Macroeconomic Theory and Policy

XLRI, Jamshedpur

2013

THE EUROZONE CRISIS: A Macroeconomic Perspective

Prepared By: ANAND ODEDRA (B13132) AMITABH VAJPAYEE (B13131) ANIRBAN CHAKRABORTY (B13134) ANUPAM MAITY (B13183) ASHUTOSH SINGH (B13138) 12/18/2013

INDEX
THE EUROPEAN UNION .. 2 PRELUDE TO THE EUROZONE CRISIS . 3 A CHRONOLOGY OF THE MAIN EVENTS . 5 CAUSES OF THE CRISIS PICTORIAL REPRESENTATION .. 6 CAUSES FOR THE EUROZONE CRISIS . 6 POLICY MEASURES . 11 EUROPEAN CENTRAL BANK . 14 ECONOMIC REFORMS AND RECOVERY PROPOSALS . 15 LESS AUSTERITY, MORE INVESTMENT . 15 INCREASE COMPETITIVENESS 16 ADDRESS CURRENT ACCOUNT IMBALANCES . 17 WHAT IS THE WAY OUT? . 18 PROPOSED LONG TERM SOLUTIONS .. 19 CONCLUDING REMARKS .. 22 REFERENCES . 24

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THE EUROPEAN UNION

The European Union (EU) is quite unique in the international system. The original goal behind the integration of Europe was to prevent the recurrence of the devastating wars of the first half of the twentieth century. The seeds of a united Europe were laid post WW 1. Presently 28 countries are part of the EU. There are various bodies that govern specific functions of the EU. Here we shall focus on the relevant points for the later part of the discussion. Convergence Criteria are the necessities that an individual country has to meet so as to become a part of the Union. It has been observed that the countries have fulfilled the criteria at the time of joining, however, they have violated these rules time once they become members. The salient features of the Maastricht Treaty that the country has to comply by are as follows: Inflation Rate : <1.5% higher than average of best three other countries Government Deficit/GDP <3% Government Debt/GDP <60% Interest Rates < 2% more than three lowest countries Stable exchange rate There are several salient features of the union that need to be highlighted at this point. The European Union had integration in mind and to a large extent, it had proceeded as planned towards its goals. At the time of the crisis, the following were in place: Free flow of goods and services Tax-free trade area Free flow of people No custom, no need for ID card All citizens from any of the 28 countries enjoys same rights and benefits However, there have been violations of the norms laid down by the treaty. These add up to the crisis and a lot of what happened can be attributed to the constant and blatant flaunting of norms of the Maastricht Treaty. Examples include: Inflation norm: In 2012, 12 countries did not meet criteria. Government Deficit norm: In 2009 and 2010, 15 countries did not meet criteria. Debt/GDP Ratio Norm: Greece and Italys ratio was always above the EU average. The graph of the Public Debt % to GDP goes to show that countries like Greece were much worse off than the rest of the Eurozone. However, Germany, the forerunner when it came to size and scale of the economy, had little external trade surplus. Most of its trade surplus came

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from countries within the EU which meant that this was recorded as a deficit in the balance sheets of the other Eurozone countries.

PRELUDE TO THE EUROZONE CRISIS

The Eurozone crisis has several features in common with other similar financial-stress driven episodes in the history of Economy. To start with, it demonstrated some of the characters that are common to such crisis. The parallels that can be drawn are as follows: Preceded by a comparatively long period of swift credit growth, Copious availability of liquidity Low risk premiums Strong leveraging Soaring asset prices Development of bubbles in the real estate sector. The collapse of the banking systems and the subsequent crisis that precipitated in the year of 2007 was brought about by a chain of events. These events were to an extent chronological. The analysis of this can be broken down into several steps which may or may not overlap to a certain extent. There are sub reasons for these events as well but here we focus on the main
The presence of stretched leveraged positions as well as maturity mismatches made financial institutions in the European Union highly vulnerable to any corrections in asset market. This led to the deteriorating loan performance and disturbances in the wholesale funding markets. Such episodes have happened before. The examples area bundant (e.g. Japan and the Nordic countries inthe early 1990s, the Asian crisis in the late-1990s). However, the key difference between these earlier occurences and the Eurozone crisis was its global dimension. When the crisis came to be in 2007, uncertainty among banks about the creditworthiness of their counterparts evaporated as they had heavily invested in often very complex and opaque and overpriced financial products The interbank market virtually closed and risk premiums on interbank loans soared to unprecedented heights. Banks faced a serious liquidity problem, as they experienced major difficulties to rollover their short-term debt. Policymakers still perceived the crisis primarily as a liquidity problem. This was one of the major blunders and mistakes made. Concerns over the solvency of individual financial institutions also emerged, but systemic collapse was even then deemed unlikely.

