If you are an Irish resident, you may be feeling very worried! As Irish debt levels reach new heights, the bill will once again fall on the tax payer. Irish government borrowing is almost 12% of GDP, but with two key banks requiring a bail out, government borrowing is expected to treble this figure to some 32% of GDP. The Anglo-Irish bank requires approximately £30 billion and Allied Irish also requires more cash. The Irish Finance Minister said:
‘The state has to downsize these institutions to prevent them becoming a systemic threat to the state itself.’
The Irish have already faced a round of austerity cuts and with the latest banking catastrophe, the next round is about to start. There are concerns that the Irish economy could move into a downward spiral, with more money being removed from the economy causing more people to lose their jobs, which will weaken public finances further and mean that more borrowing will then be required. It is hardly surprising to find a pessimistic mood on the streets of Ireland.
However, with a new interdependent world, this crisis will not only be felt by Ireland. The UK exports a large amount to Ireland – more than to Spain or Italy. With Irish tax-payers facing higher burdens and unemployment still relatively high, UK exporters may feel the squeeze. Other countries on the periphery of Europe, such as Portugal, Greece and even Spain are also feeling the pressure. There are concerns of a ‘two-speed Europe’. Below are some articles about the Irish crisis. Do a search and see if you can find any information on the problems in Greece, Spain or Portugal.
Ireland: a problem soon to be shared BBC News blogs, Stephanomics, Stephanie Flanders (30/9/10)
European recovery hope grows despite Ireland’s swelling deficit Guardian, Richard Wachman (30/9/10)
Ireland bank rescue spurs global debt concerns The World Today (ABC News), Peter Ryan (30/10/10)
Irish debt yields in new record despite better job data BBC News (28/9/10)
Euro Govt-bonds fall after overdone rally on Ireland, Spain Reuters (30/9/10)
Ireland’s love affair with masochism Telegraph, Jeremy Warner (30/9/10)
EU austerity drive country by country BBC News (30/9/10)
Anglo-Irish was ‘systemic threat’ BBC News (30/9/10)
Questions
- What do we mean by government borrowing?
- With such high levels of government debt, what would you expect to happen to interest rates on government debt? Explain your answer.
- When deciding whether or not to bail out the banks, what process could a government use?
- The Irish Finance Minister talks about the institutions becoming a ‘systemic threat’. What does he mean by this?
- Why might the UK economy suffer from the problems in Ireland?
- To what extent do you agree that there is a two-speed Europe, with the core economies, such as France and Germany making good economic progress, but the peripheral economies still suffering from the effects of recession?
- How might the situation in Ireland affect other members of Europe? Will there be an impact on the euro exchange rate?
Fears of growing debt problems in the EU have caused global stock markets to plummet. On 25th May, the FTSE was down by 2.6%, Germany’s Dax index fell by 2.34% and in France the Cac 40 was also down 2.74%. Shares across Asia fell, including those in Australia, Hong Kong, Japan and Thailand. On top of this, there are concerns of rising military tensions between North and South Korea. This has only added to the pessimism of investors.
Then came the rescue of the Spanish bank Cajasur by the Bank of Spain, which did little to restore confidence in the world economy. The Spanish deficit has reached 11% of GDP, which is nearly 4 times higher than eurozone rules allow. Spain is also suffering from unemployment of more than 20%, which has led the IMF to call for massive structural reform in the country. The euro has also weakened, as investors sell the currency, because of growing fears of debt default amongst the eurozone countries.
Amid concerns of possible default by Greece, Spain and other countries, the IMF and the members of the European Union have agreed an emergency package of €750 billion (£650 billion). €250 billion comes from the IMF, with €440 billion available as loan guarantees for struggling nations and €60 billion from emergency European Commission funding. We can only wait to see how effective this rescue package will be in restoring confidence in the Eurozone economies.
Articles
Global stock markets see sharp falls BBC News (25/5/10)
Spain must make wide ranging reforms, weak recovery – IMF Reuters (24/5/10)
FTSE falls another 2.5% after Europe’s debt crisis sparks fears in Asian markets Mail Online (25/5/10)
IMF raises fresh concerns about the Spanish economy BBC News (24/5/10)
IMF Chief Economists – doubts over Greek aid remain Reuters, John Irish (24/5/10)
Markets still tense over eurozone debt Independent, Ian Chu (21/5/10)
FTSE falls below 5,000 due to eurozone crisis Telegraph (21/5/10)
FTSE plunges nearly 3% in opening seconds (including video) Sky News (25/5/10)
The contagion of austerity BBC News blogs: Gavin Hewitt’s Europe (25/5/10)
Europe debt crisis threatens recovery, OECD warns BBC News (26/5/10)
Data
In graphics: Eurozone in crisis BBC News (24/5/10)
For macroeconomic data for EU countries and other OECD countries, such as the USA, Canada, Japan, Australia and Korea, see:
AMECO online European Commission (especially sections 1, 6, 16 and 18)
Questions
- Using a diagram, illustrate why the euro has weakened.
- Explain why stock markets have fallen across the world.
- What type of reforms are needed in Spain?
