As European leaders gather for an emergency summit in Brussels to tackle the eurozone debt crisis, we consider the issues and possible solutions. In Part B we’ll consider the actual agreement.
There are three key short-term issues that the leaders are addressing.
1. The problem of Greek debt
With fears that the Greek debt crisis could spread to other eurozone countries, such as Italy and Spain, it is vital to have a solution to the unsustainability of Greek debt. Either banks must be willing to write off a proportion of Greek debt owed to them or governments must give a fiscal transfer to Greece to allow it to continue servicing the debt. Simply lending Greece even more provides no long-term solution as this will simply make the debt even harder to service. Writing off a given percentage of debt is known as a ‘haircut’. The haircut on offer before the summit was 21%. Leaders are reportedly considering increasing this to around 60%.
2. The size of the eurozone bailout fund
The bailout fund, the European Financial Stability Facility (EFSF), stood at €440 billion. This is considered totally inadequate to provide loans to Italy and Spain, should they need a bailout. France and other countries want the ECB to provide extra loans to the EFSF, to increase its funds to somewhere between €2 trillion and €3 trillion. Germany before the meeting was strongly against this, seeing it as undermining the rectitude of the ECB. A compromise would be for the EFSF to provide partial guarantees to investors and banks which are willing to lend more to countries in debt crisis.
3. Recapitalising various European banks
Several European banks are heavily exposed to sovereign debt in countries such as Greece, Italy and Spain. It is estimated that they would need to raise an extra €100 billion to shield them against possible losses from haircuts and defaults.
But there is the key longer-term issue as well.
Achieving long-term economic growth
Without economic growth, debt servicing becomes much more difficult. The austerity measures imposed on highly indebted countries amount to strongly contractionary fiscal policies, as government expenditure is cut and taxes are increased. But as the economies contract, so automatic fiscal stabilisers come into play. As incomes and expenditure decline, so people pay less income tax and less VAT and other expenditure taxes; as incomes decline and unemployment rises, so government welfare payments and payments of unemployment benefits increase. These compound public-sector deficits and bring the possibility of even stronger austerity measures. A downward spiral of decline and rising debt can occur.
The answer is more rapid growth. But how is that to be achieved when governments are trying to reduce debt? That is the hardest and ultimately the most important question.
Articles
Brussels summit: the main issues to be resolved The Telegraph (25/10/11)
EU crisis talks in limbo after crucial summit is cancelled The Telegraph, Louise Armitstead (25/10/11)
Euro zone summit likely to give few numbers on crisis response Reuters, Jan Strupczewski (25/10/11)
Factbox: What EU leaders must decide at crisis summit Reuters (24/10/11)
Hopes low ahead of EU summit Euronews on YouTube (25/10/11)
Euro crisis: EU leaders hope to reach debt plan BBC News (26/10/11)
The deadline Europe cannot afford to miss BBC News, Nigel Cassidy (26/10/11)
Why EU summit is crunch day for the eurozone BBC News, Paul Mason (26/10/11)
Southern European banks need most capital BBC News blogs, Robert Peston (23/10/11)
Will Germany insure Italy against default? BBC News blogs, Robert Peston (26/10/11)
Plan B for the eurozone? BBC News blogs, Stephanie Flanders (26/10/11)
‘No such thing as Europe’ BBC Today Programme, Stephanie Flanders and Martin Wolf (26/10/11)
Markets to eurozone: It’s the growth, stupid BBC News blogs, Stephanie Flanders (24/10/11)
Fears euro summit could miss final deal Financial Times, Peter Spiegel, Gerrit Wiesmann and Matt Steinglass (26/10/11)
Time to unleash financial firepower or face euro breakup Guardian, Larry Elliott (25/10/11)
The Business podcast: eurozone crisis Guardian, Larry Elliott, David Gow and Jill Treanor (25/10/11)
Why is Germany refusing to budge on the eurozone debt crisis? Guardian blogs, Phillip Inman (26/10/11)
Questions
- In terms of the three short-term problems identified above, compare alternative measures for dealing with each one.
- To what extent would the ECB creating enough money to recapitalise European banks be inflationary? On what factors does this depend?
- Does bailing out countries create a moral hazard? Explain.
- What possible ways are there of achieving economic growth while reducing countries sovereign debt?
- Would you agree that the problem facing eurozone countries at the moment is more of a political one than an economic one? Explain.