It was believed that the European economy, unlike that of the USA, would be largely immune to this financial turbulence. This was based on the belief that the real economy, though slowing, was thriving on strong fundamentals such as rapid export growth and sound financial positions of households and businesses This tuned out to be an illusion of sorts because the major part of international trade that was being done was between the countries of the EU; thereby making it seem that one country was accumulating a trade surplus. In reality there was little if any growth occuring.

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Bankruptcy of Lehman Brothers and fears of the insurance giantAIG (which was eventually bailed out) taking down major US and EU financial institutions in itswake Panic broke in stock markets, market valuations of financial institutions evaporated,investors rushed for the few safe havens that were seen to be left (e.g. sovereign bonds), andcomplete meltdown of the financial system became a genuine threat

The crisis thus began to feed ontoitself, with banks forced to restrain credit, economic activity plummeting, loan books deteriorating, banks cutting down credit further, and so on.

The downturn in asset markets snowballed rapidly across the world. As trade credit became scarce and expensive, world trade plummeted and industrial firms saw their sales drop and inventories pile up.

Confidence of both consumers and businesses fell to unprecedented lows.This set chain of events set the scene for the deepest recession in Europe since the 1930s

reasons leading up to the crisis. The following Info graphic summarizes the chain of events leading up to the economic crisis: As it can be seen, there was an overestimation of the trade taking place between the countries of the European Union. The trade surplus that Germany, the forerunner of the EU as far as size and strength of Economy is concerned, was also attributable to the nations of the EU to a large extent. The nations that it traded with were showing deficits in their balance sheets. Moreover there was the ever looming threat of internal collapse of the economy. These points and others will be covered in more detail in the rest of the report.
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A CHRONOLOGY OF THE MAIN EVENTS

The beginning of the crisis is a debatable event however the first clear-cut signs of it came when in 2007 BNP Paribas froze the redemptions for three major investment funds. The reason cited was its incapability to value structured products. As a result of this, the confidence of consumers as well as businesses fell to all-time lows. The direct repercussion of this was that there was a dramatic increase in the counterparty risk between banks. This was reflected in the soaring rates of lending charged by banks to each other for their short-term loans. This indirectly led to an increase in the credit default swaps and the insurance premium on banks' portfolios. People were also complacent regarding the onset of a crisis. Most observers were not even alerted that the systemic crisis would be a threat. However about half a year later all changed as the list of failed banks grew to such lengths that indications of a systemic meltdown around the corner were evident. The list includes Lehman Brothers, AIG, Fannie May and Freddie Mac, Wachovia, Washington Mutual and a few more. Nonetheless the governments were fast to respond. The damage would have been shocking had it not been for a variety of rescue operations that the governments undertook. With the fall of Lehmann brothers, investors became even more wary about the risk that bank portfolios contained. As a result of this, it became even more difficult for such banks to raise capital via the routes of deposits and shares. It came to a situation that the institutions that were deemed at risk could no longer finance themselves through conventional means involving banks. As a result of this, they has to sell assets at 'fire sale prices' and restrict their lending. Thus the prices of similar assets fell even more and thereby reduced capital and lending further a vicious cycle came into being. This can be compared to an adverse 'feedback loop' wherein economic downturn increased the credit risk, eroded bank capital even further. The primary response of major central banks - those that are situated in the United States and in Europe was to reduce common systemic factor interest rates down to a historical low thereby contain funding cost of banks. They also gave additional required liquidity against collateral so as to ensure that financial institutions didnt need to resort to fire sales. These measures resulted in huge expansion of central banks' balance sheets. This bank lending to the non-financial corporate sector eventually tapered off. The governments soon came to know that the provision of liquidity albeit essential, were not sufficient to restore normal functioning of the banking system. This was due to the deeper problem of probable insolvency associated with under capitalization. The write-downs of the banks were estimated to be well over 300 billion US dollars in the United Kingdom and well over EUR 500 to 800 billion in the euro area. In both cases this accounted for almost 10% of the GDP of the country and/or union. It was agreed in 2008 that countries would put in place financial programs to make sure that the capital losses of the banks would be counteracted.

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CAUSES OF THE CRISIS PICTORAL REPRESENTATION

Relaxed lending practices Excessive investment

Crisis: Hard Reasons

Risk assessment not proper Global Imbalances USA Subprime Crisis Improper fiscal policies framed by individual nations Contagion Problems no proper contingency measures in place. A Single Currency

Then there were 27 countries

Crisis: Soft Reasons

27 electoral democracies, 54 different points of view.

Culture, history, technology, language, customs, socioeconomic structure etc are not at all the same.

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CAUSES OF THE EUROZONE CRISIS

The Eurozone crisis has been caused from a blend of intricate factors. These factors vary from the globalization of finance; easy lending norms during the 2002 2008 period that stimulated high-risk lending and borrowing; the financial crisis of 200708; international trade imbalances; real estate bubbles; the Great Recession of 20082012; fiscal policy choices related to government incomes and expenditures; and methodologies used by nations to move out troubled banking units and private bondholders, supposing private debt burdens or socializing losses. These factors vary from country to country in the entire Eurozone. A few of them fell into the crisis because of the government debt while others lost a lot of money in the property bubble. We will now take the country wise analysis of the turnout of events that triggered the outbreak of crisis in them.

