Beruflich Dokumente
Kultur Dokumente
3.3.1. GDP........................................................................................................ 43
4.6. Conclusion..................................................................................................... 64
APPENDICES: ............................................................................................................ 67
BIBLIOGRAPHY: ....................................................................................................... 68
2
CHAPTER 1: INTRODUCTION
In many developing and advanced nations, sharp depreciations were witnessed that
were forced by the 2008-9 global financial crises. Usually, other financial crises types
have been associated with currency crises; on the other hand, a typical kind of crisis is
the Banking Crises although it is the least form that is understood. The incident of
twin crises occurring can be attributed to several causes, such as a bank crisis due to a
currency crisis, vise-Versa, or even jointly occurring.
Several theories explain the connections between banking and currency crises. In
general, the relationship can go either way, i.e. in particular situations, a banking
crisis leads to a currency crisis, while at times, currency crises can lead to banking
crises. Recent studies do not distinguish between the two and even regard them as
manifestations that occur simultaneously due to common factors (Chang and Velasco,
2000).
Most of the literatures on banking and currency crises have involved studying each
crisis apart from the other in regards to determinants. Unfortunately, until today there
has been little thorough work that involves examining the link between currency and
bank crises.
Europe and several developing and developed countries worldwide were first affected
by the financial crisis and gained global dimension, although it began in the US. Even
though it significantly affected many countries, some were more severely affected,
such as Portugal and Spain. One of the countries that was affected was Greece. Even
though it was not the main reason for Greece's situation, since the deterioration in the
financial and economic structure in Greece began a lot earlier, it is safe to say that it
triggered it. The crisis caused the situation to be clearer. We will study later on the
financial crises in both Spain and Greece to explain what caused them and how they
recovered from them. Spain reached its tipping point in its modern historys worst
economic crisis due to the crisis that caused this discrepancy to be brought to the
front.
Ireland suffered from a major financial crisis which can be described as a systematic
banking crisis and a significant economic adjustment (Woods and OConnell 2012).
3
This thesis focuses on the study of both the banking and currency crises coincidental
occurrence during the Euro Zone, especially Ireland. It aims to allow readers to
explain and comprehend the 2007-8 Irish financial crises. Ireland suffered an extreme
financial crisis that was characterized by a significant economic adjustment and a
systemic banking crisis since 2008.
4
CHAPTER 2: EXPLAINING FINANCIAL CRISES
There are many categories of financial crises. We will be focusing on two types for
now; Currency Crisis and Banking Crisis.
2.1.Currency Crisis
Over the years various speculations have been made about currency crises, which is
the most variety of crises often discussed. As times have changed, so have these
theories. To be more precise, nowadays explorations are being focused on the
functions of economic variables such as changes in income, expenses, and capacity
for multiple equilibria that affect currency crises rather than on just the essentials.
At times, a currency cannot be used as a reliable medium of exchange due to its value
not being stable. This situation is known as a currency crisis which is a form of
financial crisis. Sufficient foreign reserves can moderate its effects.
Mainly, a decrease in the value of a currency causes a currency crisis. This creates a
negative impact on the economy creating fluctuations and instability in the exchange
rate. Investors' expectations cause these situations.
We will be discussing the three top generations of the currency crisis that happened
over the past 40 years.
First Generation
International Monetary Fund and the World Bank had used nominal anchors before
the exchange rates changed in the 1970s and 1980s which were usually implemented
to currency devaluations to correct currency overvaluation in developing countries
such as Latin America.
5
The Krugman-Flood-Garber model (KFG model) started with Krugman (1979) and
Flood and Garber (1984). It viewed that crises arose from inconsistent policies;
specifically monetization of fiscal deficits along with fixed exchange rates.
At times investors foresee that central bank credit is being used by a government to
cover its extreme shortfalls. This causes the investors to act rationally due to an attack
on pegged or fixed currency. Investors start discarding the currency when they predict
that the peg has reached its end. On the other hand, they hold the currency when they
expect that the exchange rate stays unchanged.
This causes the central bank to lose hard foreign currency and/or liquid assets to be
able to support this exchange rate, thus causing the currency to collapse.
Second Generation
In this situation, investors have their expectations for the currency causing other
investors to react along with them. The difference is that here, investors attack the
currency expecting others to follow as well. In such cases, the government has to
make a choice on whether to keep the exchange rate fixed or not which might lead to
multiple equilibria and currency crisis. There can be more than a single equilibrium
considering that the government has to study the costs and benefits of its actions and
investors expectation.
As Flood and Marion(1999) explained it, the possibility of an attack can cause
adjustments to be made in policies which can create an attack and even set off a crisis,
regardless if these policies are consistent with macroeconomic essentials. Compared
to the first generation, one of the causes of a crisis is policies before an attack.
Eichengreen , Rose and Wyplosz (1996), The European Exchange Rate Mechanism
crisis encouraged the second generation models. In that crisis, countries chose to
devalue their currency when put under pressure, such as the UK, although several
other possible outcomes were in sync with macroeconomic essentials.
Third Generation
These models investigate how the rapid crumbling of balance sheets together with the
inconsistencies in asset prices (as well as exchange rates) can eventually cause a
6
currency crisis. What led to these models? They were greatly encouraged by the
1990s Asian crisis where macroeconomic imbalances were minor before the crisis.
Although there were many excesses regarding fiscal positions and the shortages in the
current account were not major and could be managed, there was a great deal of
vulnerabilities linked to the corporate and financial sectors.As previously mentioned,
balance sheets are of high importance where imbalances in the areas as indicated
earlier can encourage currency crises. Chang and Velsaco (2000) for example, show
how banking cum currency crisis can occur due to local banks having massive
outstanding debts denominated in foreign currency.
