How would, for example, Portugal defaulting on its bond payments impact the othe
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How would, for example, Portugal defaulting on its bond payments impact the other countries in the Euro-zone? What would happen to interest rates? What would be the possibility of debt crises in other Euro-zone countries? How would this impact economic growth in the Euro-zone?
Will increasing the size of the bailout fund (from which troubled countries can draw in times of crisis) help to prevent future crises? Why or why not? What is the downside of increasing this fund?
Germany seems to be the Euro-zone country that is leading the push toward greater fiscal integration as a means to greater financial stability. Why? What does Germany stand to gain by a fiscal union?
How would, for example, Portugal defaulting on its bond payments impact the other countries in the Euro-zone? What would happen to interest rates? What would be the possibility of debt crises in other Euro-zone countries? How would this impact economic growth in the Euro-zone? Will increasing the size of the bailout fund (from which troubled countries can draw in times of crisis) help to prevent future crises? Why or why not? What is the downside of increasing this fund? Germany seems to be the Euro-zone country that is leading the push toward greater fiscal integration as a means to greater financial stability. Why? What does Germany stand to gain by a fiscal union?Explanation / Answer
Portugal defaulting on its bond payments impact the other countries in the Euro-zone
Portugal had allowed considerable slippage in state-managed public works and inflated top management and head officer bonuses and wages in the period between the Carnation Revolution in 1974 and 2010. Persistent and lasting recruitment policies boosted the number of redundant public servants. Risky credit, public debt creation, and European structural and cohesion funds were mismanaged across almost four decades.[105] When the global crisis disrupted the markets and the world economy, together with the US credit crunch and the Eurozone crisis, Portugal was one of the first and most affected economies to succumb.
In the summer of 2010, Moody's Investors Service cut Portugal's sovereign bond rating, which led to an increased pressure on Portuguese government bonds.
In the first half of 2011, Portugal requested a %u20AC78 billion IMF-EU bailout package in a bid to stabilise its public finances. These measures were put in place as a direct result of decades-long governmental overspending and an over bureaucratised civil service. After the bailout was announced, the Portuguese government headed by Pedro Passos Coelho managed to implement measures to improve the State's financial situation and the country started to be seen as moving on the right track. However, this also lead to a strong increase of the unemployment rate to over 15 percent in the second quarter 2012 and it is expected to rise even further in the near future.
Impact on interest rates
ortugal's debt was in September 2012 forecast by the Troika to peak at around 124% of GDP in 2014, followed by a firm downward trajectory after 2014. Previously the Troika had predicted it would peak at 118.5% of GDP in 2013, so the developments proved to be a bit worse than first anticipated, but the situation was described as fully sustainable and progressing well. As a result from the slightly worse economic circumstances, the country has been given one more year to reduce the budget deficit to a level below 3% of GDP, moving the target year from 2013 to 2014. The budget deficit for 2012 has been forecast to end at 5%. The recession in the economy is now also projected to last until 2013, with GDP declining 3% in 2012 and 1% in 2013; followed by a return to positive real growth in 2014.
As part of the bailout programme, Portugal is required to regain complete access to financial markets starting from September 2013. The first step has been successfully completed on 3 October 2012, when the country managed to regain partial market access. Once Portugal regains complete access it is expected to benefit from interventions by the ECB, which announced support in the form of some yield-lowering bond purchases (OMTs), to bring governmental interest rates down to sustainable levels. A peak for the Portuguese 10-year governmental interest rates happened on 30 January 2012, where it reached 17.3% after the rating agencies had cut the governments credit rating to "non-investment grade" (also referred to as "junk") As of December 2012, it has been more than halved to only 7%.
Possibility of debt crises in other Euro-zone countries
Aside from all the political measures and bailout programmes being implemented to combat the Eurozone crisis, the European Central Bank (ECB) has also done its part by lowering interest rates and providing cheap loans of more than one trillion Euro to maintain money flows between European banks. On 6 September 2012, the ECB also calmed financial markets by announcing free unlimited support for all eurozone countries involved in a sovereign state bailout/precautionary programme from EFSF/ESM, through some yield lowering Outright Monetary Transactions (OMT).
The crisis did not only introduce adverse economic effects for the worst hit countries, but also had a major political impact on the ruling governments in 8 out of 17 eurozone countries, leading to power shifts in Greece, Ireland, Italy, Portugal, Spain, Slovenia, Slovakia, and the Netherlands.
The Eurozone crisis has also become increasingly a social crisis for the most affected countries, with Greece and Spain having the highest unemployment rates in the currency area. Spain's unemployment was 26.9 percent in May 2013, while Greece's rate in March was 26.8 percent
Its impact on economic growth in the Euro-zone
According to the Financial Times special report on the future of the European Union, the Portuguese government has "made progress in reforming labor legislation, cutting previously generous redundancy payments by more than half and freeing smaller employers from collective bargaining obligations, all components of Portugal's %u20AC78 billion bailout program." Additionally, unit labor costs have fallen since 2009, working practices are liberalizing, and industrial licensing is being streamlined. "But many reforms remain in the pipeline," the FT admits.
