Macro economics - Research Paper Example

To understand the European Debt Crisis, the events leading up to 2009 must be thoroughly analyzed. On February 7th, 1992 the 13 member nations of the European Council gathered together to sign the Maastricht Treaty The purpose of the treaty was to lay out key financial rules for each member state to adhere to, with the long term goal being that of creating a union between the member states promoting economical growth and free trade. The treaty primarily encompassed four points: Firstly, a close monitor on inflation rates, ensuring that no member state was 1.

5 percent higher than the average of the three best countries' rates. Secondly, tight regulation on the annual government deficit. Thirdly, member states would adhere to the currency exchange rates set by the European Monetary System (EMS). Finally, the nominal long-term interest rate should not be more than two percentage points higher than in the three lowest inflation member states. While all 13 members signed, at the end of 2010 only four countries were able to abide by the policy for Government Debt.

In essence, the members of the European Council were spending far more than they were bringing in. The inability for the European countries to manage their debt was the leading cause for the European Debt Crisis. (Arghyrou & Tsoukalas, 2011). . The creation of the Euro in 1999 was a vehicle to ease trading between its member countries and therefore benefit their economies. The countries that were joined through the Euro were Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain.

After these countries were united, countries such as Greece were able to take advantage of the lending rates of 1-3% compared to previous rates of 6% or more. Banks lowered their rates as a result of their connection with countries like Germany. The banks reduced their rates on the basis of “tacit promise”, if Greece could not repay the loan, Germany would. The same rates were additionally offered to Portugal, Italy, Ireland, and Spain. Between 1999 and 2009 Portugal, Italy, Ireland, Greece and Spain, (PIIGS) with their new access to low interest rate loans, took on huge amounts of debt to fund the activities of their countries.

This inflow of cash from the loans generated a false sense of prosperity in the countries created a 'bubble'. The loans to the countries were issued in exchange for Sovereign Bonds. When Greece announced it had financial difficulties it had a drastic impact on the sovereign bonds that were owned by the banks. The news led to an increase in the bond yields to above 7% indicating that the bond was distressed. As a result of Greece relying on deficit spending to cover their debt, issuing bonds was the only way they could manage, however, with the huge decline in their bond value they are currently not able to raise enough funds to stay solvent.

In April of 2010, the Troika—the International Monetary Fund (IMF), the European Central Bank (ECB), and the European Commission (EC, the executive arm of the European Union)—structured a bailout