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Impacts of the European Debt Crisis

Impacts of the European debt crisis
Countries all over the world were affected by the global financial and economic crisis which happened in the period 2007 to 2010. The crisis was caused by subprime mortgage borrowing in the US. The banking system issued subprime mortgage loans excessively, and this was followed by a period of economic slowdown when inflation set in. many subprime borrowers were unable to repay their debts, and this lead to crisis in the banking industry. This crisis later affected other industries in the US economy. As a result of the international between the US and other countries, spillover effects were experienced. The crisis spread to other countries, and after a short period of time all countries worldwide were affected by the crisis. The crisis affected financial markets of various countries, and this lead to collapse of several industries. The countries in the European Union were affected by the crisis, and this lead to a serious sovereign debt crisis (Grammatikos & Vermeulen, 2011).
The European Sovereign debt crisis refers to a time when European countries experienced failure of financial institutions, increasing government debt and an increased bond yield. This situation started to be experienced in 2008 when the banking system of Iceland collapsed, and this affected other countries such as Greece, Ireland and Portugal. During the crisis many investors lost confidence with the businesses and economies in European region. Greece was the worst hit country by the crisis. The situation was controlled and regulated by financial guarantees provided by some European countries. The intervention by the international Monetary Fund (IMF) was of great importance when regulating the debt crisis in the European zone. The IMF provided bailout funds to the affected countries, and this served as a measure to reduce public debt (Wignall & Slovik, 2011).
Causes of the debt crisis in European Union
Several factors triggered the debt crisis to escalate beyond control. In Ireland and Spain, the banking institutions were blamed for the crisis. The banks offered many loans to subprime borrowers in the housing and property industry. This lead to a boom and this caused widespread financial crisis when the people who had borrowed the debts started to default. A fiscal problem was experienced in the economy, and this caused a high inflation rate to be experienced. The problems encountered by the banking industry were experienced by other industries in the economy due to spill over effect. Other countries in the European region trading with Ireland and Spain experienced the same problem because they had to import and export products at higher prices. With the increase in inflation rates, prices and other fiscal measures, the GDP of the countries affected declined. The European countries started to experience the debt crisis in the year 2009, but the situation worsened in 2010. Consolidating the budget for the countries involved became difficult (Elliott, Stewart & Hooper, 2011).
Greece was the worst hit by the European sovereign debt crisis. The country suffered the highest amount of sovereign credit default swaps compared to any other countries in the region. From the diagram below, it is evident that the curve representing the economy of Greece is the tallest.
After realizing the problem facing European Union, the member countries established the Maastricht Treaty. The members resolved to limit the amount of deficit expenditures and levels of debts for each member country. Greece and Italy evaded the rules and used complicated structures to sustain their currencies and credit derivatives. However, better financial reforms were required to improve the performance of the economies of the countries in the EU (Harrington & Moses, 2011).
The different opinions adopted by the various countries were almost to collapse the EU. According to Elliott, Stewart and Hooper (2011), “reports emerging from Brussels said that Germany and France had begun preliminary talks on a break-up of the Eurozone, amid fears that Italy would be too big to rescue” (p.1). Italy started to take some precautions to rescue its economy from collapsing. The Prime Minister, Silvio Berlusconi, announced that he would step down as a measure to control the economy of the country. This was proposed to be a strategy to win investor confidence, and to increase foreign investment (Elliott, Stewart & Hooper, 2011).
The government of Greece resolved to apply different strategies to solve the financial problems. The prime minister had been blamed for making poor decisions. The need for the prime to resign could not solve the problems the country was facing (Afonso, Furceri & Gomes, 2011). Prudent fiscal and monetary decisions were required to salvage the economy of the country. Winning investors’ confidence was important because they would bring more currencies to the country. Eliminating the prime minister worsened the situation because the investors withdrew their investments from the country, and this led to a bad economic situation. The decision did not only affect the country’s economic and financial performance, but also caused other countries to suffer. Most of the countries which traded with Greece were affected negatively because the performance of their capital markets reduced (Elliott, Stewart & Hooper, 2011).
Unlike in the past debt crisis which emanated from developing countries, the debt European debt crisis originated from industrialised western European countries. Greece and other Eurozone countries experienced bankruptcy and were provided US$146 billion by IMF as a bailout. This was aimed at improving the fiscal deficit that the countries were experiencing. However, the bailout had a negative effect to the countries because they were supposed to cut down their expenditure. This means that they had to carry out mass retrenchment in the public sector. Taxes had to fix higher taxes. In addition, wages were frozen and other fiscal measures were applied to reduce the government expenditure. The conditions put in place by the IMF would affect the ability of Greece government to access more bailout money (Nelson, Belkin & Mix, 2011).