Over time, there has been an increase in capital mobility and global financial
integration which made it more difficult for countries to be able to uphold
commitments to particular exchange rate targets.
A country can peg its exchange rate, when it has high capital mobility, to another
country's currency. In that case, the country's interest rates are connected to the
foreign interest rates. When this happens, it hugely restricts its ability to have a
monetary policy that is domestically independent.
For instance, if a country tightens its domestic monetary policy, which also increases
local rates more than different tariffs, also prompts an inflow of capital following the
cross-border risk-adjusted excess return.
This causes a decrease in the initial increase in regards to domestic interest rates.
Moreover, it causes a reduction in demand for imported goods in the domestic sector,
which in return, decreases the higher interest rate's shrinking effects.
The 1990's three most severe crises dramatically tested the constraints that the unholy
trinity enforced. The three crises were the peso crisis in Mexico in 1994-95, the
1
The Impossible trinity
7
betrayal of the European Monetary System in 1992-93, and the Asian financial crisis
in 1997-98. To fight inflation in the 1990s, Germany increased its interest rates
following reunification. Many European countries linked their currencies through
EMS could not follow the same path since it would be difficult for their economies.
In 1992 the huge capital flow overwhelmed the system, and as a result, some of the
European countries left the EMS. To allow domestic interest rates to deviate from
Germany's rates, they allowed their currencies to depreciate.
After the U.S. interest rate increase, policymakers in Mexico in 1994 encountered
capital flight and political developments. Central banks in Mexico made significant
efforts to try to avoid a raise in domestic interest rates while trying to limit the peso's
depreciation. Unfortunately, their efforts were unsuccessful and ended up contributing
to the December 1994 peso crisis.
The 1997-98 Asia crises began in part with countries linking their currencies at the
time to the dollar. During which the dollar was appreciated concerning the Chinese
renminbi and Japanese yen.
Regarding the increase in Asian currencies, such as the Indonesian rupiah and the
Thai baht, about the renminbi and the yen, the Indonesian, Thai, and several Asian
countries' products became more expensive with those of China and Japan.
Competition decreased and therefore pushed their currencies towards depreciation.
Several important factors also contributed to the Asian crisis, such as weak banking
systems along with depositors panicking. Which was due to no compensation being
given regarding effective risk management devised by government guarantees,
howbeit implied or stated, against failure?
The above-mentioned cases show how rising markets along with industrial countries
have not usually been able to make strong commitments over an extended period of
fixed exchange rates.
For countries to be able to uphold a pegged exchange rate, their central banks have to
have enough access to foreign currency reserves to be able to act in response to
8
speculative attacks and always be willing to assist all the objectives of monetary
policy.
In other words, this means that their central banks have to be willing to increase
domestic interest rates to the point that it can keep the appeal of their currencies to
observers.
Countries with unstable exchange rates should not be as vulnerable to currency crises
due to the continuous adjustment in the market to minimize pressure buildup that
leads to extreme currency overvaluation and progressive tremendous distinct currency
declines that might occur in the case of fixed exchange rate administration.
In reality, intermediate and pegged exchange rate regimes, that keep relatively fixed
exchange rates but don't officially peg to a particular anchor currency, are linked with
higher vulnerability to a currency crisis, other financial crises like debt crises,
unexpected freezes in capital flowing in, and banking crises. Gorton(1988), mention
that this holds true for emerging market countries that have a greater number of
capital accounts
Nevertheless, many countries that experienced currency crises allegedly had floating
exchange rates.
The occurrence of a second crisis, so to say, can be attributed to several causes: bank
crises causing a currency crisis or a currency crisis causing a bank crisis, or both
occur due to the same reasons.
A currency attack can be caused by a bank run if the heightened liquidity related to
the governments bailout to troubled banks demolishes the ability for it to maintain
the existing exchange rate commitment
Otherwise, as mentioned earlier, a weak banking sector may trigger a currency crisis
if observers expect that policy makers would rather abandon exchange rate stability to
be able to avoid bankruptcies and additional pressure on the banking division rather
than bear the expenses of protecting the domestic currency. (Obstfeld 2012).
9
A probable reverse chain of causes, whether it be currency crises or the beginning of
banking crises, would not be considered odd. The weakening of a banks balance
sheets at the same time as currency depreciation increases the domestic currency load
of these liabilities. This is caused by a bank having compelling holdings of foreign
liabilities that are unhedged, in which a crisis shock can negatively change the
banking sector.
The dual occurrence of both currency crises and banking crises can also indicate that
they occurred due to common factors. When banks and firms invest in short-term
borrowing and fund long-term lending, they are exposing themselves to liquidity
shocks (Chang and Velasco 2000)
As a result, twin crises may be triggered by global liquidity crunches. 2007-08 global
financial crises had the same effects on the value of a currency and the health of the
banking sector in several countries. Even though it started in the United Stated and
Western Europe with the secondary mortgage derivative products, such as credit
default swaps and asset-back securities, it escalated into a worldwide deleveraging
process in which institutions shifted to limit foreign currency exposure. When a U.S.
dollar flight occurred, the payments currency and global reserve followed, resulting in
significant currency devaluations in amidst numerous developing and advanced
countries.
Figure 1 illustrates the number of currency crises that occurred in 1975-2007 after the
Bretton Woods period by using information from Laeven and Valencia (2008).
According to them, the currency crisis is defined as the nominal depreciation of a
currency by 30 percent minimum which also is a depreciation rate increase by at least
10 percent compared to the previous year. Countries refer to the first of each five-year
time frame to recognize the crisis if they meet the standards for five consecutive
years.
