Euro crisis
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Euro crisis
- 1. The Eurozone Financial Crisis PRESENTED BY:- BABASAB PATIL
- 2. The Eurozone Financial Crisis • Transmission from the United States • Housing Price Bubble and Collapse • Financial Market Freeze and Collapse • Policy Response – Support for Financial Sector – Monetary Policy – Fiscal Policy • Effect of the Euro Currency Zone • Greece’s Problems
- 3. Transmission from United States • US Housing Bubble created by – Low interest rates – Lax regulation of sub-prime mortgages with adjustable rates, two year teaser rates – Securitization of mortgages, sold to unwary buyers as highly rated • US Bubble popped when – Interest rates rose in 2006, housing prices fell – Subprime mortgages and securities defaulted
- 5. European Crisis Began Later • US Housing Prices peaked in late 2006 • European Housing Prices peaked a year later • Financial Crisis struck Europe & US at same time, August 2007, after Bear, Stearns, Fannie Mae & Freddie Mac taken over with US Government assistance in April and July of 2007 • International credit markets froze up in August 2007 when subprime based hedge funds collapsed in Europe and US. No longer able to borrow short-term funds, banks faced much higher risk premia
- 6. Interest Rate Spreads in Dollars and Euros
- 7. Why did the Crisis Spread? • Subprime Debt Obligations made in USA held around the world caused global financial shock. • Housing bubbles burst in UK , Ireland, Spain as well as US. • Failure of Lehman Bros in September 2007 caused massive panic over counterparty risk. AIG required $180 billion bailout to cover Credit Default Swaps, insurance against bond defaults underwritten without reserves. • Stress on banks around the world led to shrinking credit availability. “Shadow” off-balance-sheet banking sector collapsed as short-term funding vanished. • Falling demand spread from US to all countries; as US imports dropped, other countries’ exports fell.
- 8. Banks Under Duress: Writedowns and Capital Raised (US$ billions) Source: International Monetary Fund (2008)
- 9. Quarterly Real GDP Growth Rates Source: International Financial Statistics, IMF.
- 10. European Financial Institutions under Stress • BNP-Paribas forced to close funds in August 2007 • UK bank Northern Rock taken over by government • German state banks IKB, WestLB, BayernLB and SachsenLB bailed out by government • Irish banks given government deposit guarantees • Switzerland injects funds into UBS • Iceland’s banks unable to roll over short term borrowing, default on deposits of foreigners
- 11. Credit in the Eurozone (% change) Source: European Commission (2009).
- 12. Monetary Policy Response by European Central Bank (ECB) • ECB injected liquidity into European banks unable to obtain short-term funds in market. • Federal Reserve used Euro-dollar swaps to make dollars available to ECB to lend to banks. • ECB did not lower interest rates until October 2008 because of its focus on inflation. • Euro fell against the dollar due to “safe haven” flight to US Treasury securities.
- 13. Interest Rates in the Eurozone and the US (interbank rates) Sources: ECB, Federal Reserve Bank of New York
- 14. Financial Sector Bailouts in US & Europe • TARP and Federal Reserve programs in US • National programs in European countries, due to absence of Eurozone-wide regulator. • “Beggar-thy-neighbor” effect, as first Ireland gave deposit guarantees, then UK, then Netherlands, to avoid bank deposit flight.
- 15. Public Support to the Financial Sector (as of 18 February 2009, % of GDP) Source: International Monetary Fund (2009).
- 16. Fiscal Policy Responses to Recession • Automatic Stabilizers of falling taxes, rising welfare and unemployment payments kick in as incomes fall and unemployment rises. • Discretionary Fiscal Stimulus enacted in most countries, depending on their fiscal positions. • European countries limited by Stability and Growth Pact to 3% fiscal deficits, except in time of “exceptional economic distress.”
- 17. Changes in Budget Balances, October 2008 Source: IMF (2009)
- 18. The Role of the Euro • Previous economic crises in Europe have led to large devaluations of currencies. • Within eurozone, single currency prevents devaluation , provides automatic financial support through capital markets. • Non-euro currencies depreciated sharply in 2008, British pound sterling, Swedish kronor, Polish zloty, Hungarian forint.
- 19. Exchange Rates vs the Dmark or euro (Left Index: 1970q1 = 100 Right Index: 2007m1 = 100) Source: International Financial Statistics, IMF, Monthly Bulletin, European Central Bank
- 20. Greece’s Financial Problems • Since joining the euro, Greece has had higher inflation than other Eurozone members. • Greece has also increased debt faster than others to finance generous public sector pay, welfare, and retirement benefits, while collecting a lower share in taxes due to widespread tax evasion. • As a result, Greek goods have become increasingly expensive and uncompetitive, causing loss of market share and further reducing revenues.
- 21. Relative price indicators based on export prices Source: European Commission (2010)
- 22. The Greek Debt Crisis • Greek debt/GDP ratio reached 113% and deficit/GDP ratio reached 12.7% in 2009. • Foreign bondholders became doubtful that Greece could continue to roll over its increasing debt, forced interest rates higher. • EU faced choice between Greek default and bailout with tough conditions. • IMF and EU agreed to lend Greece up to $146 billion over three years. • Greece to increase sales taxes, reduce public sector salaries, pensions, eliminate bonuses.
- 23. Greece’s Debt Dynamics Source: Economist.com
- 24. Conclusions • Cautious Eurozone response to Financial Crisis – Interest rate policy reaction delayed: concentration on inflation target – Fiscal policy reaction muted: Stability & Growth Pact • Common currency members avoided large devaluations and foreign currency debt. • European governments have tried to act together, not always successfully. • Limited impact of falling exports due to extensive internal trade relationships. • Greece facing difficult adjustment problems, European banks avoiding losses on Greek bonds.