- What are the arguments for and against greater fiscal integration in the eurozone?
The price of petrol at the pumps has risen substantially over the past few years. In the UK, according to the AA, the average price between January and June 2011 was 133.13p. In the same period in 2010 it was 116.68p; and in the same period in 2008 it was 109.00p.
Over the first six months of 2011, the amount of petrol sold fell by 5.2 per cent. This was on top of the decline in consumption over the previous four years. Between 2006 and 2010 consumption of petrol fell by 17.4%. The consumption of petrol and diesel are given in the following table.
UK consumption of petrol and diesel (tonnes millions)
|
2006 |
2007 |
2008 |
2009 |
2010 |
| Petrol |
18.14 |
17.59 |
16.68 |
15.76 |
14.99 |
| Diesel |
20.15 |
21.07 |
20.61 |
20.06 |
20.87 |
| Total |
38.29 |
38.66 |
37.29 |
35.82 |
35.86 |
Source: Digest of United Kingdom energy statistics (DUKES) (Department of Energy and Climate Change)
So what has caused this decline in petrol sales? Are there multiple factors at work here? Have a look at the articles and consider the explanations.
Articles
Cash-strapped drivers cut petrol use by 15 per cent Channel 4 News (5/10/11)
Sales of petrol slump as skint motorists cut costs Daily Record, Jamie Grierson (5/10/11)
Petrol Sales Plunge As Cash Squeeze Tightens Sky News (6/10/11)
Fuel cost rise ‘forcing change in driver habits’ TRL News, Mary Treen (6/10/11)
Data
Digest of United Kingdom energy statistics (DUKES) Department of Energy and Climate Change
Fuel price report (monthly) Automobile Association
Brent Crude spot prices Energy Information Association
Questions
- What factors have caused a fall in consumption of petrol?
- If you choose to spend a set amount on petrol, what is your price elasticity of demand?
- What determines the price elasticity of demand for petrol?
- Why has the consumption of diesel fallen less than that of petrol?
- Under what circumstances would an increase in tax on road fuel of 3p per litre (as planned for January 2012), result in a decrease in tax revenue? Why would the price elasticity of demand for road fuel have to be significantly greater than 1 (ignoring the minus sign) and not merely above 1 for this to be the case?
- Why is it likely that people’s price elasticity of demand for road fuel will become less elastic the more they have cut back on consumption?
- Why is the demand for petrol likely to be more elastic with respect to (a) price, and (b) income over the longer term?
- To what extent is the demand for road fuel a ‘derived demand’?
- To what extent is the fall in the consumption of petrol a reflection of a movement along the demand curve for petrol or a shift in the demand curve? Explain.
Nokia is finding out just how competitive the phone industry is, as it sees its third quarter figures come in at a loss. Google and Apple have seen their market shares rise and this has had an adverse effect on the Finnish company, Nokia. This goes some way to backing up the job losses seen earlier in the year, when 7000 jobs were cut and there was a re-allocation of workers towards ‘smartphones’.
Despite Nokia’s disappointing results in this sector, it has seen growth in its sales of other more simple phones, illustrating its ability to focus on this aspect of the market. Its sales were higher than forecast at 107 million handsets in the third quarter, showing some signs of a changing trend for the firm. However, with competition ever increasing, Nokia will need to consider its future strategy very carefully.
Nokia reports lower-than-estimated loss as profit forecast for phone unit Bloomberg, Diana Ben-Aaron (20/10/11)
Nokia swings to loss in third quarter BBC News (20/10/11)
Nokia boosted by sales of cheap handsets Financial Times, Daniel Thomas (20/10/11)
Nokia beats forecasts with sales of 107m phones Guardian, Juliette Garside and Charles Arthur (20/10/11)
Nokia prepares for ‘solid’ windows phone launch Telegraph, Matt Warman (25/10/11)
Questions
- How would you describe Nokia’s strategy of focusing on cheaper and simpler phones?
- Would you say Nokia’s strategy is sensible? What factors will determine its success?
- How have Apple and Google managed to expand their market share and become serious competitors to firms like Nokia?
- Into which market structure would you classify the phone industry?
With all the doom and gloom of recent economic data, including rising inflation and higher unemployment, there’s finally a small speck of light and that’s in the form UK retail sales. The latest data from the ONS suggests that sales in the UK in September were higher than previously forecast and reversed the 0.4% decline we saw in August. A big contributing factor to this positive data was a boost to online sales, but this small glimmer of hope is unlikely to be sufficient to keep the economy going – unless sales keep rising, we are unlikely to see any significant increase in economic growth.