PORTUGAL
Government Spending & public funds mismanagement The democratic Portuguese Republic governments were involved in over-expenditure and investment bubbles via hazy publicprivate partnerships. They funded many unnecessary external aids to the government by consultancies which drilled deep holes in to the government pockets. This caused significant loss in state-managed public works, extravagant top management and head officer bonuses and Government Expenditure (annual % GDP) wages. Over Employment in public jobs The Portugal government followed an old recruitment program for the public jobs without keeping an eye on the actual requirement in the sectors. The public servants to population ratio was one of the highest in Portugal (708 as compared to 624 Euro zone average). Also, an example stating that Portugal judicial system was the second slowest in Europe despite having maximum number of judges shows how inefficient and ineffective the public system was. Portugal Banking system breakdown Other reason for the failure of the Portugal economy was failure of the Portugal banking system attributed to large scale bad investments, embezzlement and accounting frauds. In the grounds of avoiding a potentially serious financial crisis in the Portuguese
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economy, the Portuguese government decided to give them a bailout, eventually at a future loss to taxpayers.

ITALY
Accumulating Government Debts Italy has been very strangely has been shouldering the debt to GDP ratio well above 100% for decades but very astonishingly no one cared as it was paying back the interest. In the year 1999, while Italy officially accepted the euro, its debt-to-GDP ratio was 126%. It was staying afloat because of the slow steady growth which helped in the credibility of Italy. But then the economy became stagnant and was slowly moving towards negative dip. This cause panic among the investors and they raised the interest rates. Low Productivity of Italy Italy lacks in big industries to compete with the growing giants in Asia and rest of the world. Because the Italian economy is ruled by small and medium sized businesses, this can be thought of all those charming artisanal cheese and pasta makersthe capital markets are poorly

developed. And these small scale industries are unable to reach either economics of scale or efficiency owing to their small sizes. Unemployment disparity, Mafia & Poor Governance Some other factors that played minor roles are the existence of dual employment treatment in the economy where old employers are permanent and with higher wages while young employers with temporary jobs and lower wages causing a great disparity in the unemployment among the population. Also, wide spread black money market flourishes in Italy which eats away a major part of the GDP reducing the government revenues. Poor governance is also a major attributable cause for the above concerns.

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IRELAND
Property Bubble engulfed Irish Banks The Irish sovereign debt unlike other Eurozone crisis was not a result of government overspending, but due the guarantee that government took for the six core Irish-based banks who were deeply involved in financing a property bubble. These Irish banks had vanished an assessed 100 billion euros, the unemployment peaked from 4% in 2006 to 14% by 2010 and the national budget went from a surplus in 2007 to a deficit of 32% GDP in 2010. The highest ever in the history of the Eurozone and the crisis was here. Asset-Liability Mismatch The Irish banks had invested hugely in the widespread infrastructure & building project, most of which were not occupied even after being completed for years. This led a massive misbalance between the Assets that banks were banking upon to the liabilities that they were holding to the lenders. The government came to the rescue of the banks but it was not sustainable as there nothing to cash back the already occurred disaster. Ultimately the government had to lend money from IMF and European Union to overcome their deficit.

GREECE
In the early mid-2000s, the economy of Greece was among one of the fastest proliferating in the Eurozone. It propagated with an annual rate of 4.2%, as foreign money flew into the economy. In spite of that, the economy remains persistent in delivering high annual budget deficits. Major causes that led to this are below. Government spending The government was involved in huge military expenditure, public sector jobs, pensions and other social benefits. Greece was able to get finance for its spending until the world was hit by the global economic crisis in 2008. It dried up the global credit and which caused two prominent industries shipping and tourism affect severely.

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Government tried to control the economy by borrowing and spending with open hands. Tax evasion The revenue from taxes for Greece has always been significantly below the expectation levels. This was also one of the reason for growing deficit in the annual budget in the Greece economy. Corruption & unethical deeds In early 2010, it was exposed that Greece took the assistance of Goldman Sachs, JPMorgan Chase and numerous other banks to develop the financial products which aided the governments of Greece, Italy and many other Eurozone economies to conceal their borrowings and meeting unethically the deficit target as put by the euro union.

SPAIN
Housing Bubble Spain was relatively better off as far as the Debt to GDP ratio was considered among other Eurozone economies. Somewhat similar to Irish crisis, the new properties including public places, landmarks and houses were built massively which involved huge investments. Subsequently, there was no one to acquire or consume the benefits which aroused bubble speculation. Government could bear and back the deficit caused owing to the large tax revenues it had generated of the same construction spree. But this could not last for long.