- What factors are likely to determine the effectiveness of the IMF emergency package?
- Are the austerity measures in the Spanish economy likely to lead to the similar outcomes that we saw in Greece, such as widespread strikes?
- Discuss the advantages and disadvantages of the rescue package. Does rescue involve a moral hazard?
In the past few days, the euro has been under immense speculative pressure. The trigger for this has been the growing concern about whether Greece would be able to force through austerity measures and cut its huge deficit and debt. Also there has been the concern that much of Greece’s debt is in the form of relatively short-term bonds, many of which are coming up for maturity and thus have to be replaced by new bonds. For example, on 19 May, Greece needs to repay €8.5 billion of maturing bonds. But with Greek bonds having been given a ‘junk’ status by one of the three global rating agencies, Standard and Poor’s, Greece would find it difficult to raise the finance and would have to pay very high interest on bonds it did manage to sell – all of which would compound the problem of the deficit.
Also there have been deep concerns about a possible domino effect. If Greece’s debt is perceived to be unsustainable at 13.5% of GDP (in 2009), then speculators are likely to turn their attention to other countries in the eurozone with large deficits: countries such as Portugal (9.4%), Ireland (14.3%) and Spain (11.2%). With such worries, people were asking whether the euro would survive without massive international support, both from within and outside the eurozone. At the beginning of 2010, the euro was trading at $1.444. By 7 May, it was trading at $1.265, a depreciation of 12.4% (see the Bank of England’s Statistical Interactive Database – interest & exchange rates data
If the euro were in trouble, then shock waves would go around the world. Worries about such contagion have already been seen in plummeting stock markets. Between 16 April and 7 May, the FTSE100 index in London fell from 5834 to 5045 (a fall of 13.5%). In New York, the Dow Jones index fell by 8.6% over the same period and in Tokyo, the Nikkei fell by 7.6%. By 5 May, these declines were gathering pace as worries mounted.
Crisis talks took place over the weekend of the 8/9 May between European finance ministers and, to the surprise of many, a major package of measures was announced. This involves setting aside €750bn to support the eurozone. The package had two major elements: (a) €60bn from EU funds (to which all 27 EU countries contribute) to be used for loans to eurozone countries in trouble; (b) a European Financial Stabilisation Mechanism (a ‘Special Purpose Vehicle (SPV)’), which would be funded partly by eurozone countries which would provide €440bn and partly by the IMF which would provide a further €250bn. The SPV would be used to give loans or loan guarantees to eurozone countries, such as Greece, which were having difficulty in raising finance because of worries by investors. The effect would also be to support the euro through a return of confidence in the single currency.
In addition to these measures, the European Central Bank announced that it would embark on a ‘Securities Markets Programme’ involving the purchase of government bonds issued by eurozone countries in difficulties. According to the ECB, it would be used to:
.. conduct interventions in the euro area public and private debt securities markets to ensure depth and liquidity in those market segments which are dysfunctional. The objective of this programme is to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism.
Does this amount to quantitative easing, as conducted by the US Federal Reserve Bank and the Bank of England? The intention is that it would not do so, as the ECB would remove liquidity from other areas of the market to balance the increased liquidity provided to countries in difficulties. This would be achived by selling securities of stronger eurozone countries, such as Germany and France.
In order to sterilise the impact of the above interventions, specific operations will be conducted to re-absorb the liquidity injected through the Securities Markets Programme. This will ensure that the monetary policy stance will not be affected.
So will the measures solve the problems? Or are they merely a means of buying time while the much tougher problem is addressed: that of getting deficits down?
Webcasts and podcasts
Rescue plan bolsters the euro BBC News, Gavin Hewitt (10/5/10)
The EU rescue plan explained Financial Times, Chris Giles, Emily Cadman, Helen Warrell and Steve Bernard (10/5/10)
Peston: ‘Crisis is not over’ BBC Today Programme (10/5/10)
Greece ‘will get into even more deep water’ BBC Today Programme (11/5/10)
Articles
EU ministers offer 750bn-euro plan to support currency (including video) BBC News (10/5/10)
EU sets up crisis fund to protect euro from market ‘wolves’ Independent, Vanessa Mock (10/5/10)
Euro strikes back with biggest gamble in its 11-year history Guardian, Ian Traynor (10/5/10)
Debt crisis: £645bn rescue package for euro reassures markets … for now Guardian, Ian Traynor (10/5/10)
The E.U.’s $950 Billion Rescue: Just the Beginning Time, Leo Cendrowicz (10/5/10)
Eurozone bail-out (portal) Financial Times
Bailout does not address Europe’s deep-rooted woes: Experts moneycontrol.com (11/5/10)
An ever-closer Union? BBC News blogs: Stephanomics, Stephanie Flanders (10/5/10)
Eurozone crisis is ‘postponed’ BBC News blogs: Peston’s Picks, Robert Peston (10/5/10)
Multi-billion euro rescue buys time but no solution BBC News, Lucy Hooker (11/5/10)
No going back The Economist (13/5/10)
It is not Greece that worries EURO: It is China that teeters on a collapse Investing Contrarian, Shaily (11/5/10)
Data and official sources
For deficit and debt data see sections 16.3 and 18.1 in:
Ameco Online European Commision, Economic and Financial Affairs DG
For the ECB statement see:
10 May 2010 – ECB decides on measures to address severe tensions in financial markets ECB Press Release
Questions
- Why should the measures announced by the European finance ministers help to support the euro in the short term?