10
Figure 1. Currency Crises
By studying the figure, we can see that it is very common for currency crises to occur,
which they have at about an average of five every year since 1975, had relative peaks
in 1980s amid the extensive debt defaults, during the EMS and Tequila crises in the
1990s, and during the Russian debt default and Asian financial crisis in 1998.
There was a three-year period of relative stillness in 2005-2007. In 2008-09 the global
financial crisis caused significant financial market turmoil. In referral to Table 1, 23
countries suffered from a depreciation of about 25 percent in exchange rates in a
period of nine months from August 2008 February 2009, which are in agreement
with the above-mentioned currency crisis definition.
11
Table 1: Currency Depreciation against U.S. Dollar
Figure 2 illustrates the link between banking crises and currency crises, which
demonstrates the occurrences of dual crises by year. As shown above, they are not as
common as currency crises alone. 25 currency crises occurred-wide in 1994, but only
nine of them were accompanied with banking crises. The peak period for dual crises
was in the 1990s, taken from the global financial crisis in 2008-09 for which banking
crises complete data are not available yet.
12
Figure 2. Twin Crises
Table 2 shows the comparison between the abrupt stopping of the net capital inflows
and currency crises association. Results were used from Hutchisons and Noys study
(2006) of 24 rising market economies sudden stop in regards to net capital inflow
from 1975-2002. It demonstrates that 50 percent of the time currency crises happens
at the same time as the sudden stops. During this period, 34 out of the 60 currency
crises that occurred in emerging markets coexisted with a sudden stop, which wasnt
the case with the remaining 26 crises. However, there are many situations where
sudden stops occur without currency crises. 85 out of 119 abrupt stops occurred alone
without a currency crisis.
13
Table 2: Currency Crises and Sudden Stops
Currency crises high costs in regards to real output losses prompted struggles to
forecast them. Central banks and International financial institutions have tried to come
up with Early Warning Systems (EWS), of currency crises to be able to improve
supervision of financial conditions. To improve strategies that help with foreign
exchange trading, similar models were developed by numerous private investment
banks.
The warning systems of the currency crises design needs several elements:
2.1.4. Determinants
Both proven and theoretical literature have identified a wide range of currency crises
possibly related variables, which include financial fundamentals (for example
14
domestic credit growth, current account deficit, fiscal deficit, and output growth) and
macroeconomics. In addition to variables that avoid a countrys susceptibility to
attacks, such as the financial sectors general reliability and foreign financing needs.
Further possible variables consist of indicators of investors risk appetite (such as
exposure to contagion crises in other countries and interest rate differentials) or
market expectations. A currency crisis likelihood may also be affected by financial
and trade openness.
The instinct is straightforward in regards to the relationship of the currency crisis with
these variables. Predictions about the exchange rate determination can be generated
from the simple monetary model. It predicts that if money growth is greater than that
of its anchor currency's money, inflation will increase, making it more stressful for the
home currency to depreciate. If this situation continues to occur, resisting depreciation
and the last fall in its exchange rate can occur without being related to each other as a
currency crisis.
The M2 to reserves ratio captures how much international reserves support the
banking system's burdens. If a crisis was to happen, bank depositors might hurry to
convert their money from domestic currency to foreign currency. Therefore, this ratio
catches the central bank's ability to meet the depositors' demands and being able to
stabilize the currency.
The foreign reserve to external debt ratio assesses the investors risk that chose not to
be in debt to private or sovereign domestic borrowers.
Due to higher import prices, unfavorable results regarding trade decrease purchasing
power and depress domestic economic activity.
15
The decline in real GDP growth can indicate that the economic conditions are
worsening and cause the investor's confidence to be undermined in his country's
investment opportunities.
2.2.Banking Crises
Certain crises are very common but mistreated due to them not being understood. The
fragile nature of banks makes them more vulnerable to being run by depositors.
There are many safety precautions in place, such as deposit insurance, that help set
limitations to risks. Unfortunately, the public might not fully understand the situation
and increase the chance of a crisis. Individual banks problems can easily and quickly
affect the whole banking system.
For instance, the legal and judicial environments significantly influence the bank's
decisions regarding making cautious investment choices and collection on their loans.
Risks are capable of being greater due to institutional weaknesses.
It is hard to specify the exact timing of banking crisis even though they have shown a
few common patterns and have been happening for centuries.
Financial markets are difficult to manage and control. When there is an uncertain
situation, or even the option of an issue, both investors and institution act upon their
ideas and/or facts. For example, some investors might start withdrawing large
amounts of money due to fear. Soon enough, it is most likely that others will follow in
their footsteps; some for the same reasons, and others of fear from other investors'
reactions. Therefore, making it hard to coordinate financial markets.A crisis can easily
happen in such a situation, whether it be the presence of an actual problem or due to
investors' fear. Regardless of whether they are real or not, they have an enormous
impact on the market and can turn into a financial crisis and a market commotion.
16
A bank run is an example a coordination problem that might take place. It is a
platitude that banks lend long and borrow short which take after consumers and
borrowers preferences. Nevertheless, this increases the banks vulnerability to the
sudden need for liquidity. Institutions, markets, and policy makers have known these
fragilities and have tried and keep trying to come up with many coping mechanisms to
be able to handle such situations.
As mentioned earlier, safety net measures are used and can be quite helpful if they are
designed and implemented in the proper way. Alternatively, else, they increase the
chances of a banking crisis occurring.