The data, while positive, is still unlikely to have any impact on economic policy. The minutes from the Monetary Policy Committee showed that there was unanimous support for further quantitative easing, as the threat of weak growth and financial instability and uncertainty remains. An economist from Barclays Capital said:
‘We don’t think the recent strong growth in monthly sales is likely to be sustained…The environment for retailers is likely to remain challenging as consumer spending remains depressed driven by low confidence and slow earnings growth.’
The data from September is positive, but it does little to offset the decline in sales seen in August. It was revised down from 0.2% to 0.4% – some blame the hot weather, which discouraged consumers from hitting the high streets in preparation for the winter. The key data to look out for will be sales figures for the next few months. Only then will we have more of an indication about exactly which direction the economy is moving in. The following articles consider this latest economic data.
Retail sales in UK unexpectedly increase at fastest pace in five months Bloomberg, Scott Hamilton (20/10/11)
UK retail sales see stronger-than-expected rise BBC News (20/10/11)
Nothing expected from today’s UK retail sales figure FX-MM, Richard Driver (20/10/11)
Retail sales: what the economists say Guardian (20/10/11)
£1 in every £10 now spent online, says ONS Telegraph, Harry Wallop (20/10/11)
Retail sales rise more than expected Financial Times, Sarah O’Connor (20/10/11)
Retail sales up but good weather has a price Sky News (20/10/11)
Questions
- Which factors have contributed to the higher than expected sales figures for September?
- Why do economists not believe that the higher growth in sales means signs of recovery for the UK economy?
- How has higher inflation impacted UK households?
- To what extent do you think the warm weather held back retail sales?
- What could explain why there has been a significant growth in online sales?
The global economic mood is darkening. Levels of consumer and producer confidence have declined and forecasts of economic growth are being downgraded. Mervyn King, Governor of the Bank of England, stated that “this is the most serious financial crisis we’ve seen, at least since the 1930s, if not ever” (see).
So will slow recovery turn into a second recession (a double-dip)? And will recession turn into depression – the persistence of low or negative growth over a number of years? The following articles consider this frightening prospect and whether there are similarities with the Great Depression of the 1930s.
But let’s not be too downhearted. If we all are, the world could end up talking itself into depression. Consumers would seek to claw down their debts and cut back spending; producers would invest less as their confidence wanes; banks would be unwilling to lend. So is there any cause to be cheerful? Well, at least world leaders are increasingly aware of the possibility of world depression and minds are increasingly being focused on how to avoid the situation. The EU summit on 23 October and the G20 summit in Cannes on 3/4 November have EU sovereign debt problems and the global crisis at the centre of their agenda.
But if they do decide to act, what should they do? Is the answer a Keynesian stimulus to aggregate demand through fiscal policy and through further quantitative easing? Or is the approach to act more decisively to reduce sovereign debt and convince markets that governments are serious about tackling the problem – a policy response much more in accordance with new classical thinking and the type of policy that would be recommended by Thomas Sargent and Christopher Sims, winners of this year’s Nobel Prize in Economics?
Thinking outside the 1930s box BBC News blogs, Paul Mason (7/10/11)
Britain faces slowest recovery in a century Guardian, Katie Allen (12/10/11)
The Depression: If Only Things Were That Good New York Times, Sunday Review, David Leonhardt (8/10/11)
Recovery has ‘stalled’, say leading economists Financial Times, Sarah O’Connor (11/10/11)
Nobel prize in economics Republica, Opinion (Nepal), Sukhdev Shah (11/10/11)
Questions
- In what ways is the current global economic situation similar to that in the early 1930s?
- In what ways is it different? Do these differences provide more or less cause for hope for avoiding a global depression?
- Explain the following quote from the first article above: “I think that we face the quite real prospect that the market is removed as the determining mechanism for setting the price of capital within the eurozone at the sovereign level.This would put internal credit creation back under the control of the state.”
- How is the supply side of the economy relevant to (a) the short-run prospects for economic growth; (b) the long-run prospects?
- If technological progess slows down, what will be the implications for employment and unemployment? Explain.
- How is policy credibility relevant to the success of the decisions made at G20 and EU summits? (See last aricle above.) How would a Keynesian respond to the analysis of Sargent and Sims?