Euro Countries – Meager Public Finances Part II
5: A euro crisis
Euro co-operation consists of 17 EU member states , which have the euro as their common means of payment. The European Central Bank (ECB) is responsible for monetary policy for the whole area, with a mandate to achieve low and stable inflation below, but close to, two per cent. The ECB lowered the interest rate to one percent in 2009, where it has remained since. The Joint European Central Bank has also helped to buy some of the most exposed government bonds from European banks that invested in such portfolios.
Despite the common currency : Each member of the eurozone is responsible for its own fiscal policy . The danger associated with unstable debt dynamics gave rise to the “Growth and Stability Pact” . It states, among other things, that
- a country cannot have a larger budget deficit than 3 per centof its GDP.
- debt could not exceed 60 percent of GDP.
France and Germany were the first to break the criteria in 2003, and the lack of budgetary discipline spread to other members. The debt level was already high when the crisis hit. Now it must be tightened, with the help of the introduction of a higher retirement age, higher taxes and fees, collective wage cuts and lower welfare expenditures in many countries. But this does not happen without social unrest and opposition from a number of groups.
6: The future of euro co-operation
The member countries of the euro area are different in terms of level of economic development, attitudes towards inflation and budget balances . It is difficult for German politicians to convince their taxpayers, who have a high willingness to save and order in their finances, about the necessity of having to pay for Greek budget sins. It has created, and will continue to create, tensions in the collaboration.
Euro co-operation provides both costs and benefits for all parties, and Germany is far from poorly out of its membership. The country has long benefited from a weaker exchange rate and a higher competitiveness than they would have had with their own national currency. At the moment, the German economy stands out among otherwise slow-growing industrialized countries, with very good drive in the export industry.
The monetary union will probably last, with the same members as today. According to HYPERRESTAURANT, the countries with a deficit in the state budget must continue to cut sharply, while the surplus countries must continue to contribute with financial assistance in the coming years. There is a significant probability that Greece (and perhaps more PIGS countries) will end up having to restructure parts of their debt. The lender and the borrower then come together to renegotiate the loan terms to avoid defaulting on the debt.
There is also a possibility that the union may become smaller, in that one or more PIGS countries choose to withdraw from the co-operation in order to regain their national currency and monetary policy independence. With a weaker national currency, the country can achieve a boost in the export companies’ competitiveness. It will be a welcome help to improve growth and save jobs.
7: Major expenses pending
Economic recovery in the wake of financial crises has historically been weaker than average. The imbalances that have been built up in the run-up to the crisis must be rebuilt, and that will take time. Meanwhile, growth has been weaker, and unemployment higher, than in the years leading up to the crisis. The meager government finances demand austerity at a time when demand impulses from the public sector could be sorely needed.
During 2011 and 2012, the industrialized countries will save the equivalent of almost 2½ per cent of their gross domestic product. The austerity measures will be greatest in the PIGS countries, but the United Kingdom and France will also cut their budgets sharply. This will put a damper on European growth in the coming years.
Still: The measures are necessary. Although the financial crisis will cost a lot, future changes in the composition of the population will cost the industrialized countries ten times more, according to the International Monetary Fund (IMF). For the OECD countries as a whole, the proportion of the population over the age of 65 will increase from 13 per cent in 2000 to 25 per cent in 2050 (cf. «elderly wave»). This will lead to increased pension obligations and increased expenses for the health care system . Measured as a share of GDP, public expenditure related to aging in the G20 countries will increase from 15 per cent to over 20 per cent in these fifty years. European countries and Japan face the biggest challenges.
The increased expenditure on pensions and care for the elderly will mean that the debt ratio will rise to 300 per cent in Japan, 200 per cent in the United Kingdom and 150 per cent in the United States over the next decade if budgets are not significantly changed. Interest expenses will increase markedly, and gradual budget cuts will not be sufficient to prevent debt rates from accelerating.
The PIIGS countries are a term used for the most debt-ridden member countries of the euro area: Portugal, Ireland, Italy, Greece (G for Greece) and Spain. In Greece and Portugal, loose public spending was the reason for the high debt. Greece is also struggling with a large share of the black economy, which weakens the state’s revenue base. In the case of Spain and Ireland, a bubble in the real estate market led to very high housing construction and steep house price growth. This led to a sharp build-up of debt in companies and households, ie in the private sector. Even if the debt is not government in the first place, it can quickly end up being so. An example is the Irish state, which has had to increase its debt borrowing in order to save Irish banks that were hit hard by huge losses on their loans when the bubble burst.