Policies and guidelines are used to decrease fragilities for instance, as previously
stated, limits on balance sheets mismatches which can be caused by maturity
mismatches or specific actions of financial institutions. Unfortunately, creating and
supervising these policies and guidelines tricky and easier said than done. It can
backfire if it is not designed or implemented as it should be.
Barth, Caprio, And Lebine (2006), show that the public sector might lead to
inaccurate effects due to misinterpretation of information or simply due to fear.
Banks might resort to assuming excessive leverage which can be with moral hazard
due to state guarantees. Some institutions know that they are huge and think that they
will not fall. This can cause them to take the extreme risk making them more
vulnerable. In general, banking system fragilities can occur as a result of policies at
minor and major levels.
While some perspectives view liquidity and funding issues as triggers to these
situations, a broader perspective point illustrates that asset markets' issues are in
relation to banking crises. Even though they might seem to have begun from
liabilities, but they usually reflect solvency problems.
17
When bank loans start sinking or when securities decline regarding value, banks will
run into problems. In several crises cases, such as the 1980s Nordic banking crisis, the
1990s Japan crisis, and the latest European crisis, there weren't any major deposit runs
on the banks, but they were undercapitalized and needed they governments support
due to major issues occurring from real estate loans.
Certain types of issues in asset markets can, unfortunately, go unnoticed for a while,
leading to a banking crisis when payment difficulties come to light amongst a large
number of banks, such as mortgage loans. These loans have played a key role in the
latest crisis.
Banking crises and other types of financial panics or worries do not just randomly
happen. Many events and actions eventually lead to this situation. It cannot be
determined which are the specific sources and their risks are hard to predict ahead of
time.
Gorton (2012) shines that at certain times there are concerns in regards to these debts
not getting repaid. This causes depositors to worry about risks and for their money
hence demand the cash from their banks. Policies and procedures prevent banks from
being able to fulfill these entire requests on the spot, which may cause a state of panic
amongst depositors. The large scale bank suffered greatly due to this back in the
1930s.
At times, banking crises in rising markets can be triggered by external forces. Some of
which include prices of goods, global interest rates, and sudden changes in capital
flows, which in turn lead to an increase in disappointment in loans.
Policies and regulations may cause panic amid depositors. Banks may pass through
difficulties that lead to fears. At times governments interfere in an unplanned ad-hoc
method, without explicitly stating where other institutions stand.
18
Governments can cause runs on banks by imposing withdrawal limits for example,
which can trigger runs on banks. 2001 runs on banks in Argentina is an example of
this situation.
Government actions can directly trigger runs: the runs on banks in Argentina in 2001
occurred when the government imposed a limit on withdrawals, making depositors
question the frankness of the entire banking system. This has also been reflected in
advanced countries, where it was caused by governments not being consistent in their
policies and interventions.
The significance of all the factors mentioned earlier in how much of an effect they
have in causing crises is yet to be determined. This is due to all the factors being
examined at the same time instead of each factor occurring at a separate time to be
able to specify what its exact effect is. Therefore, systematic banking panics need
further research and observation to be able to fill in the blanks on how the negative
influence emerges.
Many have written on the causes of the latest crisis. CALOMIRIS (2009) showing
many common factors with previous crises that have happened over the years. Despite
the fact that analysts had different viewpoints on how much effect each factor had in
causing a crisis, they all mostly agreed on what these factors were, that were also a
part of previous crises.
19
- The failure to guide and supervise the situation causing them to be late in
keeping up with the developments and foresee the events to be able to stop it
or limit its losses
There were new elements involved in the global financial crisis, mentioned below:
20
occurring, banks' positions can be further weakened if a major portion of their
liabilities in a foreign currency denominates.
Looking at Velasco's models (2007) for example, point to the contrary direction-
financial sector issues increase the chances of the currency collapsing. Models such as
these emphasize that when the bailout of troubled financial institutions by central
banks printing money, we go back to the typical situation of excessive money creating
prompting a currency crash. Another family of models challenges that banking and
currency crises have common causes. We can find an example of this in the change in
the inflation stabilization plan based on exchange-rate, such as 1987 one in Mexico.
Both theory and evidence imply that programs such as these have well defined clear
cut dynamics (Reinhart 2011)
Under Frankel (1996) , In currency crises cases, they adopt a 20 percent threshold per
year, and they considered an excess of 15 percent a year in exchange rate
depreciations a crisis. Frankel and Rose define a currency crisis of a cumulative
depreciation of a minimum of 25 percent over a period of 12 months, and a minimum
of 10 percentage points more than the 12 months before that.
It is hard to pinpoint an exact date as to when banking crises start and end. To be able
to date such crises, researchers use a qualitative approach based on a mixture of
events- such as mergers, governments helping financial institutions and taking over
many of them, forced closure, and runs on several banks. Other factors that have been
used as a criterion are in-depth assessments of the financial conditions and the fiscal
costs related to solving these situations. One of the main reasons that make it hard for
researchers to identify the exact end date of a banking crisis is due to its effects
lingering on for some time.
Several significant overlaps exist in putting dates to banking crises across different
studies. Two types of events are used by Reinhart and Rogoff to date the start of
21
banking crises: the takeover and merger of financial institutions by the public sector
and bank runs that led to them in the first place (causing them at times to even end up
inclosure). In the case of no bank runs, they take a look at closures, takeovers,
mergers, or they even look into a major financial institution that is a large scale public
one to assist. Unfortunately, this approach has certain downsides to it; the start date
might be too early or too late, and it does not give any dates to indicate the end of
these episodes. Both the observations of Reinhart and Rogoff and Laeven and
Valencia(2008) substantially overlap.
