European Sovereign Debt Crisis and Its Impact on Financial Markets and Institutions - Assignment Example

European Sovereign Debt Crisis and its impact on financial markets and s Affiliation a) Describe briefly how the European Sovereign Debt crisis commenced and explain the main causes. The European Sovereign Debt Crisis of was basically the failure of the Euro which was the monetary symbol that tied together 17 Countries across Europe (Arezki et. al, 2011). This therefore means that the start of all these is retraced back to the second world war in 1945. At this time Europe was the worst causality of the war owing to the fact that most of the countries felt the consequence of the war. In an effort to forge a united front therefore Europe hoped that they could be able to emulate the United States of America by coming together to do business and forging a united front without absolutely letting go of their sovereignty. In so doing the countries of Europe hoped that they could be able to ease the relationship between the countries. This was to enable the countries do away with barriers such as tariffs and financial requirements to be able to do across the border businesses (Gande & Parsley, 2005). With the dream of uniting Europe the problem or rather the challenge was doing business. After world war, the unified Europe was to end or rather curb any potential future wars. To achieve this, the countries agreed that elements such as the trade barriers cost of doing business as well as the physical barriers such as the berlin wall had to be brought down. The last stroke to the curving of a unified Europe therefore culminated when 24 countries of Europe across boundaries came together and agreed on one currency Euro which took effect in January 1, 1999. The countries that took part in the agreement signing therefore agreed to the fact that all the countries involved would use one financial unit which was branded the Euro (Kaminsky & Schmuckler, 2002). Problem was that the agreement to use the Euro or rather a common monetary unit the other aspect that was ignored was the fiscal policy aspect as well. The is a large disparity between the monetary and fiscal policy such that the monetary policy is one that controls money supply as well as how much in economy and determines the interest rate for borrowing. On the other hand the fiscal policy deals with the collection of taxes and expenditure. In this entire mix what is important to note is that a country or rather a government is supposed to spend as much as it is collecting in revenue and anything spent above the collected amount is borrowed and referred to as deficit spending. The solidification of the uniformity with the currency being the Euro the coming together of the European countries looked solid (Favero et. al, 2010). All the countries were growing because even the smaller countries such as Greece were able to accrue debt even the smaller countries and this were compensated by the well-off economies such as Germany. This means that despite countries such as Greece, Ireland, Spain, Portugal and Italy wallowing in debt they were still able to thrive since they did not really feel the impact of the debt thanks to the better economies such as Germany cushioning them off (Bundesbank, 2011). However in 2008 when the debt crisis emanating from the United States of America hit Europe the effect of the absence of a common fiscal policy was felt. Source: (Arghyrou & Kontonikas, 2012) Absence of a common fiscal policy In forging a common front the individual countries of Europe were carefully not to relinquish their sovereignty. This is the reason why despite the consolidation to a common monetary unit the countries were rather reluctant in doing the same for the fiscal policy as this would have meant coming up with something like a United States of Europe which they didn’t want (Codogno et. al, 2009). This meant that the issues to do with expenditure of the individual countries were not monitored and the individual countries were not help accountable by any particular structure or country. It is only when the financial crisis struck that the other countries realized the burden of being involved with other countries while the other countries also appreciated how much their economies were riding on the hard work of other countries. Source: (Arghyrou & Kontonikas, 2012) Huge debts accrued by the countries with weaker economies As a result a country with a better economy like Germany was at pains to help the other states such as Greece recover from their financial mess which was smeared with very large debt all over. They were only able to be safe by temporarily holding back when the crisis struck (Barrios et. al, 2009). This therefore meant the continued thriving of the European Union solely depended on the other countries taking some stringent measures with regards to their spending something that led to the introduction of austerity measures by German who were keen not to be affected greatly by the crisis. Such austerity measures were not well received with the unrest witnessed all over due to the plans such as cutting down of expenditures by governments to help mitigate the problem. Source: (Arghyrou & Kontonikas, 2012) In 1999 Earthquake hits Athens something that badly affected by the late 2000 financial crisis. When they joined European Union in mid-2001 Greece they embraced the Euro something that cushioned them from their debts for a while. In 2002 economic reforms adopted by Greece as well as entry to Euro make it easier to borrow money. In 2004 Greece faced a decade of debt due to the soaring of the Olympic bill. After 2005 Greece introduces austerity measures in line with the demands of the other states such as Germany. Later in 2009 due to the debt issues the credit rating of Greece drops significantly since they were not solely able to recover from the financial mess they were immersed in. In 2010 Greece are left with no option but to take the several hundred billion financial aid packages from the EU and IMF. However it is at this time also that the Greece is dominated by a lot of protests against budget cuts which in the long run trigger a run of violence. This leads to the resignation of George Papandreou as Prime Minister of Greece. (Arghyrou & Kontonikas, 2012) b) Discuss its impact on the bond market and its implications for two other markets (e.g. equity, derivatives, commodities, Forex, gold, etc). A lot of measures had to be put in place to mitigate the financial problems that had been introduced by the European Sovereign Debt Crisis. In the long term what was necessary to do was to first of all reduce the rate at which the debt was pilling without stopping the running of the economies of the different nations (Gennaioli et. al. 2014). As such the first logically steps that many nations took was to cut down on their financial expenditures through the slashing of their budgets despite the many consequences that were emanating from such (Lane, 2012). This for instance led to the resignation of George Papandreou as Prime Minister of Greece who felt that the pressure of balancing the survival of the nation and meeting the needs of the people was overwhelming. Source: (Arghyrou & Kontonikas, 2012) Some countries were therefore forced to halt the inflow of commodities something that affected the middleclass economies and the other countries that heavily relied on such. Commodities therefore being rejected or rather turned back were turned to alternative markets at a loss rather than complete loss. Consider the instance of India and Brazil that were heavily exporting their products to the European countries who had to feel the impact of the crisis thanks to the lack of markets for their products (Fang & Miller, 2002). For the first time since the introduction of the Euro the countries in European Union were at loggerhead wit regards on how to mitigate the crisis individually and collectively as countries under a single union. Bailing out countries such as Greece, Ireland, Italy, and Spain among others was proving to be tough for the other more established and will cushioned economies. Source: (Arezki et. al, 2011) The bond market was also not able to go unscathed by the crisis as these instigated immediate measures in the bond markets to cushion it. Bonds had to be let go on a cheap so as to not run the risk of no one being able to buy off the bonds. This meant that the companies, individuals and countries were at a loss because the bonds that were being sold were cheaper. Due to the accrued debt the interest rates dropped significantly and therefore the bonds had to be let off at a much lower cost than they has anticipated or hoped for. People were not able to recover their money (Manganelli & Wolswijk, 2009). Even those that went for the best bonds in which they anticipated to get the best returns were shaken by the financial debt crisis. Interests rates were raising due to the lots of debts therefore the bonds prices were dropping significantly and this was affecting the financial management as well. Basically the scenario in Europe was that prices of bonds were dropping due to the increase in debts that forced interest rates to rise. Bank lending rates in the worst affected countries such as Italy was discouraging investors and hence the bond markets also did not attract investors as well (Oliveira et. al, 2012). The few investors were cautious of the Euro bond which was drawing mixed reactions with a country like France supporting it, while other countries such as Germany completely against it. Source: (Arezki et. al, 2011) c) Discuss its impact on financial institutions such as commercial banks, securities firms etc. In an effort to cushion themselves the financial institutions had to put in place measures. Some of them if not most of them did not favour the people and the governments. Lending and borrowing was regulated and the interest rates skyrocketed as well. Due to the accrued debt the interest rates rose significantly and therefore trade instruments such as the bonds had to be let off at a much lower cost than they has anticipated or hoped for (Ehrmann et. al, 2009). The financial market was also not able to go unscathed by the crisis and as a result the institutions in this sector instigated urgent measures in the markets to cushion themselves against the anticipated effects. This is why the bonds had to be let go on a cheap so as to not run the risk of no one being able to buy off the bonds. The long term effect was that companies, individuals and countries were at pains because the investments which they took such as the buying of bonds were basically now giving lesser returns and losses. Even those that went for the safer markets in which they anticipated to get the best returns were shaken by the financial debt crisis (Gibson et. al, 2012). People were not able to recover the money they have invested in the different ventures. Interest rates were raising due to the lots of debts therefore the commodity prices were dropping significantly and this was affecting the financial management as well. Source: (Arezki et. al, 2011) People were more cautious in investing, doing businesses and going to the banks and other financial institutions due to the rise in lending rents and the adverse effects of the credit levels of their countries (Romer, 2012). The few investors were cautious of the Euro bond which was drawing mixed reactions with a country like France supporting it, while other countries such as Germany completely against it. Basically the picture in Europe was that prices of commodities and the cost of doing business were dropping due to the increase in debts that forced interest rates to rise. Bank lending rates in the worst affected countries such as Italy was discouraging investors and hence the business environment and the markets also did not attract investors as well. The different measures that were being instigated by the countries such as France and German among other member states were also being approached rather cautiously since they were not guaranteeing the survival and recovery of the European Union and its member states (Blundell-Wignall & Slovik, 2010). Some activities such as the commodities from other countries such as Brazil being rejected and turned back was not helping as this worsened off the situation. Financial institutions were doing less business because of the crisis and they did not know how to reverse this since everyone was feeling the heat. d) Analyse and critically evaluate the effectiveness of policies and measures taken so far by policy makers and financial institutions. Structural reforms The countries such as German asking the other countries with the weaker economies to tighten their structures after the crisis is one measure that were introduced. It is a measure that came a little too late but still worth lauding as it will have a significant long term effect with regards to the survival of the Euro and the thriving of the European Union (White, 2010). What made the crisis worse of the European Union is the concealment of the large amount of debts by the smaller countries such as the Greece who were thriving on the economies of the other countries. It therefore goes without saying that the choice of the stronger economies such as German to impose strict measures on other weaker economies such as Greece before helping them is an intervention that not only achieves the short term goal of getting them out of the debt but also the long term goal of stabilizing European Union for the future too. Austerity measures Austerity was about cutting down budgets and minimizing expenditures especially the countries that were worst affected. Countries with better economy such as Germany was forced to help the other states such as Greece recover from their financial problems which was worsened by the very large debt all (Mora, 2006). They were only able to be safe by temporarily holding back when the crisis struck but this was not something that needed more urgent measures apart from help. This was achieved through countries that continued thriving of the European Union solely depended on the other countries taking some stringent measures with regards to their spending something that led to the introduction of austerity measures by German who were keen not to be affected greatly by the crisis. Such austerity measures were not well received with the unrest witnessed all over due to the plans such as cutting down of expenditures by governments to help mitigate the problem. Stronger countries pushing for expansionary policy This was one strategy that was meant to cushion all the member states of the European Union from the effects of the crisis by sharing the effects across (Arghyrou & Kontonikas, 2012). It also meant the synchronization of the policies and structures to prevent another such occurrence in the future. The recovery of the countries in the turmoil such as Greece was something that would best survive by the introduction of an expansionary policy which would oversee the achievement of the set goals and targets for the recovery of the European Union. In as much as individual countries were able to recover such a policy would also see to it that the Union would apart from surviving also be able to cushion itself from the likelihood of a repetition of the same circumstance. References Arezki, R., Candelon B., and Amadou N. R. S. (2011). 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