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«The Effects of Global Crisis into Euro Region: A Case Study of Greek Crisis Bora Selçuk1 and Naci Yılmaz2 Abstract: With the parallel to the ...»

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-4 (2), 2011 European Journal of Economic and Political Studies

The Effects of Global Crisis into Euro

Region: A Case Study of Greek Crisis

Bora Selçuk1 and Naci Yılmaz2


With the parallel to the negative effect of the global crisis on the world economy,

the economies in the EU started to give negative signals. The member countries

such as Greece, Ireland, Portugal and Spain seeing the first negative effects of the

global crisis are located in the periphery of the continent. Among these countries, Greece is more important with respect to the depth of its ongoing crisis, its observed effects and being an initial example. This is the biggest financial crisis since the EU accepted the euro as a single currency and Greece involved in the Euro Region in

2001. Like some of the other member countries in EU, Greece has a huge amount of sovereign debts and budget deficit. The most sovereign debts in Greece were taken from financial institutions located in central countries such as Germany, France and Belgium. It is possible that the problems caused by the Greek non-performance issue could spread over Euro Region and that risk could affect directly currency union at first, then economic and political structure of the EU and create some problems for maintaining of its single currency, namely the euro and also the ECB. Called recently as a “naughty boy” or a “sick man” in the EU, Greece has created an important test Corresponding Author, boraselcuk@khas.edu.tr İşbank, naciyilmaz@yahoo.com Bora Selçuk and Naci Yılmaz atmosphere with regard to the integration and control of EU countries’ monetary and economic policies and the creation of common policies against global crisis. It became a laboratory country for the Union. Taking into consideration the process, the ongoing problems in the EU currency system after global crisis will be debated around the notion of “Greek Crisis” in our work.

Keywords: Euro Crisis, Eurozone, Greek Crisis, Effects of Global Crisis, Rescue Packages Introduction The events starting in 2007 as a liquidity problem in the US mortgage credit market and their rapid transition to a global crisis have deeply affected the EU and its members soon later. Greece, Ireland, Portugal and Spain were the first affected countries by the crisis.

While that was the first important crisis that Greece faced since its participation in Eurozone in 2001, that has been a test for understanding to what degree the country meets the EU economic norms and has also been a test for protecting of the unity of the EU and Eurozone. Recently, the contamination risk of the crisis in the region has a vital importance for the member states.

Developments Before the Global Crisis in The Eurozone Before the global crisis, it was often said that there were some problems in the Eurozone that needed to be solved through the serious reforms. The limitation on the integration of the EU and the problems in the future of the Euro were argued more often then before. But it is possible to analize the problems under the two main titles. The first is the dilemma between monetary and fiscal policies and second is the inadequacies in the architect of the financial system.

At the end of 2001, many EU countries started using the Euro as a currency in the process starting with the setting up the Economic and Monetary Union in 1999. The European Central Bank (ECB) was ordered with the duty of applying the monetary policies in its supranational authority for all the EU members (USAK 2011, 31-32).

Although the decisions taken by the ECB were binding for the members, the countries were left free to choose their own fiscal policies. Thus, the fiscal policies stayed in national level while the monetary policies became in supranational. The fiscal policy

European Journal of Economic and Political Studies

applications that differed from the EU monetary policies and its applications were the negative side of the case.

To overcome this negative situation, in the face of the transfer of independence created by monetary policy decisions of the ECB, it was necessary to convince the leaders and peoples of the member countries. For this reason, the authorities have taken additional measures. The first measure was the Stability and Growth Pact. In the context of the Pact, the rules that the fiscal deficits should not excess 3 percent of the GDP and public debt also should not excess 60 percent of the GDP were accepted (USAK 2011, 33).

Providing for the independence of the ECB was the other measure that was taken to prevent the political incompatibility. This measure aimed to prevent the formation of monetary policy with parallel to the member countries’ fiscal policies as a result of the member countries’ pressure on the ECB. The price stability was put forwarded as a main ECB principal and maximum 2 percent rise in the consumer price index (CPI) was accepted (De Grauwe 2007, 176).

–  –  –

The other measure was to prevent the fiscal transfer. With this measure, out of exceptional circumstances, each country was prevented to borrow from other member states following its irresponsibly borrowing with the hope that the other countries would help it (Meyer 2010). The Eurozone countries have sometimes violated the Stability and Growth Pact despite all these measures. In the pre-crises period the budget deficit rule has been violated 8 times by Greece, 5 times by Italy, 4 times by Portugal and Germany, 3 times by France. Same violations have been seen in the public debt limits. (USAK 2011, 34). To overcome this problem, the suggestions have been concentrated on more centralization in taxation and fiscal policies in the pre-crisis period. The member countries’ leaders were told that there was no possibility to continue to the current situation and economic and monetary union would be either completed or the risk of collapse would increase in the Euro Area (Ubide 2010: 45).

The issues being as the result of the transition and the change created by the architect of the global financial system were the other important problems that happened in the Eurozone. The lack of coordination among the member countries in the Union in general, leading bureaucratic understanding, the lack of control arisen from not taking sufficient measures in the face of fast financial integration that was seen in the members’ financial systems have created a financial system that was highly exposed to the risk. Around the Union, especially banking operations and banking assets have increased rapidly. Together with the management failures, the credit rating agents, which were trusted as supervisory mechanism, have also caused to increase the problems through their serious failures (De Grauwe 2010, 36-37).