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Sharp inflation & deflation As Spain lacks in natural resources, it heavily depends on its import for fuelling the country. Due to sharp rise in oil prices during the recession of 2008, the inflation reached its peak and a record height with pressure on government mounting high which was already struggling to
Spain on the Edge of Deflation

cope with the housing bubble mishap. Then the prices fell drastically and this lead to deflation in the economy and after that Spain economy could not recover from plunging negatively.

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POLICY MEASURES
European Financial Stabilization Mechanism (EFSM) It is a mechanism referring on article 122(2) of the TFEU that foresees financial support for member countries in difficulties caused by extraordinary circumstances beyond their control. It is an intergovernmental agreement to provide financial assistance of up to EUR 60 billion subject to strong conditionality in the context of a joint EU and IMF support which will be on terms and conditions comparable to those levied by the IMF. On 5 January 2011, the European Union created the European Financial Stabilization Mechanism (EFSM), an emergency funding program reliant upon funds raised on the financial markets and guaranteed by the European Commission using the budget of the European Union as collateral. It works under the authority of the Commission and aims at preserving financial stability in Europe by providing financial assistance to EU member states in economic problems. The Commission fund, backed by all 27 European Union members, has the authority to generate up to 60 billion and is given a rating of AAA by agencies like Fitch, and Standard & Poor's. Under the EFSM, the EU successfully placed in the capital markets a 5 billion issue of bonds as part of the financial support package agreed for Ireland, at a borrowing price for the EFSM of 3.59%.

European Financial Stabilisation Facility (EFSF) It is a temporary credit-enhanced SPV with minimal capitalization created to raise funds from the capital markets on its investment grade rating and provide financial assistance to distressed EAMS at lower interest rates than those available to the latter. The financial support provided to EAMS through the EFSF shall be provided on comparable terms to the stability support loans advanced by EAMS to Greece. The total volume of these two mechanisms is EUR 500 billion. While EFSM is available to EAMS and non-EAMS member states, the EFSF is only available to the EAMS. The European Union (EU) finance ministers created the European Financial Stability Facility (EFSF) to deal with the European debt scenario, which started in 2009, and was a part of the larger global financial crisis. To realise why the EFSF was created, one must first understand the fundamental requirements of becoming a member of the European Monetary Union (EMU). To become a member of the EMU, a country must follow and retain, among other specified criteria, a deficit below 3% of GDP and debt below 60% of GDP. Once a country becomes part of the EMU, it is subject to a single monetary and foreign exchange policy. However, essentially, the country does not lose its ability to set its own fiscal policy. Because of the EMU countries' ability to set their own fiscal policy, many EMU nations, like Portugal, Ireland, Italy, Greece, and Spain, spent a lot, taxed very less, and issued too much debt, which lead them into large deficits. This would not have been a problem if these countries were not part of the EMUthey could have printed more money to pay for their
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excessive spending and debt issuances. However, with a unitary monetary policy, countries within the EMU lose the facility to print money, and therefore, lack the ability to pay their debts by printing more money. This becomes a problem area when, as in the EMU, there are no limits on fiscal policy. Generally speaking, the easy-going fiscal policies of some EU member states along with deceptive statistical reporting by Greece were the major causes of the debt crisis. In early 2009, Greece claimed that its deficit was 3.7% of GDP. In October 2009, Eurostat, whose primary responsibilities are to provide the EU with European-level statistical information, published a press report stating that the Greek government misreported its deficit and debt figures. Shortly thereafter, the government of Greece adjusted the projected deficit to 12.7% of GDP, more than four times the 3% limit levied by the EMU. The Greek government also reported that its debt was 121% of GDP (well above the EMU limit of 60% of GDP). As a result, the major credit-rating firms downgraded Greek debt while investors became unsettled about other European countries with large debt and deficits. Notwithstanding opposition from some EMU member states hoping to restore confidence and safeguard financial stability in the Euro-Zone area, leaders of the Europian continent and the International Monetary Fund (IMF) agreed to make available a 110 billion rescue package to Greece if Greece implemented austerity measures. This did not in any way ease investors fears. After the Greek bailout, investors worried that other EU nations would break their promises of always being capable of paying back their debts or interest on their loans. As a result, eurozone nations government bond prices dropped significantly and market int erest rates for financially distressed EU government bonds in Greece, Spain, and Ireland increased. Shortly thereafter, investors began to worry that government finance problems would spread to European banks which held a lot of EU governments debt. Because of this, there were news of rift and that the EMU might break apart. To put an end to this speculation, calm the financial markets, and fight another sovereign debt crisis, the EU finance ministers created the European Financial Stability Facilitya limited liability company that could sell up to 440 billion of debt on capital markets and lend the proceeds to euro area member states in trouble which was part of a larger 750 billion rescue facility. The 750 billion rescue package consists of 500 billion from the twenty-seven countries of the EU and 250 billion from the IMF. The majority (440 billion) of the European contribution comes from sixteen-nation euro-zone bloc. The European Commission (EC), a branch of the governing body of the EU, made 60 billion immediately available at their disposable. European Stability Mechanism (ESM) In October 2010 (after financial assistance was provided to Greece and while conditions continued deteriorating), with the motive of ensuring balanced and sustainable growth, the EU Council agreed on the need for member states to establish a permanent crisis mechanism to safeguard the financial stability of the euro area as a whole. It was resolved that consultations should be undertaken towards a limited treaty change for said purpose but not modifying the so-called no bail-out clause included in article 125 of the TFEU. Further, the EU Council
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agreed in December 2010 that there is a need for EAMS to establish a permanent stability mechanism, i.e. the ESM. This was immediately followed by the Conclusions of the European Council57 and the EU Council decision 2011/199/EU amending Article 136 of the TFEU with regard to a stability mechanism for EAMS, both were adopted on 25 March 2011. When the EFSF expires, the EU will replace it with a permanent crisis mechanism called the European Stabilization Mechanism (ESM). The ESM will provide funds to any member state whose debt problems would threaten the euro zone. The ESM would want the private sector bondholders to share the cost of any debt restructuring on a case-by-case basis. A solvent euro-zone member experiencing liquidity problems can apply for emergency funding from the ESM and would have to implement austerity measures similar to those required by the EFSF. The country would not have to restructure its loans or decide on coming to a standstill (i.e. cease payments on its debt until a restructuring agreement has been negotiated with its creditors). However, if the IMF and the European Commission believe the country is insolvent or that its debt position is unsustainable, the country requesting the funds would have to negotiate with its creditors to restructure its debt as a condition of further bail-out funding. To facilitate the restructuring process, the European Stability Mechanism will require future bond issuances by member states to include collective action clauses (CAC). The CAC enables a majority of creditors to pass a legally binding agreement changing the terms of payment (standstill, extension of the maturity, interest rate cut and/or haircut) in the event the debtor is unable to pay. CACs are typical of the bonds issued under English law and help facilitate restructuring.

