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Summary GFG Material Week 6
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The Euro and the Eurocrisis, Lane (2012), and Fuller (2018)
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W6 - Lecture prepDecember 17, 2022 6:22 PM
Title: The Euro and the Eurocrisis
Eurocrisis (2009-12) week overview video
WI the Eurocrisis?
• Eurocrisis was a debt crisis that spanned between 2009-2012 for most countries.
• For Greece, it lasted till 2018.
W were the most • The most affected countries were the GIIPS countries: Greece, Ireland, Italy, Portugal,
affected countries? and Spain.
W were the 4 types of
crisis that composed • The Eurocrisis entailed 4 different types of crises, with a feedback loop that made the
the Eurocrisis? crisis deeper and longer:
• Banking crisis: Excessive capital inflows and credit booms caused consumption
W were the main
features of the booms and asset booms in the countries mentioned above in the early 2000.
banking crisis? Many banks became vulnerable and exposed to positions in US real estate and
derivatives, making them dependent on liquidity from the US financial system.
○ The US financial crisis was swiftly reflected in European banks'
bankruptcies.
○ Financial liberalization contributed to rapid global credit growth in 90s and
00s.
H did the credit ▪ Increased credit availability induced a real estate frenzy, which
expansion fuel the fueled house prices and increased the collateral held by home
housing bubble and
consumption boom? owners. This reinforced consumption and the asset bubble.
▪ At some point, the housing prices started falling and MBS
devaluated.
HD decreasing housing □ This devaluation eroded banks' balance sheets and resulted in
prices affect the a banking crisis, starting with the fall of Lehman in 09/2008.
banking sector? Many EU banks held said MBS.
▪ Indicators:
□ Public debt-to-GDP and high risk premia in some countries.
W were the main
features of the • Sovereign debt crisis: Greece, Portugal, Ireland, Spain and Cyprus were unable to
sovereign debt repay/refinance their gov't debt.
crisis? ▪ Low economic growth after 2008 depressed gov't's tax income.
HD investors react to ▪ Investors responded by demand in higher risk premia on sovereign
lower econ. bonds, making refinancing of private debt more costly.
prospects? ▪ Resulted from banking crisis.
• Macroeconomic crisis.
YD public debt levels
increased so rapidly? ○ Gov'ts intervened with 'rescue programs' for the financial sector. This
increased the gov't debt levels.
○ The lack of liquidity and crisis concerns caused a credit crunch, which
W was the effect of
the credit crunch? reinforced the dropping confidence stock prices, investments and
consumption (e.g.: house prices).
○ The macroeconomic crisis made the sovereign debt and banking crises
worse.
• BoP crisis:
HD the BoP crisis ○ Financial explanation: Euro periphery had been running sustained large
originate? H were the deficits in CA in 00s, financed mostly by K inflows from banks and investors
prevalent K flows? in the Euro core (running a CA surplus) who were motivated by good
profits (low perceived risk due to low private debt levels, no XR risk, low
interest rates, and free K flows).
HD this K flows ▪ Consumption and real estate booms were fueled by the K inflows,
affect (asset)
prices? which rapidly rose living standards since the inception of the euro.
Global Finance and Growth Page 78
,prices? which rapidly rose living standards since the inception of the euro.
▪ Wages increased faster than productivity, which caused inflation.
H did periphery □ Periphery countries lost national competitiveness, further
countries lose
competitiveness? compromising their CA rebalancing.
Unsustainable in long run because CA deficits depended
YD sustained CA on continuous K flows, making them prone to K stops.
deficits increased
the danger of K ◊ As the US financial crisis landed in EU, the feared
stops? sudden stopped finally happened.
▪ The common argument among regulators was that free markets
(incl. free K markets) would deliver optimal outcomes. Risk was
ignored during the good times of the financial bubble.
□ In 2009, the sentiment changed and lasted a whole decade.
WD Lane paper go • Lane's paper examines the relationship between the sovereign debt crisis and the
about?
euro.
• It investigates whether the euro is to be blamed for the crisis.
