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European Interdisciplinary Studies Programme

Academic Year 2017-2018

EU Macro-Economic Policies and Economic Governance

Describe the sequencing of events during the crisis and the reaction from side of EU
Institutions. Do you think the institutional response has been appropriate?

Professor: Benedicta Marzinotto

Student: Beka Jebashvili

Word Count: 3266

................................................................................. 14 .................................................................. 9 Monetary Policy ............................................................................. 7 Bail-out dilemma . 3 Crisis: The Origins .......................................................................................................................................................................................................................... 5 Fixing the Sovereign Debt Crisis ................................................................................... 13 Bibliography .......................................................................................................... 7 The EU Reforms ................................................... 10 Response to the crisis ............................................. 11 Conclusion .............................................................................................................................................................................................................................................................................................................................. 3 Crisis Expansion: Danger to the Eurozone ........................Contents Contagion: From US subprime Crisis to European Sovereign Debt Crisis ....

Considering that the Eurozone crisis is still an ongoing battle. The crisis which escalated in the United States (US) rapidly migrated to the whole world including Europe. Federal Reserve used the expansionary monetary policy and decreased the federal funds rate from 6. stability and prosperity.Introduction The creation of the European Monetary Union (EMU) is one of the biggest achievements of the economic integration. No. 2016. 2 Soon after the repeal of the act and the start of the new century.. Zestos. Routledge. it is relevant to look back and reconstruct the sequence of events throughout this challenge and analyse to what extent was the toolbox of the EU appropriate for overcoming it.Steagall Act and The Current Financial Crisis’ in: Journal of Business & Economics Research. it will explore the EU ways of coping with a crisis and finally it will offer a critical assessment of the EU efforts. Contagion: From US subprime Crisis to European Sovereign Debt Crisis Crisis: The Origins One of the causes for the US subprime mortgage crisis originates from the abolishment of the Glass-Stegall Act in 1999. Abingdon. p. . soon the situation became uncontrollable and it turned into a borrowing- 1 Corinne Crawford. ‘The Repeal of the Glass. p. the US was hit by the dot-com and corporate scandal crises and 9/11 attacks that slowed down the American economy. however. the paper will describe the process of the crisis contagion from the US to the Euro Area. In order to cope with this recession. 3 Ibid. 1. p.3 Low-interest rates encouraged the economic activities in the country. Secondly. 27. soon it was dramatically challenged by global financial shocks. Therefore. 2 George K. 21.5% to 1%. 127. Firstly. The Global Financial Crisis: From US Subprime Mortgages to European Sovereign Debt. 2011. Even though it started as a success story of peace. Vol. 9.1 The Act provided the legal supervision of both commercial and investment banks and prohibited activities that would allow institutions to yield higher profits through undertaking excessive risks.

Banking crisis: Lehman Brothers files for bankruptcy protection. 9 Stefan Schultz. the only option left for them was to default.de/international/business/the-return-of-the-finance-crisis-what-the-lehman-bankruptcy-means- for-germany-a-578493. p. Speech: The crisis response in the euro area. Available at: https://www.europa.html (consulted on 25.7 Due to the interconnectedness of the whole financial sector.creditcrunch (consulted on 25..04. Available at: https://www. 29. 4 In addition to this.2018).. 8 The Guardian.spending spree. On September 15.ecb. 28. p. 2008. Available at: http://www. the housing bubbles and CDO market only began to crumble after the Federal Reserve commenced the contractionary monetary policy in order to cool down the overheated economy in 2004.04. 5 Ibid. 6 Ibid.9 After the collapse of Lehman Brothers.spiegel.2018).8 This was the massive “banking and market earthquake”. This led to the aggravation of the financial crisis and its transformation into a business crisis. The distrust and low access to reliable credits temporarily froze the global trade and eventually declined it.5 CDOs were very complex financial products which were sold to investors and could be easily described as devices to deceive. one of the most influential investment banks of the US.com/business/2008/sep/15/lehmanbrothers.en. many of the borrowers. the individual defaults of borrowers soon translated into the insolvency of both commercial and investment banks. Its Timeline and Effect. risks were re-assessed globally and the financial sector was hit with a massive wave of the distrust. The boosted consumption and availability of cheap mortgages resulted in the creation of housing bubbles.10 4 Ibid. Subprime Mortgage Crisis.2018).04.com/subprime-mortgage-crisis-effect-and-timeline-3305745 (consulted on 25. the repealed regulation cleared the way for investment banks to use creativity in order benefit from the existing situation and invent new financial derivatives.eu/press/key/date/2013/html/sp130417. namely Collateralised Debt Obligations.. The downturn of the worldwide trade.theguardian.6 Hence. 22. therefore. especially subprime borrowers did not manage to keep repaying their debts.html (consulted on 25. . They soon became toxic assets which spread all over the financial sector. p. Lehman Brothers filed for the bankruptcy. The increase of the interest rate increased the monthly payments for the debtors. 10 Peter Praet. decreased the global demand and shrank the economies worldwide. 7 Kimberly Amadeo.2018). What the Lehman Bankruptcy Means for Germany. Consequently. Available at : https://www.04.thebalance. As a result.