EUROPEAN CENTRAL BANK

The European Central Bank (ECB) has taken a series of measures aimed at reducing volatility in the financial markets and at improving liquidity. In May 2010 it resorted to the following actions: It began open market operations buying government and private debt securities, reaching 219.5 billion in February 2012, though it simultaneously absorbed the same amount of liquidity to prevent a rise in inflation. According to Rabobank economist Elwin de Groot, there is a "natural limit" of 300 billion the ECB can sterilize.

It reactivated the dollar swap lines with Federal Reserve support. It changed its policy measures regarding the necessary credit rating for loan deposits, accepting as collateral all outstanding and new debt instruments issued or guaranteed by the Greek government, regardless of the nation's credit rating.

With the aim of boosting the recovery in the Eurozone economy by lowering interest rates for businesses, the ECB cut its bank rates down in multiple steps in 20122013, reaching the
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historic lows of only 0.25% in November 2013. The lowered borrowing rates have also caused the euro to fall in relation to other currencies, which is expected to boost exports from the Eurozone and further aid the recovery.

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ECONOMIC REFORMS & RECOVERY PROPOSALS

The Euro zone debt crisis in the euro area during the spring of 2010 has revealed that the monetary and fiscal policy framework of the European Monetary Union (EMU) is still incomplete. Understandably, the rules-based framework for fiscal policy created by the Excessive Deficit Procedure and the Stability and Growth Pact was insufficient to prevent a debt crisis despite its emphasis on keeping public sector deficits low and strengthening forwardlooking budgetary planning. Once the crisis occurred and financial markets were stirred up by it, it became obvious that EMU did not have policy tools to manage and resolve the crisis. Lastly, the European Union responded to the crisis by agreeing on stabilisation for Greece and by creating the European Financial Stability Facility (EFSF) that succeeded in calming the markets. Nevertheless, these responses were developed in an ad-hoc manner and on a temporary basis only and do not provide an adequate basis for dealing with any possible future debt crises in the euro area. Several proposals have been put forward for how to improve the euro zones capacity to deal with problems of excessive public debts. To prevent sovereign crises, the European Commission (2010) has proposed a number of measures to strengthen the Excessive Deficit and the Stability and Growth Pact. The above proposals focus mainly on making the rules of the current framework more effective and on strengthening their enforcement by introducing stiffer and more automatic penalties for violating these rules. The European Central Bank (ECB) has made proposals (2010) on the same lines and, at the same time, has called for the creation of a crisis management fund for the euro area, which would come into play if the strengthening of the rules-based framework does not suffice to prevent future debt crises. According to the ECBs proposal, such a fund should provide last-resort financ- ing at penalty rates to governments facing difficulties in accessing private credit markets. We agree that the euro area needs a mechanism for dealing with sovereign-debt crises in an effective and predictable way. Even the most effectively enforced set of fiscal rules will not do away with the possibility of future debt crises in the euro area. One of the crucial problems of the crisis of 2010 was clearly that policymakers had no game plan for dealing with it. The lack of any sensible rules guiding market expectations about how governments and the Commission would respond to the crisis contributed to the volatility of financial markets during the crisis and this contributed to the sense of urgency policymakers felt about the need to act.

