4308359
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SEAH SHIN HUA
QUESTION As in the Asian Financial Crisis, the monetary policy has failed to resolve the problem and eventually worsened the Asian Financial Crisis. Therefore, what do you think which policy is more effective in resolving the European Crisis, monetary policy or fiscal policy? How is it effective?
4308359
FIN 222
SEAH SHIN HUA
The European Debt Crisis also known as the European Sovereign-Debt Crisis and is often referred to as the Eurozone Crisis which is an ongoing financial crisis says that it is difficult for some of countries in the Euro area to refinance their government debt without the help of third parties. However, the European Sovereign Debt Crisis is resulted from a combination of various of complex factors which included the globalization of finance; easy credit conditions (credit agency) by encouraged high-risk lending and borrowing practices; international trade imbalance; real-estate bubbles; and the way that used by the nations to bail out the troubled banking industries and private bondholders (Kenny 2013). However, there are five countries which has affected by the European Debt Crisis, is Greece, Portugal, Ireland, Italy and Spain as these countries have failed to generate enough economic growth to make their ability to pay back bondholders the guarantee it was intended to be (Lane 2012). One of the causes of this European Sovereign-Debt Crisis was growing trade imbalances. As trade deficit is defined as a corresponding inflow of capital fund and which can drive down interest rates and stimulate the creation of bubbles. As based on the economic theory, the economy always wants to achieve trade balance which means the capital inflow must be balance with capital outflow (AmosWeb 2013). However, countries like France, Italy and Spain were having the trade deficit in their home country and this is same what had happened to the US housing bubble due the inrush of capital which has created the illusion of wealth as asset prices were rising, currencies became stronger, and everything looked fine. But, the bubbles were burst in later. In addition, for countries that running large and sustained external deficits identifies several risk factors (Lane 2012). As a large current account deficit has created short-term risks, if there is a sudden stop in funding markets, the deficit must be narrowed quickly. This is because with the large and sudden capital flow reversals have often proven costly in terms of output contractions, increasing unemployment, and causes the assets price declines. However, Greece, Spain and Portugal were all running very large external deficits. This is one of the reasons which had contributed to the Greece facing bankrupt now (Blanchard & Giavazzi 2002; Lane 2012). Moreover, there are other causes of European Sovereign-Debt Crisis which is the rating agencies. Since the beginning of the crisis, the double downgrade of Euro area nations due to the risks stemming from the debt crisis, causing a rise in bond yields and tensions in bond market which create difficulty in raising money by governments due to the low trust Creditors had after the downgrade in their ability to repay at maturity (Action Forex 2013). At the same, the downgrades from the credit rating agencies has also leads to the loss of confidence in the countries which affected the government bond yields to rise (ACCA 2012). The European Union (EU) has taken several steps to solve the problem. First, increasing the minimum level of bank capitalization in order to stabilize and increase the ability to withstand further financial shock. Second, European Financial Stability Facility (EFSF) which was created in May 2010 to raise funds to assist and provide loans to Eurozone countries which facing financial trouble, to buy sovereign debt and to recapitalize banks. The EFSF is jointly and severally guaranteed by the Eurozone countries. Third, European Financial Stabilisation Mechanism (EFSM was created in January 2011 and involves the European Commission raising funds by using the EU budget as collateral. The EFSM has lent funds in collaboration with EFSF and International Monetary Fund (IMF) (ACCA 2012).
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SEAH SHIN HUA
Reference ACCA 2012, The European Debt Crisis, accessed 28/04/2013, http://upload.news.esnai.com/2013/0328/1364453030981.pdf Action Forex 2013, Five Main Reason for European Debt Crisis, accessed 28/04/2013, http://www.actionforex.com/analysis/daily-forex-fundamentals/five-main-reasons-foreuropean-debt-crisis-20130408187344/ AmosWeb 2013, Balance of Trade, accessed 28/04/2013, http://www.amosweb.com/cgibin/awb_nav.pl?s=gls&c=dsp&k=balance+of+trade Blanchard,O & Giavazzi, F 2002, Current Account Deficits in the Euro Area. The End of the Feldstein Horioka Puzzle?, accessed 28/04/2013, http://www.cepr.org/meets/wkcn/1/1552/papers/giavazzi.pdf Kenny 2013, What is the European Debt Crisis, accessed 28/04/2013, http://bonds.about.com/od/advancedbonds/a/What-Is-The-European-Debt-Crisis.htm Lane, PR 2012, The European Sovereign Debt Crisis, Journal of Economic Perspectives, vol.26, no.3, pp49-68.