For example, Reinhart and Rogoff dated the start of the banking crisis in Japan as of
1992 and Laeven and Valencia dated it as of 1997.
For example, crises in emerging markets usually have combinations of banking and
currency crises, concerning abrupt stops in capital flows, and eventually turning into
extreme debt crises. In general, it was difficult to identify the exact date and
identification of financial crises, in which it should serve as an extreme caution when
you review the distribution and frequency of crises over the years as we see in the
next section.
We will start with discussing what happened in Greece concerning the financial aid
then move on to further discuss the cause and effect of the crisis.
2.4.1. Introduction
The European Union had its uncertainties about Greece's economic reliability before
the crisis took place, therefore put them in a challenging situation in the Eurozone.
According to the British journalist Larry Elliott, Greece's financial crisis negatively
affects the future of the Euro. Keneth Rogoff, a Harvard professor, described Greece
as a "serial defaulter." Stating that Since the Modern Greek state was founded in
22
1830, the state has, on average, been in sovereign default every other year and had
been through five big defaults in less than 200 years
Greece had an economy boom due to foreign funds and low-interest rates since
joining the Euro. Even with this, Greece splurged significantly on its public sector,
especially on pensions and jobs. This allowed the Greek government to refinance debt
with better conditions. After 1995 the cost of GDP's net interest dropped by 6.5%.
During this period Greece gained advantages in longer-term borrowing due to the
underpricing of default risk in the midst of the credit boom. In addition to the
encouragement of spending due to lower interest rates.
After Greece had adopted the Euro as its only currency, public spending skyrocketed.
Even before joining the Euro, Greece was living way over and beyond its means.
For instance, the public sector wages witnessed a 50% increase from 1999 to 2007,
which was a much faster growth rate than in most of the other Eurozone countries.
Moreover, Greeces government paid for the Athens Olympics that took place in 2014
that caused the country to run up huge debts.
While there was large outflow from the governments treasury, its income was also
struck by extensive tax evasion. Therefore, all these years of overspending caused its
budget deficit to spiral out of control.
On top of that, Greece hid much of its borrowing in an attempt to meet the required
percentage of gross domestic product cap on borrowing of the Eurozone members,
which was 3%.
Greece's concealed loans came to light when it got hit by the global financial
downturn which it was not prepared to cope with.
23
Their level of debt reached a point where Greece was not able to pay back its loans,
putting it in a situation where it was forced to get help in the form of huge loans from
the IMF and its European partners.
However, in regards to the short term, some conditions came along with these loans
that added to Greece's misfortune.
It is alleged that political parties have applied different politics which have caused the
public sector's inefficiency, corruption of moral values, foreign debt's unusual rate,
and public services' infertility. Meaning, political parties' benefits' direction were
being abused.
Furthermore, several reforms have failed in Greece, such as social security systems,
transportation, medical markets, and education. In reality, The Pasok2 government
reacted extremely slowly to Greece's financial issues and stayed away from taking
strict measures, although it was well aware of their situation. Not only that, the
situation was not addressed by any political party and failed even to mention the
country's position.
Afterward, the political and economic crisis eventually ended up being a Euro Zone
crisis. Truth be told, Greece's current problems are only a tiny fraction of the EU's
member states' financial responsibilities.
2
PASOK is a social-democratic political party in Greece and one of the country's major electoral
forces between 1977 and 2012.
24
In a nutshell, incorrect policies that were applied in the previous 25 to 30 years are
probably the causes of Greece's current situation. This progress is correlated with
insufficiency and extravagance of the Greek government, unsustainable retirement,
infertile and unfair taxation system, political parties' populist practices, competitive
low power, and political and organizational problems in the Euro Zone and EU.
For instance, Greece depended on sea transport and tourism for its import and export
which was significantly affected by the continuous increase the value of the Euro
which ended up affecting both sectors.in accordance with Papanikos (2012) , public
spending increased substantially along with incorrect political choices led to severe
problems in regards to competitive power and tremendous financial instability. All
this is essential in explaining Greece's situation
Greece's economy has some points that it is sensitive about. These points can be
divided into four topics which have caused an increase in concerns in regards to the
common effects on the financial expectations. The points are the following:
- Economic instability. Both of Greece's debts to GDP and budget deficit are
alleged to be one of Europe's highest.
- The high rate of retirement, medical spending, and prices to GDP.
- Significant erosion in the international competition which affected the
economic capacity to raise income taxes and its performance.
- Low dependability and consistency of financial statistics, major economic
issues, and the government's approach to the increasing concerns in regards to
probable financial results
25
Greece's global crisis was caused by a debt crisis by escalating financial problems. In
accordance with Vlachou (2012), it created institutions of budget deficit rating and
high debt level to cause a decrease in the country's grade in addition to losing its
prestige in international markets. All this caused a major increase in interest rates of
loans.Uncontrolled increases to economy and sustainability problems of debts were
the foundation of Greece's debt crisis. Particularly, it was evident that public sources
were not rationally managed during the period of the year 2000 alongside lawlessness
and indiscipline government spending. It is safe to say that the relation between
budget deficits and debt is directly proportional. Fiscal deficit changes are mirrored in
public debts, which prompt the budget deficit. (Figure 3)
Although the crisis has been increasing in Greece, other European Union countries
were late and unsuccessful to support it. Buiter and Ebrahim (2010), worries about
financial stability began to emerge not only about Greece but in regards to other
European Union countries as well.
Usually, sustainability of debt can be described as a consistent debt versus GDP rate.