Bailout Fund and its impact
The European Stability Mechanism (ESM) is a permanent rescue funding programme to succeed the temporary European Financial Stability Facility and European Financial Stabilisation Mechanism in July 2012 but it had to be postponed until after the Federal Constitutional Court of Germany had confirmed the legality of the measures on 12 September 2012. The permanent bailout fund entered into force for 16 signatories on 27 September 2012. It became effective in Estonia on 4 October 2012 after the completion of their ratification process.
On 16 December 2010 the European Council agreed a two line amendment to the EU Lisbon Treaty to allow for a permanent bail-out mechanism to be established including stronger sanctions. In March 2011, the European Parliament approved the treaty amendment after receiving assurances that the European Commission, rather than EU states, would play 'a central role' in running the ESM.The ESM is an intergovernmental organisation under public international law. It is located in Luxembourg.
Such a mechanism serves as a "financial firewall." Instead of a default by one country rippling through the entire interconnected financial system, the firewall mechanism can ensure that downstream nations and banking systems are protected by guaranteeing some or all of their obligations. Then the single default can be managed while limiting financial contagion.
Stand of Germany to Gain Fiscal Union
ermany and the European Central Bank have done just enough to convince the markets that the eurozone will survive, for now. But many eurozone economies remain on the critical list. Some have made heroic efforts, with results already visible. In Spain, for instance, unit labour costs are already down and exports are at a 30-year high. The pain has been immense, with 50% youth unemployment and house prices falling between 30% and 40%, but somehow people are getting through it. This has had political spin-off effects %u2013 literally so, encouraging Catalans to want to spin off from the Spanish state %u2013 but in terms of conventional party politics, the centre has held. There has been very little xenophobic rhetoric and virtually no scapegoating of immigrants.
What has happened in Spain is remarkable testimony to the resilience of the European political mainstream, with its almost instinctive commitment to moderation, bound up in a deep-rooted desire to remain part of a larger European project. But for how long, oh Lord, how long? For how many more years can these societies endure such levels of socioeconomic stress before their democratic politics lurch to extremes?
We have seen the danger already with the electoral success of the ultra-nationalist, xenophobic and (for once, the label is justified) neo-fascist Golden Dawn party in Greece. Quite different in kind, but larger in its political impact, is the Italian political impasse, which results from voters being split between the comedian Beppe Grillo's protest movement, Silvio Berlusconi and the left, plus a smaller vote for Mario Monti's "Monti for Italy" grouping, with the votes breaking differently in the two houses of parliament. With a stalemate between the two chambers, reform is stymied in the eurozone's third largest economy.
Some of this was inevitable, but it has been made worse by human error in general and German error in particular. I can entirely understand German voters' initial angry reaction to being asked to bail out other Europeans who had been much less disciplined, hard-working and productive than them, in order to save a currency which the Germans never voted to join. (In bringing down its unit labour costs, Spain is doing, in an involuntary crash course, what Germany started doing a decade ago, on its own initiative.) I would have felt that way myself. I can understand Angela Merkel and her colleagues hanging tough.
But facts are stubborn things. When the facts change, or at least become clearer, policies must be adjusted accordingly. The duty of politicians in a well-functioning liberal democracy is to recognise those facts and then explain them to voters, not to string voters along with waffle and false promises. Here's an example: the so-called fiscal multipliers, that is, the impact on GDP of a cut (or increase) in public spending. In normal times, when most of the countries with which you do business are faring OK, this multiplier may be as low as 0.2 or 0.4 %u2013 that is, GDP declines by some 0.2-0.4% for every 1% you cut public spending. But when everyone around is in recession, the effect is dramatically increased.
This was the case in the Great Depression, as the Oxford economic historian Kevin O'Rourke and his collaborators have clearly established. It is the case again today, in our Great Recession, as the economists at the IMF, the EU and other institutions are now acknowledging. In conditions of all-round recession, the fiscal multipliers can soar above one, so a 1% cut in public spending may cause a 1.5% drop in GDP. That significantly alters the calculus of austerity.
Here's another fact, slightly larger and therefore more contestable, but still quite firm: the pain of adjustment has been born mainly by the southern European "periphery", not the north European "core". Yet it took two to create this mess. Blame the feckless borrower in the south but also the shortsighted lender in the north %u2013 for instance, in German banks. That leads to another, only slightly more speculative statement. Germany has more to lose than any other country from a collapse of the eurozone. One estimate puts its banks' exposure to Greek, Spanish, Portuguese and Irish debtors alone at about %u20AC400bn. The German government's own council of economic advisers last year assessed the maximum potential losses to German creditors in a eurozone breakup at %u20AC2.8 trillion, topping the country's %u20AC2.65trn annual GDP. Any successor currency, be it an old-new Deutschmark or a north European euro (the Nordo or Neuro), would have a less advantageous exchange rate for German exports.
Not from any Keynesian dogma, not from idealism, not from sentimentality towards fellow Europeans, but in its own enlightened national interest, Germany needs to do more. It should increase its domestic demand, support a strong banking union, and embrace something like its own economic advisers' proposal for a limited mutualisation of eurozone debt %u2013 with appropriately stringent conditions. In terms of the political economy of the whole eurozone or, perhaps more accurately, its economy-driven politics, the best moment to do this has passed. That was what we must now call the Monti Moment.
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