LESS AUSTERITY, MORE INVESTMENT

In the public sector, as a result of the austerity policy, wages have been frozen or cut. Greece ( 20 per cent) and Portugal (10 per cent) have been at the forefront of cuts in real wages throughout the economy. Spain (5.9 per cent) and Italy (2.6 per cent) have also experienced
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above-average real wage losses during this period. This showcases an opening of the floodgates in comparison to the situation before the crisis of 2008/2009. In pension policy, Portugal introduced reforms in 2007 and Greece, Italy and Spain in 2010, which many other EU states had launched a decade before. Besides raising of the statutory retirement age, a toughening of the conditions for early retirement, the equalization of men and women and the abolition of job-specific differences, individual components of pension reform have been adjusted in such a way that the rise in pension costs in relation to GDP by 2040 has been slowed down significantly. Relative pension levels will fall drastically in the GIPS states by 2040. The pension reforms that have been implemented will have long-term negative consequences, especially for those future pensioner generations who have more adverse employment biographies. Longer periods of unemployment conditions entail gaps in social insurance contributions and thus reduce pension levels. Privatization policy has taken on new impetus in the GIPS states because of the Euro-crisis and the accompanying austerity policy. In Greece and Portugal, the granting of loans by the EU states was linked to extensive privatization. Spain and Italy, under pressure from the ECB and international institutions, have announced far-reaching privatizations. Among the GIPS states, Greece has been most affected and plans a veritable fire sale of state property.

INCREASE COMPETITIVENESS
Internal devaluation Many policy makers try to restore competitiveness through internal devaluation, an economic adjustment process, where a country aims to decrease its unit labour costs. In 2012, Ireland was the only country that had implemented relative wage moderation in the last five years, which helped decrease its relative price/wage levels by 16%. Greece would need to bring this figure down by 31%. Wages in Greece have been cut to a level last seen in the late 1990s. Buying power dropped even more to the level of 1986. Fiscal devaluation According to fiscal devaluation, policy makers can increase the competitiveness of an economy by lowering corporate tax burden such as employer's social security contributions, while negating the loss of government revenues through higher taxes on consumption (VAT) and pollution, which is called ecological tax reform. Germany has successfully pushed its economic competitiveness by increasing the VAT in 2007, and using part of the additional revenues to lower employer's unemployment insurance contribution. Portugal has taken a similar stance and France appears to follow this suit.

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Progress According to the Euro plus Monitor 2011 report, most critical euro zone member countries are in the process of rapid reforms. Greece, Ireland and Spain are among the top five reformers and Portugal is ranked seventh among 17 countries included in the report. The Lisbon Council in November 2012 finds that the euro zone has slightly improved its overall health. With the exception of Greece, all Eurozone crisis countries are either close to the point where they have achieved the major adjustment or are likely to get there over the course of 2013. Overall, if the euro zone gets through the current acute crisis and stays on the reform path it could eventually emerge from the crisis as the most dynamic of the major Western economies.

ADDRESS CURRENT ACCOUNT IMBALANCES

Europe is in the grip of three interdependent crises: a sovereign-debt crisis, a banking crisis and a balance-of-payments crisis. Policymakers have primarily focused on the sovereign-debt and banking crises. However, a convincing strategy for getting the Eurozone back on track needs to tackle the problem of its large internal imbalances. Rebalancing will require countries with current-account deficits to devalue. The critical question is how: internally without exiting the euro or externally after exiting the euro.

Not much attention has been paid to the imbalances within the European Union or the Eurozone. One of the reasons for this might have been that the current account of the Eurozone was roughly balanced over the period from 1995 to 2011. The external balance of the Eurozone, disguised the significant internal imbalances. Greece, Ireland, Italy, Portugal, and Spain have been running a current account deficit that has been rising since the late 1990s. This deficit was largely offset by the huge current account surplus in Germany during the whole period. The rest of the Eurozone was more or less in balance. Current account deficits and surpluses resulted in corresponding changes in the net international assets position. Germany
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slowly improved its asset position while Greece, Ireland, Italy, Portugal, and Spain accumulated a large net liability position. Greece, Ireland, Italy, Portugal, and Spain relied more and more on public support to finance themselves internationally. Until 2007 the main source of this public support was ECB Target credit. The public capital flows as reflected in the increase in the Target balances compensated for the private capital flows. They have financed or co-financed the current account deficits of Greece, Portugal and Spain since 2007/2008, and compensated for capital flight from Ireland after the Lehman crisis.

