Over the years, fiscal crisis in various regions have led to recession which hurts the economies of the concerned countries. Currently, Europe is battling a detrimental debt crisis that has put economic growth across Europe at stake. In this case, Greece is the most hit country by the current European debt crisis because it has huge debt to settle. Ironically, it is quite difficult to experience any significant growth because its competitiveness within the Eurozone remains low, yet it is expected to recover and settle its debts. Greece has no control over the Euro because it is controlled by the European Central Bank that regulates financial flow and rates within the Eurozone. In general, the European debt crisis has affected European countries in different ways. For instance, Greece owes Germany and France a huge government debt. It is estimated that Greece, Portugal and Italy are the biggest debtors within the Eurozone. By the end of the first quarter of 2015, Greece has a government debt to GDP ratio of 168.8%, followed by Italy with 135.1%, whereas Portugal recorded a ratio of 129.6%. On the other hand, the lowest debtors were Bulgaria with the ratio of 29.6%, Luximbourg with 21.6& and Estonia with 10.5%. As a result, the public debt to GDP ratio for the Eurozone has risen to 92.6 percent in the first quarter of 2015 (RT, 2015). Therefore, this article will give a comprehensive overview of the European debt crisis with focus on Greece.
Factors Causing the Eurozone Crisis
In theory, there are several factors that are causing the Eurozone debt crisis. Some of these factors include trade imbalances, the existence of a monetary union without a fiscal union, inflexibility of the monetary policy, loss of confidence, and the increase in government and household debt levels.
Currently, the Europe is experiencing trade imbalances. This can be traced back to the period between 1999 and 2007. During this period, trade imbalances were evident. For instance, countries such as Spain, Ireland, Italy, and Portugal exhibited payments imbalances. On the other hand, Germany’s public debt relative to its GDP was far better; thus trade surplus increased. In this same period, the fiscal deficits for Spain, Italy and France increased due to lack of capital inflow. It is also suggested that labor costs affected trade deficits leading to the increase of trade imbalances, especially in Southern countries within the Eurozone. In addition, the competitiveness of these countries decreased significantly. Countries that experienced faster growth of wages than productivity lost their competitiveness. For instance, Greece, Italy and Portugal allowed a faster growth of wages compared to Germany that restrained its labor costs. This is why Germany experiences a lower unemployment rate and public debt (Wimmer, 2015).
The second factor causing the European crisis is the structural faults within the Eurozone (Razin, 2012). It is apparent that the region has established a monetary union through the adoption of the Euro as the common currency within the Eurozone system. In contrast, there is not fiscal union, in order to ensure uniformity in controlling taxation, treasury functions and pension. As a result, monetary policies within the Eurozone differ from the fiscal policies of member countries.
Inflexibility of the monetary policy is also considered as one of the key factors causing the crisis. The adoption of the Euro as the common currency has made it difficult for member countries to create their currencies to pay debtors. It also prevents countries from devaluating their currencies to increase their competitiveness. This inflexibility of the monetary policy can only be solved through exiting the Eurozone by the affected country, which in turn means default of its debts.
Moreover, loss of confidence within the Eurozone has worsened the crisis. It has emerged that sovereign debt from the trade bloc is not safe, contrary to the assumptions. As a result, bonds have increased the risk for European countries. On the other hand, investors do not have confidence in the European Central Bank because it lacks employment mandate. It only has inflation control, unlike the U.S. Federal Reserve that exhibit dual mandate; thus able to contain crisis through adjusting rates.
Finally, budget deficit has worsened the crisis. This deficit is attributable to the low interest rates on bonds and private credits. At first, countries that had originally strong currencies received low interest rates for bonds as opposed to the high rates enjoyed by countries that had weak currencies. This situation spurred government and private spending in the latter leading to an economic boom that culminated into a financial crisis.
Where Europe Stands Now
In response to the Greece debt crisis, the Eurozone has agreed to support Greece to get out of the crisis through bailout loans. Earlier, Germany required Greece to leave the monetary union for atleast five years. However, Germany has changed its idea and agreed with the EU resolution. According to EU’s memorandum with Greece that was signed on 19 August, 2015, the country will receive the third bailout through the third economic adjustment program. This agreement will see Greece receive financial assistance of up to €86 billion over the next three years. This bailout is expected to restore the Greek’s economic stability through enhanced competitiveness, financial stability, sound public finances, and high employment (European Union, 2015).
