Crisis in the Eurozone: The Global Impact of Common Currency

Beginning in 2009 the global economy experienced the most severe recession in the last 50 years.  Initially spurred by the financial crisis at the end of 2008, when Lehman Brothers filed for bankruptcy, private capital slowed and global trade contracted. This led to the decrease in the Gross Domestic Product for many developing countries, yet their overall deficits increased.  Many of the members in the European Union have been slow to recover from the economic fall-out.  Several countries, in fact, are still heavily in debt.  The EU uses the acronym PIIGS when referring to these troubled countries: Portugal, Ireland, Italy, Greece, and Spain.

Greece is by far the worst off in comparison to the other EU members.  In 2009, the country reached record level debt of 113% of their GDP, or 300 Billion Euros, which was forecasted to rise to 125% by the end of 2010.  After refusing assistance several times, Greece finally requested a bailout package from the EU in May 2010.  It was granted to the tune of 110-Billion Euros.  However, due to the conversion from the Greek Drachma to the Euro, the country was faced with severely large increase of their national debt.  Greece amassed a deficit equal to 13.9% of their GDP – the highest in modern history!

Because of the rising anger over government corruption and mismanaged spending, the EU took a hard line with Greece when they requested a second bailout package earlier this year.  There is speculation that if adequate changes are not made, Greece will be the first country forced to leave the Eurozone.  Thus, the country agreed to take extreme austerity measures in an effort to curb spending and drastically reduce their budget.  Not only will the plan cut spending by 14 Billon Euros, but the government will raise taxes in hopes of producing a similar amount in revenue over the next five years.  The citizens of Greece have been outraged by these measures for months because they feel the changes will not improve the welfare of the country, prompting the need for a new government to be sworn into place in conjunction with the implementation of the the austerity measures.  Much of the public sector will be affected as some employees have been forced to take a 15% cut in pay, while 80,000 others have been asked to leave their jobs, ultimately adding to Greece’s already sky-high unemployment rate.

Protests broke out in June when the government revealed a plan that would cut healthcare, education, defense, and social security benefit spending.  The plan also raised the retirement age to 67 for benefits (a dramatic change from the current age of 50).  To help offset the burden from the citizens, the plan proposes selling 10% of the government’s telecom shares to Germany.  As the Irish Republic and Portugal have subsequently been granted bailout packages, there has been additional economic fall-out in the EU as the Italian and Spanish governments need the EU to buy bonds to try to bring down their borrowing costs.  Protests became even more violent in October when the measures were finally voted into place by Parliament.

There is added concern that the bailouts will ultimately affect the US Economy because the countries that are assisting in the bailout will now have less money to spend on American goods, causing more layoffs here.  With the recent news of Italy’s equally massive economic failures, many argue that infusing more money into an inefficient economy will not solve the underlying problem of decreasing the overwhelming debt that these countries have incurred.   Many economists are now arguing for the elimination of the euro in order to help salvage the depressed economies.  It leads to the question: do the benefits outweigh the consequences of maintaining one uniform type of currency in the emerging global economy?

Once touted as the savior of Europe, the majority opinion seems to be turning in the direction opposite direction and there has been suggestion that the PIIGS would fare better if they were accountable for their own fiscal and monetary policies to boost their economic recovery.  Paul Krugman made the case in Thursday’s New York Times article that if governments are unable to borrow against their own currency, they will incur higher interest rates than countries that retain the ability to print their own currency in times of financial crisis.  By parting from the Eurozone, Greece could regain control over its own economic future.  While the country will suffer from austerity measures either way, but there is less likelihood that the entire Union would suffer if Greece defaults on their loans because the bailout money would be better spent on recapitalizing the countries with stronger economies.

This leaves the EU officials concerned about whether all countries with weak economies will leave the monetary union.   Italy is the next in line to default as they were pushed this week to the brink of bailout that the EU currently cannot afford.  The funds are currently tied up in assisting the battered economies of Greece, Portugal and Ireland.  Sky News reported that while Italy is better off now that Berlusconi resigned bailout, should the EU be able to dictate government policy in countries that use the Euro?  Being involved in economic and business policy has proved disastrous thus far.  Austerity measures have not worked thus far to help countries out of recessions, yet Portugal is faced with protests this week that are supposed to help them cut spending enough that they do not default on their loans, much of which will affect France if they do.