17 The above-mentioned statistical controversy.1.cit.13 Even though early signs of the crisis were already visible on the bond markets of Greece in 2009. The €uro Experiment. 56. 12 Hence. 16 Philip R.14 Not long after. To simplify. Cambridge University Press. ‘The European Sovereign Debt Crisis’ in: Journal of Economic Perspectives.Crisis Expansion: Danger to the Eurozone 11 The contagion of the crisis to Europe started in 2009. 3.. p. The real problem was rooted 11 George K. Cambridge. Available at: http://ec.04. In a study published in 2008. the bond market reacted..15 Moreover.2018). 2012. Zestos. 2016. 12 Ibid. 56-58. The trust towards Greece’s public finances disappeared and the bond yields skyrocketed early in 2010 compared to other countries. Vol. p. 17 Ibid. op. the European Commission underlined that the European Monetary Union was a resounding success and an important “pole of stability”. who proclaimed the EMU as a shield from the shocks of financial and economic turmoil. Lane. Zestos. 13 European Commission. 26. 16 Promptly after the announcement. Thus. EMU@10: successes and challenges after 10 years of Economic and Monetary Union.cit. above-mentioned countries partially lost access to borrowing opportunities. the 2009 budget deficit turned out to be more than double of previously announced 6%. 47.htm (consulted on 25. the high bond yield percentage represents the perception about the credit risk. the EU officials did not manage to fully realise the inevitability of oncoming danger. 14 Paul Wallace. The first sign of crisis arrival was showcased by the frozen interbank lending market. on which they heavily relied on.europa.eu/economy_finance/publications/pages/publication_summary12680_en. was only the surface. pp. Greece finally lost the opportunity to borrow more and faced the likelihood of default. In 2009 Greek Prime Minister Papandreou inculpated the previous government for forging the real data about the Greek Public deficit which was much larger than publicised. As the yields surged. the illusion of resounding success has been shed. 47. Jean-Claude Trichet. Portugal and Ireland and to a lesser extent for Spain and Italy. p. op. The latter automatically resulted in the significant increase of bond yields for countries like Greece. p. however. which created the narrative of fiscal irresponsibility as the primary reason for the crisis. No. the narrative was also shared by the president of the European Central Bank. . 15 George K.

‘The European Union’s Response to the Sovereign Debt Crisis: Its Effect on Labor Relations in Greece’ in: Fordham International Law Journal.04. 36. p. No. Uncertainty caused by Greece affected the government bond yields in Ireland which already suffered the burst of the housing bubble in 2008. In addition to this Cyprus became the direct victim of Greek’s inability to pay back the debt. . The sovereign debt crisis which took off in Greece hit one country after another and created the domino effect.20 To summarize.2018).coleurope. Available at: https://www. (consulted on 26.pdf. the financial crisis which started on the different continent. 2013. 1533.deeply in the architecture of the monetary union. transformed into a business crisis and finally triggered the sovereign debt crisis in the Eurozone.19 The investors all around Europe witnessed the financial vulnerability of the Euro Area and this fed the distrust towards the Eurozone and intensified the fear of a further contagion. Italy and Spain. 21 Lieven Tack. The sequence was continued in Portugal. The Sequence of the Crisis Events21 assistance in May 2010 18 Ibid. in the timespan of three years. divergences between countries and 18 macroeconomic imbalances. Vol. Lecture Material: European Economic Integration.eu/system/files/uploads/intranet-page/lieven_tack_-_european_economic_integration_- _2017-2018_-_slides_classroom. 20 Ibid. 19 Joanna Pagones. 5. as Cypriot banks were major creditors of Greek borrowers. Financial Crisis in the US 2008 Global Business Crisis 2009 Sovereign Debt Crisis in the EU 2010 Figure 1. These imbalances created a milieu for contagion throughout Europe.

