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?
The debts of many countries in the eurozone are becoming increasingly difficult to service. With negative growth in some countries (Greece’s GDP is set to decline by over 5% this year) and falling growth rates in others, the outlook is becoming worse: tax revenues are likely to fall and benefit payments are likely to increase as automatic fiscal stabilisers take effect. In the light of these difficulties, market rates of interest on sovereign debt in these countries have been increasing.
Talk of default has got louder. If Greece cannot service its public-sector debt, currently standing at around 150% of GDP (way above the 60% ceiling set in the Stability and Growth Pact), then simply lending it more will merely delay the problem. Ultimately, if it cannot grow its way out of the debt, then either it must receive a fiscal transfer from the rest of the eurozone, or part of its debts must be cancelled or radically rescheduled.
But Greece is a small country, and relative to the size of the whole eurozone’s GDP, its debt is tiny. Italy is another matter. It’s public-sector debt to GDP ratio, at around 120% is lower than Greece’s, but the level of debt is much higher: $2 trillion compared with Greece’s $480 billion. Increasingly banks are becoming worried about their exposure to Italian debt – both public- and private-sector debt.
As we saw in the news item “The brutal face of supply and demand”, stock markets have been plummeting because of the growing fears about debts in the eurozone. And these fears have been particularly focused on banks with high levels of exposure to these debts. French banks are particularly vulnerable. Indeed, Credit Agricole and Société Générale, France’s second and third largest banks, had their creidit ratings cut by Moody’s rating agency. They have both seen their share prices fall dramatically this year: 46% and 55% respectively.
Central banks have been becoming increasingly concerned that the sovereign debt crisis in various eurozone countries will turn into a new banking crisis. In an attempt to calm markets and help ease the problem for banks, five central banks – the Federal Reserve, the ECB, the Bank of England, the Bank of Japan and the Swiss National Bank – announced on 15 September that they would co-operate to offer three-month US dollar loans to commercial banks. They would provide as much liquidity as was necessary to ease any funding difficulties.
The effect of this action calmed the markets and share prices in Europe and around the world rose substantially. But was this enough to stave off a new banking crisis? And did it do anything to ease the sovereign debt crisis and the problems of the eurozone? The following articles explore these questions.
Articles
Central banks expand dollar operations Reuters, Sakari Suoninen and Marc Jones (15/9/11)
Europe’s debt crisis prompts central banks to provide dollar liquidity Guardian, Larry Elliott and Dominic Rushe (15/9/11)
From euro zone to battle zone Sydney Morning Herald, Michael Evans (17/9/11)
Global shares rise on central banks’ loan move BBC News (16/9/11)
Geithner warns EU against infighting over Greece BBC News (16/9/11)
How The European Debt Crisis Could Spread npr (USA), Marilyn Geewax (15/9/11)
No Marshall Plan for Europe National Post (Canada) (16/9/11)
Central banks act to help Europe lenders Financial Times, Ralph Atkins, Richard Milne and Alex Barker (15/9/11)
Central Banks Seeking Quick Fix Push Dollar Cost to August Lows Bloomberg Businesweek, John Glover and Ben Martin (15/9/11)
Central banks act to provide euro zone dollar liquidity Irish Times (15/9/11)
Central banks pump money into market: what the analysts say The Telegraph (15/9/11)
Central banks and the ‘spirit of 2008’ BBC News, Stephanie Flanders (15/9/11)
Central Bank statements
News Release: Additional US dollar liquidity-providing operations over year-end Bank of England (15/9/11)
Press Release: ECB announces additional US dollar liquidity-providing operations over year-end ECB (15/9/11)
Additional schedule for U.S. Dollar Funds-Supplying Operations Bank of Japan (15/9/11)
Central banks to extend provision of US dollar liquidity Swiss National Bank (15/9/11)
Questions
- Explain what is meant by debt servicing.
- How may the concerted actions of the five central banks help the banking sector?
- Distinguish between liquidity and capital. Is supplying extra liquidity a suitable means of coping with the difficulties of countries in servicing their debts?
- If Greece cannot service its debts, what options are open to (a) Greece itself; (b) international institutions and governments?
- In what ways are the eurozone countries collectively in a better economic and financial state than the USA?
- Is the best solution to the eurozone crisis to achieve greater fiscal harmonisation?
- What are the weaknesses of the European Financial Stability Facility (EFSF) as currently constituted? Should it be turned into a bank or special credit institution taking the role of a ‘European Monetary Fund’?
- Should countries in the eurozone be able to issue eurobonds?
