billion less yearly payment of interests as approximated by economists (Stein, 2011). Efforts have been by the eurozone monetary policy through the European central bank to help in rescuing Greece which has been coordinated by several actions. This is in response to the escalating threat of the world’s economy as a result of the crisis in Greece. First and foremost, the European Central Bank made a cut on the interest rates to a record low of 0.75%. This was an urgent move to counter the extreme run of the economic information. However, this has driven the strong shift in recuperating the State’s bond purchase policies or flooding banks with a long lasting liquidity term (Bartha, 2011). According to Butler (2010), the European Central Bank is also anticipated to make a further cut with more measures to enable the Greece economy to come back to its feet. Consequently, the Bank of England whose lending rates are currently hitting low of 0.5% has intentions of rejuvenating its printing procedures and purchasing of US$ 78 billion of its assets. This is in line with its freshly established monetary guidelines to assist in lifting the eurozone out of downturn. The reaction by the European Central Bank to ease the market tension has been implemented through cutting of borrowing costs for debts by 25 basis units. The interests’ rate record low of 0.75% has the main purpose of promoting the declining eurozone economy. The justification for this move was instigated by the increased pressure on European Central Bank by the investors and other stakeholders such as the IMF to take bolder steps in countering the economic downturn. Hence the European Central Bank had to buy back most of the sovereign debt securities for Greece distressed economy. Besides, the cuts and the interest reduction were justifiable in the sense that price stability in the medium term will be guaranteed to ease the mounting pressure in the economy. The scheme undertaken by the European Central Bank comprised leaving the interest rate constant at 0.5% (Janssen, 2012). Even though cutting of interest rates to a low of 0.75% has been expected to have some temporal impact, many market experts are in agreement that this would assist the deteriorating economies of the 17 member countries inclusive of Greece (Plagnol, 2010). The analyst further reason that the actual impact on the ailing economies is not what they actually aim to achieve but it a matter of mental game that is being played to appear in support of the investor’s and IMF proposition. However, the reduction in interest rates is highly appreciated by the Southern European banks which have heavily borrowed loans from the European Central Bank in the recent past. If the policy is implemented in accordance to the agreement with the 25 basis points reduction in yield, it will eventually reduce the yearly interest payment from the US$ 1.253 trillion in 3 years time by approximately 2.5 billion Euros. What’s more, according to the recent studies, there are rough and straining times for entire Euro-zone economy which have predicted by various market analysts. Germany economy in particular is the greatest common currency area that might experience a diffident downturn. This rate cut is not anticipated to reduce the euro crisis or absorb the pressure of the exorbitant borrowing costs that has contributed to challenges in refinancing the debt structure of Italy and Spain. Notably, the interest rate cut will probably not have an impact on the actual economy in Greece (Kulish & Geitner, 2012). Furthermore, the interest rate cut can help in reviving the debt stricken banks in Greece’s economy. This is because the banks will have a lot of cash at their disposal since the cost of borrowing will be low hence it can easily lend to other private sectors and households consequently improving on their returns. The impact of the interest rate cuts The declaration by the Eurozone states of their intentions to stem the depression yielded some promising results for a few weeks but later on they were proved to be insufficient in the event of the unanticipated shock. Most vivid was in the last quarter of 2011 and the first quarter of 2012 when European Central Bank gave a loan of 1 trillion Euros to banking institutions at a rate of 1 %. The expectations were that the banks would promote its financial management in the eurozone region. The markets also thrived well for numerous months, but Greece’s economy had unconvincing first round of elections. There were fresh reports concerning Spain’s banking tragedies that started to spread and in the occasion of these shocks in Italy and Spain, their state bonds also followed suit and crumbled. The international and European equity markets also crumbled. It is estimated that the recent moves can withhold the shocks even though previous measures did not produce positive results. The Greece’ market is hanging on the balance and the eurozone leaders are unable to a mass enough resources in promotion of the euro. As a result of the summit held by the European Union, the complete lending authority inclusion of the monetary policies went over from the initiators European Financial Stability Facility (EFSF) which is estimated to be about 750 billion Euros. Eventually there was a proposal by the Germany Council of Economic Experts in the early period of 2011 to have a debt liberation fund which would end the crisis in Europe. Moreover, the leader’s have remained stranded on the way they are going to tackle their exit from the crisis. Ultimately, the top leaders are likely not to consent to the current circumstances in giving out Eurobonds to counter the European Central Bank bond buying as a method of terminating the crisis in the eurozone. In their opinion the move can only guarantee a slight change in the economy but its sustenance is in doubts. It is expected that the prices and wages will continue to slump within the timeline in the eurozone. Conclusion From the discussion above it fundamental to note that by lowering further the interest rates less impact can be noticeable. Greece’s economic status is on the balance given the fact that lower interest rates might not help in cutting down of the acute rate of unemployment in Greece. As noted in the discussion, the merge of recession, emerging bond yields and the economic austerity has resulted into a dangerous cycle in the country. There are doubts concerning the ability of Greece to finance its huge debt burden have instigated up the securities yield which has impelled the state to cut on its budgets and increase its taxation. This will further cripple the economy of the nation in spite of all the measures mentioned in the discussion. It is the duty of the entire eurozone fraternity to look for other measures that can enhance exit from the eurozone crisis. Relying on the interest rate cut is not enough to revive Greece’s economy. References Bartha, E. (5 January 2011). “A mixed Day for European Debt, The Wall Street Journal Butler, E. (13 June 2010). “Hidden debt is the Country’s real monster. The Sunday Times (London). Jerome L. S. (2011). The Diversity of Debt Crises in Europe, Cato Journal, Vol. 31, No. 2 (Spring/Summer 2011). Copyright © Cato Institute Nicholas K. & Geitner, P. (June 14, 2012). “Merkel Stresses Limits to Germany’s Strength. The New York Times, Retrieved July 23, 2012 Ronald Janssen (28 March 2012). “The Mystery Tour of Restructuring Greek Sovereign Debt Social Europe Journal, Retrieved 23 July 2012 Plagnol, V. (2010). “European Bond Markets in Financial Crisis.” Reuters, Ecowin Stein, J. L. (2006). Stochastic Optimal Control, International Finance, and Debt Crises. Oxford: Oxford University Press Read More