on the other hand. the euro-zone leaders encountered a dilemma of rescuing insolvent countries or staying loyal to the no-bailout clause laid down by the Treaty on the Functioning of the European Union. . p. would augment already existing problems in other vulnerable member states. bailout beneficiaries had to decrease the government spending and increase taxes in order to decrease their public deficits and debts. Zestos. As a result of this pressure.. 29 Ibid.cit.26 The possible adverse outcome of following the rule. 92. 27 Paul Wallace op. the IMF pressured the officials in Brussels. abiding by this inviolable rule. 25 Ibid. 74. Article 125. in May of 2010. p. 27 Therefore. 29 22 Paul Wallace op. the EU took the approach of the IMF 28 for bailing out member states and used austerity programs as a conditionality. 91. the president of the ECB and the Member States finally decided to introduce fiscal rescue funds. op. p. Consolidated Version of the Treaty on the Functioning of the European Union. The Greek default would eventually mean the exit of Greece from the Monetary Union. 24 Paul Wallace op.cit. 91. 23 Official Journal of the European Union. 26 Ibid.cit. In other words. p.. 22 According to the Article 125 TFEU. as it would hit back on the American economy. carried an enormous risk not only for Greece but even French and German banks. neither member states nor the union should assume the responsibility for the commitments of others.Fixing the Sovereign Debt Crisis Bail-out dilemma In the midst of the crisis. In addition to this. This method was heavily supported by Germany. was coupled with an external influence from the US administration which was fostering the recovery of the country and was disturbed by the possibility of further escalations in the euro area. the whole 24 Eurozone and the future of the single currency. as it would have no other way “to restore access to its central bank for both the government and the banks”25 This exit. 28 George K.23 Hence...cit. to lift the ban from the bail-outs.

T/ESM 2012-LT/en 1. consisting of the ECB.04. Oxford University Press. challenged the applicability of this article because the existing situation was neither a natural disaster nor the occurrence beyond the control of governments. it was the private company EFSF set up in Luxembourg with a capacity of €440 Billion. in: European Policy Analysis. 34 Official Journal of the European Union. the governments of troubled member states contributed to the creation of the problem. pp. which was intended to issue bonds and provide loans for the countries in need. 30 The first €110 Billion rescue programme for Greece was launched on the 2nd of May 2010. 2012/C 169 E/12.267.”32 However. Oxford. member states agreed on the need of creating “permanent crisis mechanism to safeguard the financial stability of the euro”. Apart from this. 30 Eurofond. p. became the guardian of the austerity conditions. the Troika. the Union may provide the financial assistance to the countries in the case of “natural disasters or exceptional occurrences beyond its control. establishing a permanent crisis mechanism to safeguard the financial stability of the euro area. Troika. 2014. in October 2010. in 2012. member state governments committed themselves to the creation of the European Financial Stabilisation Mechanism (EFSM) with a limited capacity of €60 Billion. 33 Bruno de Witte. the European Commission and the IMF.eurofound.33 Furthermore. this bailout fund was to be followed by two additional ad hoc rescue instruments that had to rescue not only Greece but other vulnerable states as well. In the time-span of several days. Article 122. 5-6. According to this article.34 In March of the following year.europa.eu/observatories/eurwork/industrial-relations- dictionary/troika (consulted on 27. especially Germany. the European Council amended the Article 136 TFEU by adding a special provision enabling the use of stability mechanisms (under a strict conditionality) in case of its indispensability for ensuring the stability of the monetary union. First.35 After the revision. Consolidated Version of the Treaty on the Functioning of the European Union. Available at : https://www. 35 Treaty Establishing the European Stability Mechanism. The Euro Trap. Member states. On the contrary. The latter was set in place by the 31 enforcement of the Article 122 TFEU.Meanwhile. 32 Official Journal of the European Union. justification of the creation of this mechanism through Article 122 was legally uncertain. .2018) 31 Hans-Werner Sinn. ‘The European Treaty Amendment for the Creation of a Financial Stability Mechanism’. Issue 2011.