- Why should the ECB’s Securities Markets Programme not result in quantitative easing?
- Explain what is meant by sterlisation in the context of open market operations.
- What will determine whether the measures are a long-term success?
- Explain why there may be a moral hazard in coming to the rescue of ailing economies in the eurozone. How might such a moral hazard be minimised?
- Why should concerns about Greece lead to stock market declines around the world?
- What is the significance of China in the current context?
Greece’s public deficit currently stands at 13.6% and the UK isn’t that far behind. Austerity measures are planned to reduce the Greek deficit to less than 3% of GDP by 2014. This will be achieved through a variety of spending cuts and tax rises. This is the price that Greece will have to pay to receive a £95 billion bailout. Wages are likely to be frozen, cuts will be evident throughout the economy in areas such as education and pensions and the general population may see a tax rise.
In response to these proposals, on which Parliament will vote by the end of the week, the Greek economy has suffered from widespread strikes. Flights were grounded, trains stopped, schools shut, hospitals closed their doors, offices closed for business and those close to retirement are considering resignation before the measures are passed.
As life almost comes to a stop in Greece, could the UK follow suit? It’s no secret that the UK deficit is enormous – £163 billion or about 12% of GDP. Nor is it a secret that spending cuts and tax rises are inevitable. Furthermore, over the past two years, there have been several high profile strikes. (See article The Winter of Discontent: the sequel? and Turbulence in the air). A spokesman from The Public and Commercial Services Union said:
“If the cuts are anything like what is being suggested, industrial action by the unions is not only likely, it’s inevitable”.
The bailout of Greece may avert one Greek tragedy, but another one could be just around the corner and that’s not just for Greece.
Greece brought to half over general strike over cuts BBC News (5/5/10)
Greek strikes test government austerity plans Reuters (4/5/10)
Bank of England Governor: poll winner will be out of power for a generation Independent, Andrew Grice and Colin Brown (30/4/10)
Flights grounded, shops shut in Greek strike Channel 4 News, Kris Jepson (5/5/10)
Greek strikers hit Athens streets over austerity plan BBC News (4/5/10)
Greek strikes test government austerity plans The Economic Times (4/5/10)
Questions
- What is the purpose behind the strikes? How effective are they likely to be?
- What are the costs of strikes to a) consumers b) businesses c) the wider economy?
- Why is collective bargaining more effective than individual bargaining?
- Why could the Greek picture be a possible forecast of the UK economy after the May election?
- Are strikes a price worth paying if the government is to reduce its debt?
Taxpayers may actually be in profit by several billion pounds, following reports from Lloyds that their profits are up in the first three months of 2010. At current share prices, the taxpayers are in profit by approximately £2 billion and this figure is expected to rise, as share prices continue to rise. Lloyds is 41% owned by the public, after a £17 billion bail-out rescued the debt-ridden bank. These profits follow two years of losses by Lloyds TSB and HBOS of over £6 billion in 2008 and 2009.
So, what has caused this change in fortunes? First, there has been a fall in the number of loans, which have gone bad. The bank said, “In our wholesale division, the level of impairments has been significantly lower than the last quarter of 2009 and is also at a lower level than our initial expectations for 2010″. Second, there has been a widening gap between the interest charged on a loan and the interest paid to depositors. However, despite this good news, this bank (and others) are still not lending enough to stimulate economic growth. Furthermore, as Lloyds still remains heavily dependent on loans both from British and overseas taxpayers, it could be some time before taxpayers see any return on their ‘investment’.
Lloyds: Black is the colour of spring BBC News, Peston’s Picks, Robert Peston (27/4/10)
Lloyds Banking Group returns to profits Guardian, Jill Treanor (27/4/10)
Lloyds profits revive as bad debts imorive Reuters, Edward Taylor and Clara Ferreira-Marques (27/4/10)
Lloyds Bank returns to profit Telegraph (27/4/10)
Lloyds and RBS shares to rise to give taxpayer potential £9bn profit Guardian, Jill Treanor and Larry Elliott (26/4/10)
Questions
- How have fewer bad debts and different lending and saving rates contributed to rising profits for Lloyds?
- If profits are back up, why are British banks still not lending enough?
- What factors will determine when the taxpayers actually see the return on their ‘investment’?
- In the Guardian article, ‘Lloyds Banking Group returns to profit’ what does it mean by “The bank did not change its earlier guidance that it expected to achieve £2bn of synergies and other operating efficiencies from the HBOS takeover by the end of 2011”?
- To what extent is the news about profits at Lloyds Banking Group and RBS a useful tool for the government in the upcoming election?
- Why is it so important that banks begin to increase their lending? What will determine the size of the effect on GDP of any given increase in lending?