In his report “Crisis in the Eurozone and how to deal with it”, Paul DeGrauwe states that the only way to effectively control the monetary policy within the Union means that the members have to agree on political policy as well.  In effect, all of the countries with the same monetary currency need to have a centralized government.  This is not something that most citizens in the EU would readily vote for, as this would cause drastic changes for some of the current welfare vs. non-welfare states.  After hundreds of years of separation, it is hard to predict the outcome of uniting 17 different and unique forms of government and will also abolish the freedom each country currently has over public policies and how they conduct business in the global market.  If Europe were to adopt a central government, just for the sake of retaining one singular monetary unit, what is to stop the rest of the world from doing the same?

From a business perspective, it is better to maintain a diverse portfolio in order to retain a competitive edge in the marketplace.  Countries will fare better in the global economy if they continue to trade the items for which they have a competitive advantage.  Moving to one unit of currency, or one centralized political movement will strip countries of a competitive edge and dilute the market place of choice.


Reference Articles

Krugman, Paul, “Legends of the Fail”, New York Times, November 10, 2011

“Berlusconi Quits After Austerity Package Vote”, Sky News, November 12, 2011, Updated November 13, 2011, Retrieved from: http://news.sky.com/home/business/article/16108875

DeGrauwe, Paul, “Crisis in the Eurozone and how to deal with it”, Center for European Policy Studies, No. 204, February 2010, Brussels

Other Works Cited

(1)  BBC News, “Timeline: The unfolding eurozone crisis”, Updated August 8, 2011, Retrieved from: http://www.bbc.co.uk/news/business-13856580

(2)  BBC News, “Greek Government Austerity Measures, Updated June 30, 2011, Retrieved from: http://www.bbc.co.uk/news/business-13940431

(3)  Katrandjian, Olivia, “Greek Debt Bailout could affect the US Economy”, ABCNews.com, June 19, 2011, Retrieved from: http://abcnews.go.com/Business/greek-debt-bailout-affect-us-economy/story?id=13879426

(4)  Kakassis, Joanna, “Saving Greece: Can New PM Lucas Papademos Save Its Economy?”, Time Magazine, November 11, 2011

(5)  Schuman, Michael, “Greek PM Ditches Referendum: Should Greece Lose the Euro?”, The Curious Capitalist Blog, Time.com, November 3, 2011, Retrieved from: http://curiouscapitalist.blogs.time.com/2011/11/03/should-greece-ditch-the-euro/

(6)  The World Bank, “The Global Economy in 2009”, 2010 World Development Indicators, Part 4: Economy, pp. 217-218 updated April 2011, International Bank: Washington, DC

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Economic Theory

After learning about the various approaches towards stabilization of our economy, I would have to say that I most closely agree with Keynesian’s theory behind economic policy.  Keynes stipulated that decisions by the private sector can sometimes lead to inefficient outcomes for the public sector and advocated for monetary policy actions by the Federal Reserve (which was to be created after his theory became widely accepted) and fiscal actions by government in an effort to fill in the gaps of the business cycle.  I disagree with the Classical Economic theory or Say’s Law that ruled supply will create demand.  Logically, in the short-term, if there isn’t adequate employment or a sufficient money supply, then the purchase of goods and services proves quite challenging for consumers.  The Monetarist theory, developed by Milton Freidman proved to be quite ineffective in the late 70s and early 80s as well.

When an economy is in contraction, Keynes’ recommended increased government spending and lower interest rates to help boost consumer spending.  Since this theory was adopted, after the Great Depression, it has proven to be the most reliable way to shift the economy back into expansion.  However, Keynes was not a big proponent of large expansions either because this led to an increase in money supplies that he hypothesized was the catalyst to high interest rates.  He mandated that the government’s main focus for fiscal policy should be placed on smoothing out the difference between peaks and valleys in the overall state of the economy.