esm. 267-270.. First of all. op. 98.04. op. cit.europa. p.2018) 39 Peter Praet.eu/financial-assistance (consulted on : 30. Six-Pack 36 Paul Wallace. . Also.cit.cit. Rescue Funds 37and Amounts of Received Bailouts. 38 ESM. 36 Table 1.38 The EU Reforms In addition to the ad hoc crisis resolution mechanisms. the EU’s response to the crisis also included reinforcing the economic governance. The innovativeness of this change mainly underlies in the introduction of reversed qualified-majority voting during the enforcement of sanctions under the Excessive Deficit Procedure.intergovernmental European Stability Mechanism (ESM) was established with a limit of €500 billion. 37 Hans-Werner Sinn. the Union was concentrated on improving the fiscal governance. Due to the fact that previously existing Stability and Growth Pact (SGP) lacked the binding power. op. Available at : https://www. Six-Pack (2011) which 39 increased the credibility of the possible sanction threat in the case of violation. p. it was revised through the group of six regulations.. Financial Assistance.

but the structural deficit as well. Coordination. involves a certain requirements regarding not only a general budget deficit. and Governance..europa.. 44 European Parliament. 41 Ibid. However. It requires member states to submit their national budget plans to the Commission and the Council before they are adopted by the national parliament. the binding nature of the latter is still questionable.pdf (consulted on 30.cit. 42 Peter Praet. cit. op.”43 Apart from the fiscal governance reforms.2018). the European Semester was complemented by yet another reform. Hence. the definition of a balanced budget envisaged in the Fiscal Compact. 40 After the entry of the six-pack into force. Available at : http://www. two pillars were set up: Single Supervisory Mechanism (SSM) and Single Resolution Mechanism (SRM).cit. This reform “codifies further changes to the EU fiscal surveillance calendar and provides for enhanced surveillance of member states experiencing financial difficulties or risk thereof.europarl. namely by the Two-Pack. 43 Paul Wallace op. in order to improve the fiscal surveillance of the EU. p. The first one gives the ECB the power to monitor financial institutions of the Euro Area. Later in 2013.eu/RegData/etudes/divers/join/2014/497748/IPOL-ECON_DV(2014)497748_EN. the European Semester was established in 2011. Moreover. 44 Monetary Policy 40 Paul Wallace op. the significant change was initiated in 2012 when the Commission proposed to create a Banking Union. however. 187. 187. Main Institutional Elements of the Banking Union. It obliges the signatory states to have a budget balance (or surplus) while also laying down the obligation for them to transpose the treaty provisions into the national legislation.04. they became fully operational only in 2014 and 2016 respectively. the banking union still lacks a European Deposit Insurance Scheme. The intergovernmental Treaty also known as the Fiscal Compact entered into force in 2013. 42 Finally.established the macroeconomic imbalance procedure. Member States commenced the talks about the Treaty 41 on Stability. while the second one is used for rescuing the failing banks. p. .

Despite. Hence this policy change did not manage to 46 incentivise the production as banks hesitated to finance businesses and consumers.cit. before slowly recovering. the ECB interest rate (REPO) was consistently higher than the US federal funds rate. the fact that the crisis originated from the US.cit. with an introduction of long-term refinancing operations with a maturity of three years. the US recovery was much more stable.cit. (as a result of German resistance) finally had a positive impact on investors and it created an impetus for investments and economic growth. even though it was never realised. 3. However. who undertook a “whatever it takes to save the euro” approach. the recovery turned out to be slow and unsteady. was replaced by Mario Draghi. The situation changed in November 2011. the recession in the EU was much stronger. This announcement.The major step towards overcoming the crisis however.25%. p. Moreover. the ECB went even further and announced the program of Outright Monetary Transactions. the European authorities undertook various measures for tackling the crisis. he made a decision to decrease the REPO rate by 0. In order to improve the situation. 80. the liquidity supplies to financial institutions increased. 82-83. op. 47 George K.. 45 Even before Draghi. As soon as Draghi was appointed. 46 George K. 47 Response to the crisis Even though. In addition to this. 45 Paul Wallace op. was taken only when the previous president of the ECB.. The increased liquidity relieved the situation of commercial banks in the distressed countries. Zestos. while the Euro Area GDP took the so-called double dip. Zestos. p.. op. the ECB commenced the expansionary monetary policy in 2008. pp. . Jean-Claude Trichet.