From the diagram above, it is evident that the crisis has affected the GDP of the countries in the EU. All countries had their GDP decreasing at a very high rate, with Ireland experiencing the highest rate of decline. The GDP in Ireland dropped from a high of 5% in 2000 to as low as -33% in 2010. Other countries also experienced declining GDP but a low rate. Greece was also adversely affected by the crisis compared to other countries in the region (Liu, 2011).
It is evident from the above diagram that the interest rates in the European Union have been increasing. This has affected the economies of the countries in the region. Greece is worst affected because it indicates highest increase in the interest rates. The interest rates of Greece skyrocketed as high as 18%, and this is an indication that the country has been the worst hit. The other countries had maximum interest rates of 13%. However, Ireland is the second affected in the region (Liu, 2011).
The capital market was affected by the sovereign debt crisis, and this reduced investors’ confidence. It was not normal for developed countries to experience debt crisis, and investors had confidence in the EU capital markets before the crisis occurred. A slower response to government bonds was experienced during the debt crisis because the securities had lower ratings. The announcements made by financial agencies negatively affected the performance of capital markets in the European Union (Arezki, Candelon & Amadou, 2011).
Spillover impacts of the debt crisis to other countries
The European debt crisis had spillover effects that affected other industries other than the banking sector. Other countries outside the EU were also affected by the crisis through the spill over effect. The sovereign rating downgrades had significant impact to the economic performance of various financial markets in the economies of various countries. The sign and degree of the spill over impacts were determined by the type of announcements, the nature of the resources of a country and the rating agency (Arezki, Candelon & Amadou, 2011).
The European debt crisis had a spillover effect similar to the Asian debt crisis of the 1997. The Asian debt crisis affected the financial markets in Latin America. However, the European debt crisis had a less impact to the Latin American countries. This was caused by the perfect economic reforms done in the countries. The Latin America has done adequate financial reforms after the crisis that affected them in 1997, and this has made them to remain immune from the EU debt crisis. Even though the Latin America experienced a deteriorated fiscal performance in 2009, the erosion was lower compared to other regions (Batten, Szilagyi & Szilagyi, 2011). The experience in Latin America did not generate anxieties about debt viability. This was caused by the application of monetary solutions rather than fiscal measures to regulate the debt crisis. Latin America has been able to access finances locally and externally. In addition, financial needs have been managed properly in Latin America. However, Latin America is not totally immune from the spill over effects of the EU debt crisis. There is the risk that global financing will affect the Latin America. Some Latin American countries use international credit markets in partially fulfilling their financial requirements (Lynn, 2010).
The European sovereign debt had an impact locally and internationally. This was caused by the fact that capital markets in the world are interrelated and countries interact in transacting capital goods and services. International trade facilitated the wide spread of the debt crisis to other countries. Through trade, countries involved import or export products with the affected countries. The inflation rates of the affected countries causes the products exported to have high prices. This causes the importing countries to sell the products at high prices to cover up the cost. This leads to inflation in the other countries (Silvia, J. (2011).
According to Obstfeld and Taylor (2011), countries have liberalised capital markets, and this has increased foreign investment in many countries. International trade agreements have encouraged governments to remove barriers to trade, so that many investors in the global markets can exchange their products. The capital market has been increasing with the opening up of trade boundaries in many countries. However, the free trade in capital markets caused the debt crisis to increase at a higher rate. Capital markets also cause inflation to spread among the transacting countries. In the European Union, investors bought bonds and other capital assets at high prices hoping that the prices would reduce in the near future. Foreign investors would bring in more money to the EU regions. With the experience of debt crisis, the investors suffered losses due to the poor performance of the EU economies. This affected the economies of the home countries of the investors (Batten, Szilagyi & Szilagyi, 2011).
The global financial crisis initiated the financial and economic crisis was the main cause of the European sovereign debt crisis. The European sovereign debt crisis has affected all the countries in the region and globally. However, Greece and Italy have been affected to a larger extent. The capital markets in these two countries were affected such that investors lost their confidence and withdrew their investments. The crisis was caused by poor banking policies and the housing boom in the US, and this later spread to other countries in the world. In the EU, many countries had tried to conserve the situation spillover effects from the international trade caused poor performance in both economic and financial markets. This has resulted into inflation, increasing interest rates, poor performance of the country’s GDP and high government expenditure. Investors’ confidence has declined because the economies are not performing well. In addition, the bond prices have been affected by the declining economies. Spillover effects have been experienced in Latin America and other global economies. To solve this problem, IMF has issued bailout to the affected countries. This has helped reduce the adverse economic effects of the crisis.

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