WD Eichengreen & • Eichengreen & Termin's paper provides a historical comparison of episodes of fixed XR
Termin's paper go regimes.
about? • It argues how the GS intensified the great depression in the 1930s.
• Similarly, it argues that the euro aggravated the crisis in the 2010s.
WD Fuller paper go • Fuller's paper studies how failures in its design made the Euro area fragile, and what
about?
lessons can be learned from the crisis experience to reform institutional design.
• Reflection questions to keep in mind while reading:
• Why were Europeans so unlucky to suffer from 4 crisis at the same time?
• How does one type of crisis result in another?
• What can be done to increase competitiveness and economic growth?
• What institutional changes are necessary to prevent the repetition of the crisis?
Summary: Eurocrisis was a debt crisis, mostly over 2009-2012. The most affected countries were the GIIPS. It actually
entailed 4 crises:
- Banking crisis: excessive credit booms and K inflows led to ↑ consumption and ↑ asset prices. Banks became
dependent on liquidity from the US financial system (exposed to positions in US real estate and derivatives). When
housing values dropped in the US, MBS devaluated (contracting the value of banks' assets) and banks lost access to
liquidity.
- Sovereign debt crisis: GIIPs were unable to repay/refinance gov't debt in face of ↑ funding costs and ↓ expected tax
revenues.
- Macroeconomic crisis: Gov'ts bailed out the financial sector, incurring large debt. There was a credit crunch due to
increased uncertainty, it decreased stock prices, consumption and investments. The macroeconomic crisis made the
crises above worse.
- BoP crisis: In the 00s, euro periphery were running sustained deficits and euro core sustained surpluses. K flowed
from core to periphery in search of better rents, ignoring risk (perceiving low risk due to low private debt levels, no XR
risk, low interest rates and free K flows). These flows boosted consumption, wages and house prices, at the cost of
making the periphery less competitive (higher labour unit costs because wages grew faster than productivity). This
exposed the GIIPS to a sudden stop, which was triggered by the US financial crisis.
Some say that the euro is to blame for the crisis (e.g.: Lane, Eichengreen & Termin). Lane argues that the problem was
the institutional structure of the EU without mechanism that correct macroeconomic imbalances. Fuller says that
what is to blame is the unstable complementarity in European financial markets between the growth models favoured
by European savers (in the northern ‘core’ of Germany and other exporting states) and its borrowers (in the debt-
fuelled and demand-driven eurozone periphery, including countries like Greece and Ireland).
Global Finance and Growth Page 79
, W6 - Lane, 2012
December 18, 2022 1:17 PM
Title: The European Sovereign Debt Crisis
Introduction
• 3 phases in the relationship between the euro and the European sovereign debt crisis:
1. Initial institutional design of the euro plausibly increased fiscal risks during the
pre-crisis period.
2. Once the crisis occurred, these design flaws amplified the fiscal impact of the
crisis dynamics through multiple channels.
3. The restrictions imposed by monetary union also shape the duration and tempo
of the anticipated post-crisis recovery period, along with Europe’s chaotic
political response and failure to have institutions in place for crisis management.
Pre-crisis risk factors
• Debt was comparable in EU in the aggregate than in US until the mid 2000. There was
however great variation across countries in the EU.
• IT and HL had much higher debt-GDP ratios (~90%)
• Low spreads on sovereign suggest that markets did not expect substantial default risk
and certainly not a large scale fiscal crisis.
• The good growth performance and positive financial environment masked the
accumulation of macroeconomic, financial and fiscal vulnerabilities.
Financial imbalances and external imbalances
• Credit grew very fast due to the elimination of XR risk, mostly in the Euro periphery.
This credit expansion fueled inflation and consumption booms, as well as housing
booms.
• The preceding domestic credit expansion is a key predictor of a banking crisis.
• The consumption booms also led to large trade imbalances, with periphery
countries running a large CA deficit and Germany running a large surplus.
○ Euroarea as a whole was running a nearly balanced CA.
▪ The growth of some countries came at the cost of that of others.
•
Global Finance and Growth Page 80
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