The European Union is currently in a deep crisis because of the Euro. It is the single currency of 17 European Union’s member states which together make up the so called Euro area. Indeed, in early 2010, the euro crisis began with the Greek debt crisis where the cost for financing government debt was sharply rising. This crisis caused a crisis of confidence as the fear of asovereign debt crisis in Portugal, Ireland, Italy and Spain was increasing.
In this analysis of the Euro crisis, we will first look at the Eurozone’s principles and weaknesses in order to propose solutions to bring back stability and growth within the Euro area. What would be the best solution to implement taking into account the interest of each State within the Euro area?
The Eurozone’sprinciples and weaknesses
There is no doubt that the current economic and financial crisis spotlighted to the world the weakness of the Eurozone. The major problem of the Eurozone is that there are one currency and one central bank but with 17 governments to coordinate. That is why, the European Union created the Stability and Growth Pact (SGP) to facilitate and maintain the stability within the Eurozone.Member states had to present an annual budget deficit lower than 3% of GDP and a public debt no higher than 60% of GDP. Before the financial crisis, the SGP seemed to have succeeded in increasing the harmonization between the various member States’ national budgets and economies. However, the financial crisis spotlighted the hidden weaknesses of the Eurozone principles.
Indeed, in reality,during the financial crisis, the Maastricht system failed to maintain stability and to reduce huge economic disparities between euro member states.
To begin with, have a look at the theory of the economic cycles on the budget deficit level (which is one of the principles of the Growth and Stability Pact. Between 1999 and 2009, the economy can be divided in periods of booms and busts). During boomperiods, private debt tends to increase sharply. And during bust periods, it is the opposite situation for the growth of the public and private debts. The revenues of the government decline, the social expenses increase and as the private debt is guaranteed by the government, government debt has to be issued to rescue private institutions. During bust periods, this mechanism tends to increasepublic debt and slow down private debt growth. Consequently, during the 2005-2009 boom-bust period (boom period: 2005-2007, bust period: 2007-2009), the increase of the private debt growth became unsustainable and forced to issue large amounts of debts. As a result, this cyclical mechanism of government debt leads to an unsustainable public debt level.
And more particularly, the public debt levelbecame particularly unsustainable in Greece and largely exceeded the 3% maximal level. In order to finance social benefits, the Greek social model ran large deficits and sustained low interest rates. At the same time, Greece failed to implement financial reforms. Consequently, when the global financial crisis began in 2008, Greece was the first Eurozone member states to be hit by a deep sovereigndebt crisis. To illustrate the Greek financial situation let’s have a look on some figures. In May 2010, the country’s deficit reached 13, 6 % (relative to GDP) which ranks among the highest in the world. Due to this critical situation, the Greek credit rating was decreased to the lowest in the Eurozone which clearly reveals the high risks of default of the Greek government. Through harsh spendingcuts, the Greek government of George Papandreou is acting to fill the financial burden.
In January 2010, Greece was found sitting on debts and even if Greece cheated with figures, according to Theo Waigel, who is the German former finance minister and the architect of the Stability and Growth Pact, “The European Commisson and the other institutions should have questioned Greece’s budget...