Effect of Government Deficit and Government Debt on Economic Growth
In general, government deficit and government debt have significant influence on economic growth. Government deficit is usually the difference between government expenditure and the national income which translates to public saving. This is an integral part of national saving or loanable funds. In theory, saving and investment influence interest rates that determine economic growth. This is why deficits and debts are solved through the adjustment of interest rates (Seater, n.d.). In the case of Greece, government deficit and debt are relatively high leading high interest rates that have reduced investment. Ordinarily, high deficits have been found to hamper economic growth in countries with high government debt, and this is the case for Greece (Grunden Financial Advisory, 2012).
In practice, crisis within a monetary union can be solved through two main policy responses: bailouts and austerity reforms. Bailouts are desirable if a country wishes to stay within the union. In this case, the country with the debt is given financial assistance to adjust its economic growth. Greece has opted for this form of policy response. The benefit of this response is that countries that owe Greece will not lose their money. However, bailouts are associated with shortcomings. Some of the disadvantages include the moral-hazard effect and the failure of the country to recover (Lawrence, 2009).
On the other hand, austerity reforms enable a country to restructure its monetary system such as the devaluation of the currency. This is only possible after exit from the monetary union. Advantages of this policy response is defaulting debt and regaining competitiveness through currency devaluation. This enables the country to shrink its budget deficits. Disadvantages include high unemployment, unfavorable financial environment for companies, impoverishment of population, and low production. This is the situation in Bulgaria that has adopted austerity policy response (Petkov, 2014).
Trouble of Monetary Union without a Fiscal Union
In retrospect, it is apparent that a monetary union without a fiscal union can be troublesome. This can be evidenced with the situation in Europe. Ideally, the Eurozone exhibits a monetary union in which member countries share a common currency. As such, the European Central Bank is responsible for controlling inflation. However, the lack of a fiscal union that is characterized by common treasury functions, pension and taxation policies has made it difficult for the affected countries to adjust their budget deficits.
In a brief conclusion, the European debt crisis appears to be one of the main reasons hampering economic growth in Europe. It is apparent that the establishment of the Eurozone has exposed some countries to high risks leading to high government debts and deficits. An outstanding example is Greece that has incurred a huge public debt. As a result, the European Commission has signed a bailout response to assist Greece to stabilize its economic growth. Other countries such as Bulgaria and Astonia have introduced austerity reforms to address the crisis. Therefore, there is need to restructure the Eurozone system, in order to enable it have dual mandate: control of inflation and employment as the U.S. Federal Reserve.
European Union (2015). Financial assistance to Greece. Retrieved from http://ec.europa.eu/economy_finance/assistance_eu_ms/greek_loan_facility/index_en.htm
Grunden Financial Advisory (2012). Deficits, debt, and markets. Retrieved from http://www.grunden.com/deficits-debt-and-markets.html
Lawrence, H. (2009). Topical insight: bailouts. Retrieved from http://www.dictionaryofeconomics.com/resources/default/bailout
Petkov, V. S. (2014). Advantages and disadvantages of fiscal discipline in Bulgaria in times of crisis. Contemporary Economics, 8 (1), 47-56. DOI: 10.5709/ce.1897-9254.130
Razin, A. (2012). What really ails the eurozone?: faulty supranational architecture. Contemporary Economics, 6 (4), 10-18.
RT (2015). Eurozone debt to GDP ratio grows to 92.9%. Retrieved from https://www.rt.com/business/310490-eurozone-countries-total-debt/
Seater, J. (n.d.). Government debt and deficits. Retrieved from http://www.econlib.org/library/Enc/GovernmentDebtandDeficits.html
Wimmer, M. (2015). Economic output in Germany will increase by 1.8 percent in 2015 and 1.9 percent in 2016. Retrieved from http://diw.de/sixcms/detail.php?id=diw_01.c.513837.en