Eurozone in Crisis Part I

2011 was another dramatic year for the world economy, and for the eurozone in particular. Six out of 17 European heads of state had to resign during the year, and neither Italy nor Greece are anymore ruled by politicians, but by experts. During the financial crisis in 2008, it was the government that had to save the banks.

In 2011, the same authorities themselves stood on the edge of the precipice and needed help. At the same time, there are signs of social unrest in a number of European countries, as a consequence of sharp cuts in the public sector, wage cuts and mass unemployment. In some of the most vulnerable countries, unemployment among young people has risen to almost 50 per cent.

  • What is the background to the euro crisis?
  • Why do the financial markets suddenly lose confidence in the ability to pay of some countries?
  • What kind of tensions are there between eurozone countries?
  • How are eurozone countries trying to get out of disability?

2: Prehistory – a bit about currency unions

A monetary union, such as the eurozone, would mean that two or more states have a common currency unit . A common currency also requires a common central bank with responsibility for making coins and banknotes, as well as managing the countries’ interest rates . World history is full of examples of such unions. The United States stands out as perhaps the most successful of all, while the euro is probably the most ambitious project.

Economists have long argued against the euro on the basis of the large economic differences between European countries . They believe the differences make it very challenging for the European Central Bank (ECB) to conduct its monetary policy. In Norway, the central bank – Norges Bank – can adjust interest rates according to conditions in the Norwegian economy: If unemployment rises, or inflation falls more than desired, Norges Bank can reduce interest rates to stimulate the economy, and vice versa. A lower interest rate could make it easier for businesses to sell and hire, and inflation could pick up. The ECB, on the other hand, must take into account the economic situation in all 17 member states. This can sometimes be a big challenge, especially when some countries are experiencing an upturn while others are experiencing a downturn.

According to DENTISTRYMYTH, the US Federal Reserve may also face similar challenges. The economic situation can vary a great deal from state to state. However, two important factors separate the American monetary union from the European one:

  • The USA has more mobile labor – greater flow of labor: In the USA (at least until recent years) labor has moved relatively quickly from an area in decline and with rising unemployment, to an area with growth and vacancies. The creation of the EU’s internal market – with the free flow of labor – was an important step towards achieving similar mobility in Europe as well. However, both language and cultural differences still act as an obstacle to migration between euro area countries.
  • The United States has a common fiscal policy: The US states fall under the national (federal) state budget. This involves money transfers between states (as between counties and municipalities in Norway). Eurosona has no similar mechanisms for transfers to deficit countries.

Lack of mobility and a common fiscal policy have probably contributed to creating large imbalances (different competitiveness, large trade imbalances – more on that below). In many ways, we can see this as a fundamental cause of the crisis the eurozone is experiencing today.

Already in the years before the monetary union was established in 1999, southern European countries experienced higher wage and cost growth than countries in the northwest. This development should in principle have weakened the competitiveness of the southern euro countries. The prices of the goods they sold rose relatively more than they did in the north. The persistent weakening of the currency of the countries in the south (which made their goods cheaper in other countries) meant that they nevertheless maintained their competitiveness.

This opportunity to compensate disappeared when the euro was introduced . Nevertheless, wage and price inflation have remained higher in the southern euro countries. The consequence is that i.a. Italy, Greece and Spain have steadily lost competitiveness relative to, for example, Germany.

This is clearly shown in a figure that illustrates so-called real exchange rates – a simple measure of competitiveness – for selected European economies. The values ​​were set at 100 in 2000. A higher value will mean that competitiveness will be weakened against the country’s trading partners. The figure shows that Italy’s competitiveness, according to this target, has weakened by around 40 per cent in the last 10-11 years.

Eurozone in Crisis 1

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