In Greece, this rate (from mid 1990s-2007) has been consistent. The deep recession
significantly affected Greece; it caused an increase in the rate of debt/GDP and a
dramatic development in the country (Bryson 2011).High priced precautions that were
taken in regards to public debt stock (above Maastricht criteria, 60 percent of GDP)
and the gradual increase of GDP rate (160 percent), in addition to the deterioration in
production leveled to enormous budget deficits to appear in Greece (figure 4).
26
Figure 4: Greece Government Deficit and Maastricht Criteria
This debt crisis that faced Greece spread to Spain, Portugal, Italy and gained global
dimension in the region. If a comparison is made between Greece's and EU's budget
income and outcome, Greece's budget income is lower than the EU17's 3and EU27s4
average. However, the budget deficit was high (figure 5).
Figure 5: The comparison of Greeces Budget Income and Outcome with EU27 and
European Region Countries (17) (Average between 2006 2011)
Source: http://epp.eurostat.ec.europa.eu/statisticsexplained/index.php/
Nationalaccounts%E2%80%93GDP
3
EU-17 countries :Germany, Austria, Italy, Greece, Spain, Portugal, France, Belgium, Luxembourg,
Netherlands, United Kingdom, Ireland, Denmark, Finland, Sweden ,Norway and Switzerland-
European Commission
4
EU-27 Member States include: Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark,
Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg,
Malta, the Netherlands, Poland, Portugal, Romania, Slovak Republic, Slovenia, Spain, Sweden and the
United Kingdom."-European Commission(https://datacollection.jrc.ec.europa.eu/eu-27)
27
One of the essential reasons can be claimed to be evasion of tax and shortage of
discouraged precautions in Greece5. A high evasion of tax in a country creates
taxation system unfairness and negatively affects development. The lack of
precautions in this matter increases the evasion. Mainly, accountancy practices should
be modernized, penalties in regards to fraud should be more disincentives, and the
organizational frame creating the interaction between citizens and the government
must be simplified (Meghir, Dimitri and Nikos 2010).
The period following 1980, Greece witnessed a spending decrease in investments and
more consumption spending, which were caused by the significant increases in public
debts. The pressure of high prices, i.e. massive social security in regards to open
frames, caused this increase in government spending. This, in turn, caused a decrease
in investment spending and an increase in consumption expenditure (figure 6).
5
http://www.bbc.com/news/magazine-33479946
28
Figure 7: GNS
A large portion of Greece's foreign debt is public debt. Greece's external debt suffered
from a dramatic increase over the last two decades. During the 1990s, Greece loaned
its foreign debt at a 4.1% rate of GDP annually, which later on rose 6.1 % during the
200s making it 10.2% (figure 8). Nevertheless, financial resources that were gained
from foreign debts couldn't be used by Greece to increase production capacity to
increase competitive power. A major fraction of external debt was used import that
was directed at consumption.
29
Greece declined to become at 96th place in the Global Competitiveness Index in
2013, after it being at the 83rd place in 2010.6Greeces economic chronic weakness
and erosion in competitiveness can be used to explain why its export performance is
lower than the other countries in Europe and the structure of its current
deficit.7Greece's current account balance can be seen in figure 9 after 2000. Greece
exports less than it imports; meaning, it produces lesser than it consumes. The state
provides some of the financings with foreign debts. Current account balance went
from a rate of -7 percent of GDP in 2001 to a rate of -15 percent of GDP in 2008 due
to the decline in competitiveness effect. This -15 percent is fivefold of the European
Union's Maastricht criteria. During the following period in 2001, it became -10
percent which was worth about -29.3 billion dollars, which is 9.8 percent of GDP;
equivalent to threefold of Maastricht criteria. During the same period, Ireland, Italy,
and Portugal had 1.1 percent, -3.2 percent, and -6.4 percent respectively.
However, it is safe to say that the Greek government's debt-maturity structure has an
irregular and short range. Besides, foreign investors had held about 79 percent of the
public debt, and Greece's international investment position was at -82.2% of
6
Schwab, K. and Xavier Sala-i-Martin, "The Global Competitiveness Report 2012-2013", World
Economic Forum, 2012, http://www3.weforum.org/docs/WEF_GlobalCompetitiveness Report_2012-
13.pdf
7
Sklias, P. and George G. (2010), "The Political Economy of the Greek Crisis: Roots, Causes and
Perspectives for Sustainable Development," Middle Eastern Finance and Economics, Issue 7, pp. 167-
177., http://www.eurojournals.com/MEFE
30
GDP.8Even though Greece had little inflation rates between 2001 and 2009, when
compared to previous times, they were considered quite high levels under the EU
criteria. Both significant increases in wages and prices in Greece decreased the
country's competitiveness when compared with the Eurozone.9The inflationary
pressure in Greece strengthened during 2010. Increases in Special Consumption Tax
and VAT rates caused a 4.7 percent inflation rate in 2010. In the following year, the
inflation rate declined to 3.3 percent (figure 10).
8
Cabral, R. (2010), "The PIGS External Debt Problem," 8 May, http://www.voxeu.org/article/gips-
external-debt-problem.
9
Provopoulos, G. A. (2010), "The Greek Economic Crisis and Euro," The Scholars Association of the
Alexander S. Onassis Public Benefit Foundation Conference, Athens 21 June, BIS Review 87/2010,
http://www.bis.org/review/r100624d.pdf
31
Source: http://www.imf.org/external/ data.htm
While the debt crisis continued, the pressure on its real economy increased due to
severe austerity measures; increase in public expenditure cuts, the number of
unemployed people and layoffs.10Hence, the limitation increased the seriousness of
the unemployment problem. The unemployment rate increased rapidly from 7.6
percent to 17.3 percent from 2008 to 2011. In 2012 the rate was estimated to be 23.8
percent (figure 12).