Friday 5 August 2011 saw the end of a very bad fortnight for stock markets around the world. In Japan the Nikkei 225 had fallen by 8.2%, in the USA the Dow Jones had fallen by 9.8%, in the UK the FTSE 100 was down 11.6% and in Germany the Dax was down 14.9%. In the first five days of August alone, £148 billion had been wiped off the value of the shares of the FTSE 100 companies and $2.5 trillion off the value of shares worldwide.
But why had this happened and what are likely to be the consequences?
The falls have been caused by the growing concerns of investors about the health of the global economy and the global financial system. There are worries that the European leaders at their summit on 21 July did not do enough to prevent the default of large countries such as Spain and Italy. There are concerns that the US political system, following the squabbling in Congress over raising the sovereign debt ceiling for the country, may not be up to dealing with the country’s huge debts. Indeed, the rating agency, Standard & Poor’s, downgraded the USA’s credit rating from AAA to AA+. This is the first time that the USA has not had top rating.
Then there are worries about the general slowing down of the world economy and how this will compound the problem of sovereign debt as it hits tax revenues and makes it harder to reduce social security payments. Underlying all this is the fear that the problem of indebtedness that contributed to the banking crisis of 2007/8 has not gone away; it has simply been transferred from banks to governments. As Robert Peston states in his article, linked to below:
The overall volume of indebtedness in the economy is therefore still with us – although it has been shuffled from financial sector to public sector.
And if you took the view four years ago that the quantum of debt in the system was unsustainably large, then you would argue that by propping up the banks, the day of reckoning was being postponed, not cancelled.
… just like the awakening in 2007 to the idea that many of the housing loans and associated financial products were worthless, so there is a growing fear that a number of financially overstretched governments, especially in the eurozone, will not be able to repay their debts in full.
Which brings us to the consequences. Key to the answer is confidence. If governments can reassure markets over the coming days and weeks that they have credible policies to support highly indebted countries in the short term and to sustain demand in the global economy (e.g. through further quantitative easing in the USA (QE3)); and if they can also reassure markets that they have tough and credible policies to reduce their debts over the longer term, then confidence may return. But it will not be an easy task to get the balance right between sustaining recovery in the short term and fiscal retrenchment over the long term. Meanwhile consumers are likely to become even more cautious about spending – hardly the recipe for recovery.
Videos
Markets turmoil: What you need to know BBC News, Jonty Bloom (5/8/11)
Turmoil on stock markets persists as share prices fall BBC News, Robert Peston (5/8/11)
Global stock market crash – video analysis Guardian, Larry Elliott and Cameron Robertson (5/8/11)
S&P downgrade US AAA credit rating BBC News, Marcus George (6/8/11)
U.S. loses AAA credit rating Reuters, Paul Chapman (6/8/11)
U.S. loses AAA credit rating from S&P CNN (5/8/11)
US loses AAA rating ITN (6/8/11)
Shares slump amid euro fears Channel 4 News, Faisal Islam (4/8/11)
What triggered the turmoil? Financial Times, Sarah O’Connor and Edward Hadas (5/8/11)
Fears eurozone woes will spread BBC News, Stephanie Flanders (5/8/11)
Articles
FTSE 100 tumbles in worst week since height of the crisis The Telegraph, Richard Blackden (5/8/11)
Global recession fears as stock markets tumble to nine-month low The Telegraph, Alistair Osborne (3/8/11)
Global markets on the brink of crisis Guardian, Larry Elliott (5/8/11)
A week of financial turmoil: interactive Guardian, Nick Fletcher, Paddy Allen and James Ball (5/8/11)
Turmoil on stock markets persists BBC News (5/8/11)
Bank worries bring echoes of 2008 BBC News, Stephanie Flanders (5/8/11)
The origins of today’s market mayhem BBC News, Robert Peston (5/8/11)
Time for a double dip? The Economist (6/8/11)
Rearranging the deckchairs The Economist (6/8/11)
High hopes, low returns The Economist (4/8/11)
The debt-ceiling deal: No thanks to anyone The Economist (6/8/11)
Six years into a lost decade The Economist (6/8/11)
Debt crisis Q&A: what you need to know about Standard & Poor’s credit rating The Telegraph, Richard Tyler (6/8/11)
U.S. Will Roll Out QE3 After S&P Rating Cut, Li Daokui Says Bloomberg (6/8/11)
China flays U.S. over credit rating downgrade Reuters, Walter Brandimarte and Gavin Jones (6/8/11)
US credit rating downgraded to AA+ by Standard & Poor’s Guardian, Larry Elliott, Jill Treanor and Dominic Rushe (5/8/11)
Reaction to the US credit rating downgrade Guardian (6/8/11)
Market turmoil and the economics of self-harm Guardian, Mark Weisbrot (5/8/11)
Week ahead: Markets will sort through credit downgrade Moneycontrol (6/8/11)
S&P Statement
S&P statement on lowering US long-term debt to AA+ Guardian (6/8/11)
Stock market indices
FTSE 100: historical prices, 1984 to current day Yahoo Finance
Dow Jones Industrial Average: historical prices, 1928 to current day Yahoo Finance
Nikkei 225 (Japan): historical prices, 1984 to current day Yahoo Finance
DAX (Germany): historical prices, 1990 to current day Yahoo Finance
CAC 40 (France): historical prices, 1990 to current day Yahoo Finance
Hang Seng (Hong Kong): historical prices, 1986 to current day Yahoo Finance
SSE Composite (China: Shanghai): historical prices, 2000 to current day Yahoo Finance
BSE Sensex (India): historical prices, 1997 to current day Yahoo Finance
Stock markets BBC
Questions
- Why have share prices been falling?