Summarized to the simplest of terms, Keynes theory suggests that excessive saving causes recessions or depressions.  If consumers do not spend money, companies that hire individuals do not make money and if companies do not make money, then they do not have money to spend on labor and therein lies the center of the vicious cycle that can spiral downwards from there.  Instead he debated that governments should focus on correcting the fluctuations in the short-term, rather than thinking the economy would self-correct in the long term.  To quote Keynes, “In the long term, we are all dead.”  When applied over the long-term of the past several economic expansions and contractions, Keynesian Economics has proven to be the most effective at creating stabilization.  We still have expansions and recessions, but we have seen overall steady growth and less variance in the economy when it rises or falls.

Our current monetary and fiscal policy seems to be a blend of Keynesian Economics and Classical thinking.  I believe this is a crucial error on the public sector’s part.  Unemployment has continued to be higher than the natural rate for more than 18 months, yet the government has advocated for cutbacks in spending which is strictly against what Keynes would recommend and the current policy has failed to pull the economy out of a recession.  As the global market begins to make severe cutbacks in their public sectors, I fear that will lead to larger amounts of private sector savings, instead of investing which will only deepen the state of the recession.

It is impossible at this point for the economy to recover when there aren’t enough jobs for workers who are willing to work, and the private and public sectors are equally at fault for creating the shortage.  Keynes emphasized that government’s main focus for spending should be on basic research, public health, education, and infrastructure, yet these are the areas experiencing the largest decreases in government spending.  The proposed tax increase, from the current administration, will only exacerbate the recession, according to Keynes.  From a common person’s perspective, this seems like a shortcut by the government to stabilize the economy.  After all, without any training in economic policy, how does the government expect to get any water when the well is dry?


Works Cited

(1)   Krugman, Paul and Robin Wells. Macroeconomics. 2nd Edition. Worth Publishers. 2009

(2)   Klein, Ezra, “Larry Summers: ‘I think Keynes mistitled his book’”, The Washington Post, July, 26, 2011

Unemployment Forecast Remains Bleak

Unemployment measures the percentage of workers in the current labor force (persons 16+) who want to work, but are unable to find jobs.  At the end of August, the Bureau of Labor Statistics (BLS) reported the unemployment rate in the United States was 9.1%, which has remained relatively unchanged since April 2011.  There are nearly 20 states with employment rates higher than the national average, however.  While Healthcare, Mining and other private sectors saw marginal increases in hiring, the Telecommunications and Manufacturing industries had declines.

The unemployment rate does not accurately reflect the number of workers who are marginally attached – a number that rose from 2.4 to 2.6 million over the previous 12 months.  These are people in the labor force, similar to those who are unemployed, who want to work and have looked for work in the past year, yet have not reported a work search within the four weeks prior to the most current BLS Study.  This number also does not take into account those who have been out of work as long as two years and have become so discouraged, they have stopped looking for work completely.  Workers who have been forced to into part-time employment, but want to work full-time (underemployed) are measured separately, and increased in August to 16.2%.

Economists were hopeful that August would bring enough job growth to lower the national unemployment rate down to 8.9%, demonstrating that the economy is indeed in recovery.  They were instead greeted with the news that the US is in what some are calling an “economic paralysis”.  The average workweek, as well as the average hourly wages for nonfarm workers, was both down a nominal amount in August.  This causes economists concern because fewer hours means a possible decrease in the disposable income people would have to spend.  The unemployment rate is affected by the overall business cycle – when the Gross Domestic Product (GDP) is growing, jobs are up and people have money to spend, but when the GDP falls, jobs are cut and people decrease their expenses.  This often propels the economy into an even deeper state of recession.

Since the two main concerns of macroeconomics policy are unemployment and inflation, it is important to look at the whole picture when it comes to our state of employment, rather than just the small view of our national unemployment rate.  A better indicator of the current state of employment may be to also look at the percent of the population with a job, which now sits at a mere 58.2%, a 28-year-low.  The government is not doing anything to boost consumer confidence out of the current recession, as they too continue to experience layoffs, despite the Minnesota workers returning after the partial government shutdown last month.