10
SESRIC REPORTS, "The Eurozone Debt Crisis: A Second Wave of the Global Crisis?", On the
Global Financial Crisis, SR/GFC/11-8, January-June 2011, p.5
32
2.4.5. Conclusion
The economy has experienced one of the greatest crises ever since 2007. The financial
crisis started in the USA and extended worldwide affecting numerous both
developing, and developed countries, one if which was Greece. The crisis sped up the
economy's corruption and exposed the persistent weaknesses in it. Greece accepted
the Euro as its local currency in 2001; however, they should have discussed the
exclusion of the Euro as its common currency. Europe paid and is still paying the
price for supporting Greece, who is well aware of it. A structural reform is required in
regards to the sustainability, transparency, and competitiveness of the economy to be
able to solve Greece's issues in a short time. This change should be supported and not
limited to its economy, but to its society and politics. In reality, this is a situation of
"loss of prestige" and nor an economic problem.
33
2.5.Eurozone financial crises: Spain:
2.5.1. Introduction
Spanish history has seen many fluctuations over the past years. It rose under the
Romans for 600 years, under or partially under the Moors for 700 years, and reached
its peak of power (100 years of empire building) in the sixteenth century. From then
and until the 1970s, the Spanish nation dove downwards. The overall events can be
compared to an upside-down letter "V" graph. Unfortunately, all this led to the
enormous gradual loss, which resulted in the Spanish nation becoming weak and
powerless. In regards to the political ends of things, there was not much of political
stability. From 1814 to 1923, Spain had suffered 43 coup d'tats, a horrific civil war
from 1936 to 1939, and after which they spent 36 years being under the dictatorship
of Generalissimo Franco.
The graph took a different turn and turned up again after Franco died in 1975. After
his death, King Juan Carlos was his heir and returned democracy to Spain. The way to
a new Constitution was paved in a negotiation transition period, which was also a
model for the other countries. After that, Spain held its first free elections which had
not happened in almost forty years. Consequently, this led to Spain returning to the
international showground after being isolated while under the dictatorship. In 1982,
during the ten years that followed, the Socialist party was elected to power, causing
the country to feel a new sense of modernity. In the same year, Spain was integrated
into NATO, followed by being incorporated into the European Community in 1986.
The following 25 years, more or less, witnessed a period of modernization and
exceptional growth for Spain.
Certainly, Spain had one of the most successful economies in Europe before the 2008
global crisis that struck it. At the time Spain was doing much better than the other
European countries that were stuck in regards to reshaping its labor markets and
welfare systems, and also lowered unemployment and improved flexibility. Following
the global crisis in 2008 by about five years, the Spanish economy was able to break
out of those patterns and had a remarkable economic performance. However, this all
came to an abrupt stop when Spain was hit with a global financial crisis in 2008. Due
34
to that, Spain has been suffering from one of the worlds worst crises ever since the
1940s.
Before the 2008 crisis, Spain was a model country after its European integration and
its shift to democracy. Unfortunately, this dream did not last long and was shattered
causing Spain's economy to implode after 2008. What caused this to happen?
Decision-making structure and policy changes, the states structure, the organized
interest role, and institutional degeneration were all factors greatly explain the
severity of Spain's economic crisis.As well as its membership with an unfinished
monetary union. As of 2014, the country is facing a triple crisis; fiscal, financial, and
competitiveness.
Spain, in 2008, had continuous growth and was benefiting from ongoing economic
expansion for the longest time, fourteen years in a row, in modern history. This
played an important element in the lessening of its per capita gross domestic product
with the European Union. At the time, the only country in the Eurozone that had a
better record was Ireland.
In twenty years, Spain witnessed a growth of 20 points in regards to it's per capita
income, a point annually, to end up reaching close to 90% of the average EU15. In
2008, Spain entered the average EU25. The country witnessed an average growth of
about 1.4% points greater than the European Union since 1996.
Unemployment faced a 12.05% decreased from 20% to 7.95% from the mid-1990s to
the beginning of 2007, which was the lowest it has seen since 1978. At the time and
amongst the European countries, Germany had the largest economy followed by
Spain in second place which created the most significant number of jobs; which was
an average of 600,000 jobs annually over the last ten years.
The Spanish economy witnessed a spectacular growth of 3.9% and 3.8% in 2006 and
2007 respectively. Employment and income growth per capita were contributed by
economic growth. In 1997 and 2007, Spain was responsible for 33% of the EU15s
total employment. In 2006, Spain had created 772,000 new jobs. This was due to their
increase in active population by 3.5%, which was the highest in the European Union
that was led by the integration of women in the working market and the new
35
immigrants. The number of women that were in the labor market increased from 59%
to 72% from 1995 to 2006 respectively.
In 2008, the nation's worst fears were confirmed by the crisis. The housing bubble
was facing failure which fuelled corruption and caused bad practices in the financial
system, in the Cajas sector11 to be more precise.
Spain's largest companies obtained between 40-60% of their benefits from abroad.
However, these figures decreased by about ten percentage points in the years before
the crisis, and there was a drop in all kinds of foreign direct investment in the country,
falling from a 38.3 bn Euros to 16.6 bn Euros from 2000 to 2005 respectively. In
2006, the current account deficit was up to 8.9% of GDP, and in 2007 it reached more
than 10%. In regards to absolute terms, the US had the largest deficit followed by
Spain (86,026 mn Euros); imports were 25% greater than exports and Spain's
companies were losing market share worldwide. Future predictions were not looking
so great either. In 2008, the trade deficit had reached 9.5%.