- Does the fall reflect ‘rational’ behaviour on the part of investors? Explain.
- Why does ‘overshooting’ sometimes occur in share price movements?
- Why has the USA’s credit rating been downgraded by Standard & Poor’s? What are the likely implications for the USA and the global economy of this downgrading?
- How is the downgrading likely to affect the return on (a) existing US government bonds; (b) new US government bonds?
- Why might worries about the strength of the global recovery jeopardise that recovery?
- To what extent has the debt problem simply been transferred from banks to governments? What should governments do about it in the short term?
With a mounting crisis in the eurozone, heads of government met in an emergency meeting in Brussels on 21 July.
The task was a massive one: how to tackle Greece’s growing debt crisis and stave off default; how to protect other highly indebted countries which have already had to seek emergency bailouts, namely Ireland and Portugal, from falling market confidence and thus rising interest rates, thereby making their debts harder to service; how to prevent speculative pressures extending like a contagion to other highly indebted countries, such as Spain and Italy; how to prevent speculation against the euro and even to prevent its break-up; how to reduce the size of budget deficits at a time of low growth without jeopardising that growth. A problem is that Greece has already adopted the required austerity measures for it to receive a second bailout from the EU agreed at the end of June, and yet its debt burden is likely to rise as growth remains negative.
Eurozone leaders recognised that the stakes were high. Failure could see contagion spread, interest rates soar and perhaps one or more countries leaving the euro. No agreement was not an option. As it turned out, the agreement was more comprehensive than most commentators had expected. Markets reacted positively. Stock markets in Europe and around the world rose and the euro strengthened.
So what was the agreement? Has it solved the Greek and eurozone crises? Will it prevent contagion? Or has it merely put the problem on hold for the time being? Will more fundamental measures have to be put in place, such as much fuller fiscal union, if the eurozone is to function as an effective single currency area? The following is a selection of the hundreds of articles worldwide that have reported on the summit and the agreement.
Articles
Greece thrown lifeline by eurozone leaders BBC News, Chris Morris (22/7/11)
A Marshall plan with ‘haircuts’: The draft agreement Guardian, Chris Morris (21/7/11)
Banks forced to share pain of bailout for Greece Independent, Sean O’Grady and Vanessa Mock (22/7/11)
EU leaders agree €109bn Greek bail-out Financial Times, Peter Spiegel, Quentin Peel, Patrick Jenkins and Richard Milne (21/7/11)
Greece to default as eurozone agrees €159bn bailout The Telegraph, Louise Armitstead and Bruno Waterfield (21/7/11)
Europe steps up to the plate The Telegraph, Ambrose Evans-Pritchard (21/7/11)
Greek bailout boosts global markets Guardian, Julia Kollewe, Ian Traynor and Lisa O’Carroll (22/7/11)
Greek bailout deal: What the experts say Guardian (22/7/11)
Bailed out – again. Eurozone throws Greece €109bn lifeline Guardian, Ian Traynor (22/7/11)
New package for Greece must match last year’s if it is to stave off default Sydney Morning Herald, Malcolm Maiden (22/7/11)
Russian or Belgian roulette? The Economist, Charlemagne’s notebook (21/7/11)
Saving the euro: A bit of breathing space The Economist, Charlemagne’s notebook (22/7/11)
Europe’s ‘safe haven’: corporate bonds Financial Times, Demetrio Salorio (21/7/11)
Summit that saved the euro? Financial Times, John Authers and Vincent Boland (21/7/11)
Greece aid package boosts stock markets BBC News (22/7/11)
Q&A: Greek debt crisis BBC News (22/7/11)
Timeline: The unfolding eurozone crisis BBC News (22/7/11)
Eurozone summit: It may be a solution, but doubts remain Guardian, Larry Elliott (21/7/11)
German taxpayers are being asked to socialise Europe’s debts The Telegraph, Jeremy Warner (22/7/11)
The eurozone is not a nation state Financial Times blogs, Gavyn Davies (20/7/11)
One step back from the abyss BBC News blogs, Stephanie Flanders (22/7/11)
For long-term gain, the EU will have to share the pain Independent, Sean O’Grady (22/7/11)
Greek debt deal ‘not the last word’ BBC Today Progrgamme, Stephanie Flanders and Sir John Gieve (22/7/11)
Questions
- Outline the measures agreed at the eurozone heads of government summit on 21 July.