–  –  –

As a result of the ECB’s monetary policy of keeping the inflation below 2 percent, alike the US, it was seen a housing boom and a price rise in housing sector especially in Spain, Ireland and Italy higher than those seen in the other member countries in the period between 2002- 2007 when the global economy has shown a positive trend. In Spain 400.000 new houses were built only in Madrid and its surroundings but their prices have increased more than 150 per cent between 2000-2008 (EIU, 2008). In the same period, a consumption boom has been in Greece and Portugal (Lapavistas et al. 2010: 20).

With the onset of the global crisis, while the attention was paid to the US and Chine, the EU being the biggest economy in the world with its GDP of 16.8 trillion dollars has faced with serious problems. It was asked how the Union would react to the problems. The countries such as Germany, France, England, Italy and Spain that built the core of the EU process were slow to develop the coordinated policies against the global crisis (Yıldızoğlu 2010: 228). Experts

Bora Selçuk and Naci Yılmaz

claimed that the EU recovery would slower against the effects of the global crisis than that in the US and the Emerging Countries.

The leading neo-liberal model and the EU administrative structure have eliminated the member countries’ freedom to develop exchange rate, interest rate policies compatible with their national circumstances and fiscal policies being able to apply for the period of crises and hindered the monetary expansion.

As the crisis caused to increase unemployment and social opponent throughout the EU, the governments applied more and more for preservative measures (Yıldızoğlu 2010: 228). If the Brussels continues to impose solid fiscal discipline, it will not be surprising that the economic and social effects of fiscal policies toward contraction bring on the agenda the political crises, which are able to endanger the future of Euro and Eurozone, (Yıldızoğlu 2010: 303-304).

Prior to the crisis, the unification process and the stability of the Euro were provided by the ECB. For a single model, the difficulty of harmony faced by the countries that were different from each other with regard to their economic and social structures led some of them such as Greece, Ireland, Portugal and Spain to borrow at different interest rates than Germany (Yıldızoğlu 2010: 232).

–  –  –

Affected by the global crisis, the EU countries started to wane in 2009. The EU was the slowest recovering economic block from the crisis in the projections done by the international economic institutions such as IMF and World Bank. The Euro Area was stated to face with not only the wane in economic growth but also with the bankruptcy risk in 2010.

Table 1.1.

Effects of the Global Crisis in Growth Rates Source: IMF 2010, 2 The global crisis showed its most negative effect in the way of budget deficit in the EU countries. The budget deficits were increased by the cost of the governments’ application of support packages for financial system against the crisis and by the contraction in the housing sector in which tax earning was high in general. Greece, England, Ireland, Portugal and Spain were the first affected countries by the budget deficit.

The demands of central countries such as Germany, Netherlands who were facing with the lesser problems on the countries being in the periphery such as Greece, Portugal, Spain have forced the second group in economic, politic and

Bora Selçuk and Naci Yılmaz

social aspects (USAK 2011, 19). The global crisis also showed its some effects in the way of the contraction in domestic demand and credits and tightening of credit conditions. The situation has affected negatively the growth in the EU countries. In February 2008 Manufacturing Industry Confidence Index (PMI) fell below threshold value of 50 and stayed there until August 2009 (ISM 2011). This process signaled that the positive expectations toward the growth in the EU have not occurred yet.

The losses in the financial sector in the Eurozone and England have become equal to those in the US. Imposing limits on bank credits weakened the possibility of financing to non-financial sector. The decline in domestic and foreign demand prevented economic growth. Increases in credit standards, declines in asset prices, householders’ incomes, consumer goods and housing investments and increases in savings have caused to the decline in the total demand throughout the EU countries. The decline in the world trade has also affected negatively the EU exports. The credit boom and increasing competitiveness seen all over the EU have created the problem of idle capacity in the member countries. The crisis led to the over- capacity and low-demand in manufacturing sector; credit boom and increasing in non-performed loans in financial sector.

The crisis made feel itself the most extensively in labor markets. The contraction in economic activities created by the decline in the levels of investment, production and consumption have caused to the increase in unemployment.

While the unemployment ratio in the EU-27 countries was 7.5 per cent in 2007, it increased to 18.8 per cent in 2009 (Maliye 2010: 4). The loss of confidence for the Euro as a consequence of the last events brought the escape from the Euro. However, it was observed that the depreciation made increase the power of competitiveness in the EU foreign trade.

It was also observed that the EU member governments mainly in Germany, France and the United Kingdom produced the solutions involving economic and financial preservation and supported their strategic industrial sectors and national financial institutions and took measures to preserve their domestic markets against the problems faced by them. It was afraid that those developments could erode the three steel legs, which were assumed to be base for the EU, consisting of single market, single money (Euro) and “single sovereignty” having superiority over the national states (Yıldızoğlu 2010: 231-232).

In order to prevent the negative effects of the crisis, a painful treatment was offered in which the stimulation for increase in competitiveness, the reforms in labor markets for decline in the costs, the rationalization of public sector through

European Journal of Economic and Political Studies

reorganization and harmony with the technological developments. This treatment caused to the cuts in social spending and to the social problems throughout the EU (USAK 2011: 17).

In order to decrease the negative effects of the deepening global crisis in the Euro Area, the European Central Bank (ECB) paved the way by increasing 25 base points the policy interest rate to 4.25 per cent on July 3th in 2008. Here the aim was to decrease the possible effects of inflation and the increasing burden on the price stability in the medium term (Parasız 2009: 135-136).

In order to preserve the value of the Euro, the Union was brought under pressure by the saving of Greece, the support of the Baltic and the Eastern European countries and the need for preventing Ireland, Portugal, Hungary and Spain to go in crisis.

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