WHAT IS THE WAY OUT?

The first option, the one favored by European finance capital, is to grant emergency loans to Greece. Loans will allow Greece to continue to service its debts so that bondholders do not incur any losses. The conditionalitys include reduction of government spending on social sectors, freezing of government jobs, reduction in wages, privatization of the pensions sector, labor market reform and other such measures. It will severely contract the level of aggregate demand in the Greek economy and thereby push it into a prolonged and deep recession. This will ensure a deflation in the Greek economy relative to Germany, leading to a possible reduction in the trade deficit. The second option, the one that should be favored by the working class in Greece and other countries, is to work out a credible debt-restructuring program with bondholders and force the German economy to reflate. Debt-restructuring would ensure that some of the cost of readjustment is borne by finance capital. Increasing aggregate demand in the German economy through a mix of fiscal and monetary policy would revive demand, push up inflation, decrease real interest rates and thereby boost private investments. Other options will open up, if Greece and other countries in the periphery decide to opt out of the euro zone altogether.

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PROPOSED LONG TERM SOLUTIONS

1. EUROPEAN FISCAL UNION: Fiscal union is the integration of the fiscal policy of nations or states. Under fiscal union decisions about the collection and expenditure of taxes are taken by common institutions, shared by the participating governments. It is often suggested that the European Union adopt a form of fiscal union. Most member states of the EU take part in financial and monetary union (EMU), founded on the euro currency, but most conclusions about levies and spending remain at the nationwide level. Thus, whereas the European union has a monetary union, it does not maintain a fiscal union. Control over fiscal policy is advised central to nationwide sovereignty, and in the world today there is no considerable fiscal union between independent countries. However the EU has certain restricted fiscal forces. It has a role in concluding the level of VAT (consumption levies) and tariffs on external trade. It also spends a allowance of numerous billions of euros. There is furthermore a Stability and Growth Pact (SGP) among members of the Eurozone (common currency locality) proposed to co-ordinate the fiscal principles of constituent states. Under the SGP, constituent states report their financial designs to the European Commission and interpret how they are to accomplish medium-term budgetary objectives. Then the Commission assesses these plans and the report is sent to the financial and economic managing group for remarks. Eventually, the assembly of financial and Finance Ministers concludes by qualified majority whether to accept the Commission's recommendation to the constituent state or to rewrite the text. However, under the SGP, no nations have ever been penalised for not gathering the objectives and the effort to penalize France and Germany in 2003 was not fulfilled. Thus, after the Eurozone urgent situation, some people in Europe sensed the need for a new union with more powerful fiscal influence amidst constituent states.

On 2 March 2012, all constituents of the European Union, except the Czech Republic and the United Kingdom, signed the European Fiscal Compact, which if ratified by the 25 countries would implement stricter caps on government expending and borrowing, encompassing automatic sanctions for nations breaking the rules. However, following are the arguments advocating the introduction of fiscal union in the EU: 1. LOCAL PROBLEMS NEED LOCAL SOLUTIONS As long as the European Union is made up of independent countries with their own voted-intooffice authorities, their troubles are going to be essentially localized and they will need localized solutions. Squeezing them into a common monetary straightjacket has clearly failed and supplementing a fiscal union would just exacerbate an existing unsustainable situation. Governments need flexibility to deal with their own problems. Fiscal union would involve
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ballooning of the EU allowance provoking endless bickering among the 27 constituent states on how to share it out, not to mention the amplified scope for graft and bureaucratic inefficiency. Its a recipe for gridlock. 2. DEMOCRATIC DEFICIT Fiscal union is often looked upon as detrimental to national independence. Setting budgets is essentially the responsibility of sovereign parliaments. Transferring that power to some distant, opaque Brussels institution would be deeply undemocratic. History tells us citizens will not agree to taxation without representation. 3. EVRERYONE PAYS MORE The tax harmonization that will follow fiscal union will only move in one direction: up. Countries like Ireland or Slovakia which boosted their economies with innovative revenue policies will be forced to apply high taxes as part of a French-led crusade against fiscal dumping. This shall be a major blow to Europes competitiveness.

FOR
NO EMU WITHOUT EFU: Combining supranational monetary policies with national fiscal policies is unsustainable. A fiscal union run by a fully empowered EU Finance Ministry under proper democratic oversight will give the Union strength and stability, mutualizing credit risk while imposing tough fiscal discipline. UNITED WE STAND: Closer economic union is the only way to halt Europes decline in the new global environment. Fiscal union would raise Europes market credibility and eurobonds would rival US treasuries. EFFICIENCY: A European fiscal union, with proper institutions would be able to provide joined-up management of the EU economy as a whole.

