Leadership and Decision Making in the Eurozone
1. Decision Making
1.1 The concept of a “perfect” UNION
United Europe was at its birth and remains at its heart an economic idea. Its purpose was peace, but the means were economics. The purpose of the UE was to avoid another World War by binding together the nations, economically and financially so that is no longer in their self interest to go to war. In 1957 the European Economic Community took birth. In 1979 was the first experiment with a currency union by linking European currencies which led to the European monetary system, the precursor of the euro. Once the euro was established it seemed like the big steps to get those next levels of cohesion never actually happened. The “sin” of the European monetary union was that they created a system where you had monetary union without fiscal union. The structure of euro was such that you had to take fiscal discipline by the governments on faith because the European Union does not touch the fiscal sovereignty of governments. We would have a group of countries with wildly diverging economic growth potential and frankly fiscal positions with one interest rate, one currency. Unfortunately, the issue was that the fiscal discipline wasn’t there whereas the monetary discipline was. The thought was handing over monetary policy to the European Central Bank would go a long way in obviating the problems of the different fiscal regimes. It is a very tough monetary authority which in the end put the screws on economic growth in Europe. That’s where the seeds of the current problems were planted because countries like Greece and Italy were unable to grow as much as the others and had therefore to resort to lax fiscal discipline in order to grow. Financial markets treated all euro members pretty much the same handing out loans to Greece on nearly the same terms as loans to Germany. Behind that big error was misplaced assumption that all the euro countries were in it together, that none would let a fellow fail. Governments began to take on more and more debt. Greece took the most dangerous path. To make up for weak job creation in its private economy, it pumped up the public payroll. That meant more borrowing.
1.2 The contagion
The whole thing began with lousy real estate loans in the US but it evolved from there. Individuals over-borrowed which got the banks into trouble, the banks being bailed out by countries.
When the first germs from the US started to spread to other countries around 2008, the Europeans were quite optimistic thinking the crisis was predominantly in the US.
There is nothing that happened in sub-prime mortgages in the US that can explain why Greece was able to get into the euro-zone by lying about its finances, and why that chicken finally came home to roost.
In October 2009, a rude surprise from Greece, a budget deficit predicted to be around 3% of GDP was actually 12%. Foreign investors who had been buying Greece’s debt panicked.
By early 2010 they started to charge more and more to lend to Greece. And the first shock to the euro system was the knowledge that Greece actually was borrowing far more than people had thought.
And that frankly speaks to a structural flaw in the EU. It is very slow in making decisions because there are so many governments that have to have their say, and therefore the Greece problem which could’ve been tackled easily and resolved was never resolved.
The first phase of the crisis was: will Greece be able to repay its debt, will it need help?
That led up to the first bailout of the crisis in Greece in May 2010. Greece got a bailout and Europe had built a rescue fund, but because of the way the euro-zone was designed the contagion was difficult to control.
Fearing inflation and restricted by its mandate, the European Central Bank stepped in only tepidly and reluctantly.
Europe put Greece on an extreme diet of austerity and hoped for the best....
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