GDP Growth Rate (%) in the EU and US. A bright example 48 The World Bank.washingtonpost. 52 Ibid. 50 The World Bank. ‘A historical institutionalist explanation of the EU's responses to the euro area financial crisis’.04.2018). 231. the decisions on 52 the first stage of the crisis were dominated by the member state unilaterally. Hence. after several years. One of the main reasons argued in the scholarly debate concerns the imposed austerity measures. in: Journal of European Public Policy. 2.worldbank. 4 3 2 1 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -1 -2 -3 -4 -5 United States Euro area Figure 1. op. Available at: https://www.org/products/wdi (consulted on 30. p. The decrease of the spending and increase of taxes further demotivates production in already struggling country and leads to crippling economic growth which might increase the deficit even more.2018). Vol. World Development Indicators. IMF: Austerity is much worse for the economy than we though.49 Indeed. Available at: https://data. 49 Brad Plumer.com/news/wonk/wp/2012/10/12/imf-austerity-is-much-worse-for-the-economy-than- we-thought/?noredirect=on&utm_term=. up till today Greece has not managed to come out of recession and is suffering from the highest unemployment rate in the EU. cit. which halted the process of overcoming the recession in the EU.48 There are number of reasons. . even the economist of the IMF. 51 Amy Verdun.d75223ef2db5 (consulted on 30. Olivier Blanchard admits that this type of procyclical fiscal behaviour can do more damage than good. it is important to underline that the EU was slow and hesitant to come up with a solution “as the EU structures are less suitable for speedy decision”. 51 Therefore. No. 22. Germany portrayed austerity as an only way of overcoming the crisis.04. 2015. .50 Additionally.

He further argued that the sequence of the events in case of the Euro crisis was almost reversed and “As a consequence..en. Even though the process of assisting the indebted Member States took off in a chaotic manner.europa.ecb. Unfortunately. Lecture : A consistent strategy for a sustained recovery. Meanwhile. this should have been followed by the recapitalisation of banks and finally by the creation of excessive debt framework so that recapitalised banks would absorb potential losses.eu/press/key/date/2014/html/sp140325. As Mario Draghi has underlined. both banks and governments began to act pro-cyclically”.for this is Germany which impeded almost every proposal that would potentially “create inflation. which employed monetary expansion policy and re-established the market confidence. the institutional response was partially effective to assist the troubled countries.04. op. 54 Mario Draghi. This achievement can mainly be attributed to the ECB.”53 Finally. there also doubts about the sequencing of the events. Conclusion The EU has partially managed to overcome the negative consequences of a global financial crisis. 88. the austerity measures attached to bailouts added extra pressure on countries in recession and resulted in various negative consequences including the high unemployment. Overall. the Banking Union and also new packages for fiscal disciple have more enforcement tools and thus can guarantee better convergence. raise the interest rate for Germany.54making the situation even harder. the institutional design was advanced by the creation of permanent ESM.cit. Zestos.2018) . the EU policy was mostly concentrated on the balanced budget and a stricter fiscal consolidation through austerity. the first step for tackling the crisis should have been the creation of solid backstop for both governments and banks.html (consulted on 30. instead of acting as a shock absorber. Available at: https://www. Hence. 53 George K. or result in a burden to its taxpayers. throughout the process. p. According to him. increased debt/GDP ratio and low economic growth.

Routledge.04. ‘A historical institutionalist explanation of the EU's responses to the euro area financial crisis’. 1533.Steagall Act and The Current Financial Crisis’ in: Journal of Business & Economics Research. 22.worldbank. 5. WALLACE Paul. 2016.org/products/wdi (consulted on 30. LANE Philip R. Cambridge. No. . 9. 127. ‘The Repeal of the Glass. p. Articles and Other Sources: CRAWFORD Corinne. 2014. p. 56. ‘The European Union’s Response to the Sovereign Debt Crisis: Its Effect on Labor Relations in Greece’ in: Fordham International Law Journal. p. in: Journal of European Public Policy. Consolidated Version of the Treaty on the Functioning of the European Union. 2012. 27. Abingdon. 2012. 2016. The Euro Trap. p.Bibliography Primary Sources: Official Journal of the European Union.2018).. Oxford. The Global Financial Crisis: From US Subprime Mortgages to European Sovereign Debt. No. T/ESM 2012-LT/en 1. 36. 3. Treaty Establishing the European Stability Mechanism. ‘The European Sovereign Debt Crisis’ in: Journal of Economic Perspectives. 2015. 2013. The €uro Experiment. 1. ZESTOS George K. No. World Development Indicators. Available at: https://data. 2. 2011. Oxford University Press.1. Vol. . 26. PAGONES Joanna. p.. VERDUN Amy. 231. No. Cambridge University Press. Secondary Sources: Books: SINN Hans-Werner. Vol. The World Bank. Vol. p. p.267. Vol.

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