The theory behind many of the cutbacks was to “super-charge the private sector”.  The private sector has not hired many of the people who have been laid off by state and local governments, due to fears of an even weaker economy, which means there are even fewer consumers to boost spending and, in effect, cause our real GDP to grow.  Some economists advise the government to create policies that avoid public sector layoffs if they really want to lower the unemployment rate and help boost an economic recovery.


Works Cited

(1)   US Bureau of Labor Statistics, “The Employment Situation – August 2011”, September 2, 2011, Retrieved from: http://www.bls.gov/news.release/empsit.nr0.htm.

(2)   US Bureau of Labor Statistics, “Unemployment Rate State-By-State, July 2011”, August 19, 2011.

(3)   Censky, Annalyn, “August Jobs Report: Hiring Grinds to a Halt”, CNNMoney.com, September 2, 2011, Retrieved from: http://money.cnn.com/2011/09/02/news/economy/jobs_report_unemployment/index.htm.

(4)   “The Horrific August Jobs Report” Opinion Brief on TheWeek.com, September 2, 2011, Retrieved from: http://theweek.com/article/index/218898/the-horrific-august-jobs-report.

Recent Actions by the Federal Reserve

The Federal Open Market Committee (FOMC) met on August 9, 2011 to review the economic situation during the first two quarters of 2011.  The committee agreed that recovery remained slow and labor conditions continue to remain weak.  The summary of the minutes were progressively dismal from there with the news that the real GDP has not rebounded to pre-recession levels, as once thought, since consumer spending remains fairly unchanged for the year, and the international trade deficit has widened significantly since May.  June marked the end of the 2nd phase of the Fed’s economic stimulus package as the Treasury purchase program completed.  Upon this news, stocks fell sharply and the S&P downgraded the US credit rate on long-term debt.  The sluggish US economy has impacted the global market tremendously and the European economies remain unstable as well.

In an effort to avert a global depression, the FOMC voted to keep the discount rate at 0.75%, and the federal funds target rate between 0% and 0.25% – which has not changed since December 2008 and will continue to hold through mid-2013.  Of course, the hope is that the lower interest rates will spur consumer spending back into action.  M2 levels saw a rapid expansion in June and July of this year reflecting the public’s current unwillingness for risky investment spending, rather to keep their money in safe-haven flows, furthering the mark of low consumer confidence in the state of the current economy.

While some members of the committee think that more aggressive measures are needed to spur the economy, Ben Bernanke voted in favor of keeping the rates status quo.  Historically, the prescription for the monetary policy mandates low rates in order to maximize employment and stabilize prices, and the majority of the committee believes that this remains the appropriate response to the current economic conditions.  Those who dissented felt that the FOMC needs to adopt language that shows forward guidance of rates being low for an “extended period” rather than a definitive negative outlook through 2013.  Their concern is that it dictates how the economic outlook will evolve, or rather the committee is expressing its own lack of confidence in a speedy economic recovery.

Initially the FOMC would not take any further measures to stimulate the economy because they feel that monetary policy cannot alleviate all of the various strains on the economy.  However, on September 21st, the FOMC has opted to put their focus on driving down long-term interest rates by purchasing $400 Billion in Treasury Securities, stating that the economy clearly needed help.  There is speculation that Ben Bernanke will possibly recommend a 3rd round of economic stimulus policy.  Of which, cutting back on government spending will be eliminated.  This could likely be the boost the economy needs and consumers are hoping for to create jobs and lift confidence enough to reinvest in the US market again.


Works Cited

(1)  Board of Governors, “Minutes of the Federal Open Market Committee” Tuesday, August 9, 2011, 8am, Washington, DC.

(2)  Federal Reserve Press Release, Board of Governors of the Federal Reserve System, September 21, 2011.

(3)  Malin, Jay, Times Topics: Federal Reserve (The Fed), Updated September 21, 2011, Retrieved from: New York Times.