AGAINST
LOCAL PROBLEMS NEED LOCAL SOLUTIONS: Squeezing the EU member nations into the same monetary straightjacket has clearly failed and adding a fiscal union would just exacerbate an already unsustainable situation. DEMOCRATIC DEFICIT: Setting budgets is a core responsibility of sovereign parliaments. Transferring that power to some distance, opaque Brussels institution would be deeply undemocratic. Citizens will not accept taxation without representation. WELL ALL PAY MORE: Countries like Ireland or Slovakia that boosted their economies with innovative revenue policies will be forced to apply high taxes as part of a French-led crusade against fiscal dumping.

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2. EUROBONDS European bonds are proposed government bonds issued in Euros jointly by the 17 eurozone countries. Eurobonds are liability investments whereby an shareholder loans a certain amount of cash, for a certain amount of time, with a certain interest rate, to the eurozone bloc entirely, which then ahead the cash to the individual national governments. Eurobonds these days are intended as a way to tackle the eurozone debt crisis. The idea, propounded by the European Commission, appears to be of certificates that will fully replace existing national bonds. Technically, a eurobond is a debt contract, that records the borrowers obligation to pay interest at a given rate and therefore the principal quantity of the bond on such dates. Because Eurobonds would enable already highly-indebted states access to cheaper credit because of the strength ofalternative Eurozone economies, they're disputed. On 21 November 2011 the european Commission instructed European bonds issued together by the seventeen eurozone nations as a probably effective way to handle the monetary crisis. On 23 November 2011 a written report was presented, analyzing the feasibleness of common issuance of sovereign bonds among the EU member states of the eurozone. Sovereign issuance within the eurozone is presently conducted separately by each EU member country. The introduction of commonly issued eurobonds would mean a pooling of sovereign issuance among the member states and therefore the sharing of associated revenue flows and debt-servicing costs.

3. EUROPEAN MONETARY FUND Germany and France are designing the launch of a clearing new initiative to strengthen financial co-operation and surveillance inside the eurozone, encompassing the establishment of a European Monetary finance (EMF), according to senior government officials. Their intention is to set up the directions and devices to prevent any recurrence of volatility in the eurozone arising from the indebtedness of a single member state, such as Greece. The first minutia of the plan, including support for an EMF modelled on the International Monetary Fund, were revealed by Wolfgang Schuble, the German investment minister. The fund would have assets to lend to eurozone constituent states in economic difficulty, but only subject to very strict situation to constrain excessive allowance deficits and scrounging. The concept was suggested by Germany and they are now endeavouring to get France on board.

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CONCLUDING REMARKS
We believe that a little more prudence with regard to monitoring the fiscal policy of individual countries of the Eurozone would have helped mitigate the crisis. Moreover, the austerity measures taken by the Eurozone and especially those that were imposed on PIIGS did little to improve the condition of those countries. The gaping deficit that was revealed at a later date could have been seen to using growth measures, which we believe are more sustainable than imposing austerity measures. Simply put its similar to jailing a person just because they cant pay their debts. This doesnt help either party involved. The borrower cant make money because of the restrictions and the lender cant get his principle back as the borrower will still have little, if any, money to pay. Policy changes are necessary. Steps in that direction have already been taken. Compliance to the Maastricht treaty after grant of membership was an issue. As pointed out in the initial parts of this report, the members of the Eurozone violated the treatys conditions time and again. It also made membership for those countries failing to meet criteria as some of the criteria were tied to the current performance of the member countries e.g. the inflation rate had to be the average of the three best countries with regard to that parameter. Thus, better compliance and stricter action has to be imposed for offenders. Contingency measures need to be looked into especially due to the Eurozone being a union sharing policies as well as a common currency.

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REFERENCES
1) Economic Crisis in Europe: Causes, Consequences and Responses, European Economy Publication Number 7, Year 2009, Economic and Financial Affairs Directorate, EU. 2) The Eurozone Crisis Its dimensions and Implications, January 2012; M R Anand, GL Gupta, Ranjan Dash 3) Eurozone crisis: beggar thyself and thy Neighbor, Journal of Balkan and Near Eastern Studies, December 2010, Costas Lapavitsas. 4) Eurozone crisis : The corporate perspective, January 2012, Herbert Smith 5) Policy Lessons from the Eurozone Crisis - The International Spectator: Italian Journal of International Affairs, December 2012, Chiara Angeloni. 6) Eurostat Statistics Explained: Structure of government debt (October 2011 data) 7) Budget deficit from 2007 to 2015 Economist Intelligence Unit 30 March 2011 8) Rainer Lenz: Crisis in the Eurozone Friedrich-Ebert-Stiftung, June 2011 9) Global Financial Stability Report International Monetary Fund, April 2012 10) Story, Louise; Landon Thomas Jr., Nelson D. Schwartz (14 February 2010). 11) "Wall St. Helped to Mask Debt Fueling Europes Crisis". New York Times (New York) September 2011. 12) International Monetary Fund: Independent Evaluation Office, Fiscal Adjustment in IMFsupported Programs (Washington, D.C.: International Monetary Fund, 2003).

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