Eurozone in Crisis Part III

When the interest rates the Italian state has to pay on its loans began to rise in the summer of 2011, suddenly the calculation no longer became as simple. The development of a country’s government debt as part of value creation depends on two key factors:

  • new borrowings
  • the relationship between the country’s economic growth and the country’s borrowing rates.

If the interest rate is higher than the growth, the debt level will rise as part of value creation, even without new debt borrowings. And the debt will rise more the higher the debt is from before. Such a snowball effect can quickly make a former manageable debt unmanageable.

5: Psychology and expectations

The example Italy illustrates how important psychology and expectations in the financial market can be. Initially, there was no news that should change the perception of the country’s ability to pay. But in turbulent times with a lot of uncertainty, it often takes little. In an interview in July 2011, the then Prime Minister Silvio Berlusconi stated that he did not support a warning plan for tightening in the public sector.

Statements that had normally been regarded as relatively unimportant should prove to trigger a sustained rise in Italian interest rates . When interest rates first began to rise, some investors became uneasy about the aforementioned snowball effect and the danger that the country could not pay its debts. They thus demanded an even higher interest rate to lend Italy money, since the risk had increased. An interest rate spiral was underway.

6: Receipt costs

According to EHISTORYLIB, European top politicians, led by Germany’s Angela Merkel and France’s Nicolas Sarkozy, have “run” from summit to summit precisely to prevent such a crisis of confidence , or interest rate spiral. Through intense tug-of-war, the parties have on several occasions presented “The grand bargain” – packages of measures that apparently should be large enough to save the monetary union. But so far, the result has largely been the same after each round: The turmoil in the financial markets has quickly flared up again.

Also nationally, politicians in several countries have taken action to create confidence in their countries’ future ability to pay. Countries that have received aid loans from the EU / IMF – Greece, Ireland and Portugal – have been faced with tough demands for budget cuts and economic reforms as conditions for the loan (Greece in particular). Other countries, such as Italy and Spain, have implemented similar measures after being put under pressure by the financial markets. Some, with the United Kingdom (not the eurozone) as the prime example, have voluntarily announced sharp budget cuts without any signs of mistrust in the markets.

Landa has thus experienced varying degrees of pressure to start tightening in the public sector. Common to them all is that the measures have pain . Historical experience tells us that economic growth in the aftermath of financial crises is often weaker than after other phases of decline. For most eurozone countries, growth has also been weak since the financial crisis began in 2008 (exception: Germany). In many countries, production in January 2012 was lower than four years earlier.

Unemployment is high. In the eurozone in general, more than 10 per cent of the labor force is still without a job, in Spain more than 20 per cent. In fact, the eurozone could badly need new demand impulses. Instead, an attempt is being made to implement public austerity measures – such as wage freezes and cuts, cuts in pensions, increased taxes, etc. This will probably contribute to lower activity and even more unemployment, at least in the short term.

7: Social and political unrest

The states spent a lot of money on saving the banks in 2008 and 2009. Now they are trying to save the same states by cutting public welfare benefits. For many, this is, to put it mildly, difficult to accept. Aid measures against the banks probably saved the world economy from an even deeper period of decline, and were thus important.

But the measures also “saved” many financiers with partly staggering incomes. Now many people know that it is “most people” ( Main street ) who are left with the bill (after Wall street ). In several countries, people have therefore taken to the streets to protest. With a particularly high unemployment rate among young people across large parts of Europe, it is easy to understand the frustration.

For the state leaders, there is a twisted balance between taking into account demands from outside and the protests from their own population. It is especially demanding when the professional advice spreads in all directions. Some economists believe that large cuts in public spending are the best medicine for building confidence and sustainable long-term government finances. Others believe that one can only achieve the same long-term goal via major public stimuli aimed at promoting growth.

Eurozone in Crisis 3

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