- Explain what is meant by a ‘haircut’ in the context of debts. What types of haircut were agreed at the summit?
- How big a reduction in Greece’s debt stock will result from the deal? Why may it not be enough?
- Explain how the European Financial Stability Facility (ESFS) works? How will this change as a result of the agreement?
- What vulnerabilities remain in the eurozone?
- What are the arguments for closer fiscal union in the eurozone? Is more required than merely a return to the Stability and Growth Pact?
Today (16/6/11) in Greece, the Prime Minister is trying to form a new government that will help the country tackle its large and growing debts. Austerity measures have been put in place by the Greek government and these cuts and subsequent job losses (unemployment now stands at 15.9%) have resulted in massive riots.
Critics of the eurozone and Greek membership are suggesting that the price Greece has to pay to remain a member might be too high. Billions of euros have already been given to the bankrupt country and yet it seems to have made little difference – more money is now needed, but Finance Ministers have so far been unable to agree on how best to finance another bailout. These concerns have adversely affected financial markets, as investors sell their shares in light of the economic concerns surrounding Greece. The trends in financial markets over recent weeks suggest a growing feeling that Greece may default on its debt.
If an agreement isn’t reached between European leaders and/or Greece doesn’t accept the terms, then it could spell even more trouble and not just for the Greek economy and the eurozone. Banks across Europe have lent money to Greece and if an agreement isn’t reached, then this will mean losses for the private sector. Whilst these losses may be manageable, further trouble may arise due to contagion. Other countries with substantial debts, including Spain, Ireland and Portugal could mean a significant increase in these potential losses.
As the crisis in Greece continues, doubts remain over whether the European leaders even know how to deal with the crisis and this creates a lack of confidence in the markets. Activities over the coming weeks will play a large part in the future of Greece’s eurozone membership, trends in financial markets and the direction of the UK economy. The following articles consider Greece’s debt crisis.
Greece debt crisis sends financial markets reeling BBC News (16/6/11)
Euro slumps vs Swissie, Greece intensifies concern Reuters (16/6/11)
EU and IMF agree Greek debt deal Financial Times, Peter Spiegel (16/6/11)
Greece crisis: Commissioners fear ‘future of Eurozone’ BBC News, Joe Lynam (15/6/11)
Stocks slump as Greece crisis turns violent Bloomberg Business Week, Pan Pylas (15/6/11)
Euro slides as Greek default fears deepen Financial Times, Peter Garnham (16/6/11)
Germany insists all of EU must pay for Greece bailout Guardian, Ian Traynor (15/6/11)
US stocks slump on US, Greek woes Associated Press (16/6/11)
More time to argue about Greece BBC News, Stephanie Flanders (16/6/11)
Greece: Eurozone ministers delay decision on vital loan BBC News (20/6/11)
Greece crisis: Revolution in the offing? BBC News, Gavin Hewitt (19/6/11)
Greece crisis: Not Europe’s Lehman (it could be worse) BBC News, Robert Peston (20/6/11)
Greek debt crisis: eurozone ministers delay decision on €12bn lifeline Guardian, Ian Traynor (20/6/11)
Eurozone must act before Greek crisis leads to global meltdown, IMF warns Guardian, Larry Elliott (20/6/11)
Greece: Private-sector voluntary aid may be impossible BBC News, Robert Peston (21/6/11)
Greece crisis and the best way to cook a lobster BBC News, Stephanie Flanders (22/6/11)
Questions
- What is meant by contagion and why is this a potential problem?
- What are the options open to European leaders to finance the bail out?
- If an agreement is not reached or Greece do no accept the terms, how might the UK economy be affected?
- What has been the impact of recent events in Greece and Europe on financial markets and currencies across the world? Explain your answer.
- Why are critics suggesting that the price of Greece remaining in the Eurozone might be too high? If Greece was not a member state what would it mean it could do differently to help it deal with its mounting debts?