Before 2007, even when compared to Germany, Spain was in an extremely enviable
fiscal position. It had a budget surplus from 2005 until 2007. This changed when
11
Banking sector
36
Spain got struck with the crisis collapsing the real estate market, deteriorating the
fiscal position, and experiencing massive deficits.
Spain's enormous inflow of capital from other European countries was a problem that
ended up causing significant inflation and rapid growth. In reality, the fiscal deficit
turned out to be a result instead of a cause of challenges in Spain. The Spanish global
financial crisis and the burst of the real estate bubble caused a massive increase in
unemployment, and a deep deficit in the budget, which was caused in part by
emergency spending that was meant to limit human costs and in part by depressed
revenues. The Spanish government reacted to this situation with a public works
stimulus of an enormous 8 billion. This decision, along with the dramatic decrease in
income, caused a huge hole in the accounts of the Spanish government causing a
massive deficit.
Spains private sector practiced extreme borrowing and lending rather than its
government, which created the circumstances for the crisis. Meaning, the issue wasnt
public debt rather was private debt. Spain faced a problem of the continuous increase
of the private sectors indebtedness that was caused by the compilation of bank loans,
reckless investments, and provoked by current account imbalances and
competitiveness. The Spanish private sectors debt, nonfinancial and households
corporations, was 227.3% of GDP by the end of 2010; there was an increase in total
debt from 337% of GDP to 363% from 2008 until mid-2011 respectively.
From another viewpoint, many economists believed that the issue was that Euro
countries were involved in a fixed initial exchange rate which meant that the problem
was in the exchange rate system.
This conclusion said that they thought that their economies would come together in
productivity, meaning that the Spain would become, in effect, more like Germany. If
this turns out to not be possible, plan b would be for the citizens to move to other
countries that have more productivity. Working in their offices and factories would
allow them to increase their productivity levels or, as the OCA theory argues, allow
37
Them to construct a full fiscal union to be able to provide for the permanent transfers.
As time went by, both these theories proved to be unrealistic and, as a matter of fact,
the opposite ended up happening.
Over the past ten years, the productivity gap between Spain and Germany increased,
rather than decreased, causing Germany to develop a primary current account surplus.
Other periphery countries, including Spain, had huge current account deficits that, at
the time, used capital inflows to finance these deficits.
On this subject, one could argue that EMU introduced incentives that worked in the
exact wrong way. Divergence in productivity levels increased due to the structural
reforms, which were necessary to encourage convergence less necessary, from the
Souths capital inflows.
A false sense of security was fostered from adopting the Euro as the common
currency amongst private investigators.
Before the beginning of the financial crisis and during the years of excitement
following the beginning of Europe's monetary and economic union, the private capital
moved freely into Spain. Due to this, the country ran approximately 10% of GDP in
current deficits, which in turn aided in the finance of massive spending over income
excess in the private sector. However, the outcome didn't have to be negative. Spain,
and the rest of the peripheral countries, investments could have been helped by these
capital inflows to be more productive and to eventually catch up with Germany.
Dismally, in Spain's case, they mostly caused a massive bubble to occur in the
property market, unendurable borrowing levels, and consumption. The huge bubble
eventually burst to cause a reduction in the country's real economy which also
knocked down the banks that used to gamble on loans to construction companies and
property developers.
38
in 2007, which brought "sudden stops" regarding worldwide lending causing a fall in
the spending and borrowing in the private sector and a fiscal crisis wave.
The banks were a third problem which developed slowly. Despite all its problems, the
Spanish financial system, between 2008 and 2010, was one of the least systems that
were affected by the European crisis. During that stage, Spain did not receive any
direct assistance from Brussels, unlike the other 40 institutions that did. The Spanish
banking system was ranked the third strongest Eurozone member by Moody's in
December 2010. The first two were Finland and France, followed by Netherlands and
Germany in fourth and fifth place. Greece, Portugal, and Ireland came after. However,
this success did not last long.
There were several factors that were accountable for the Spanish bank's performance
deterioration after 2009. First is the economic crisis' direct effect. The balance sheets
were severely impacted by the economical conditions deteriorating. Non-performing
loans rose due to the compilation of the Spanish mortgage market suffering from
continuous waves of losses, which were triggered by record-high unemployment, and
the deep recession. The United States and many other countries suffered from a huge
burst of their property bubble. Spanish Land Property experienced a 500% increase
between 1997 and 2007, which was the greatest increase amongst the OECD
countries. The banks were deeply affected by the real estate sector's collapse. Spain's
banking assets were still falling after the crisis started in five years. By the end of
2011, 180 billion were classified by the Bank of Spain as troubled assets, while
banks had 656 billion worth of mortgages. 2.8% of these mortgages were labeled as
nonperforming.
The second factor was the countrys concern over its sovereign debt. As discussed
earlier, mismanaged public finances did not originate with the Spanish crisis. This
crisis has been a large problem regarding private sector debt that keeps growing,
mixed with irresponsible bank loans and investments, specifically from the Cajas, in
addition to being aggravated by current account imbalances and competitiveness. To
understand the problem, there was a dramatic increase in gross debt of household in
39
the ten years before the crisis. It was 20% more than the Eurozone average by 2009,
86% of GDP opposed to 66%. Since May 2010, strict policies were implemented that
provoked the country's fiscal position. Spain's debt to economy ratio was 36% before
the crisis and is predicted to get to 84% by 2013.
In summary, Spain seems to have plunged into a terrible doom loop, which has
already burdened Portugal and Greece which prompted their bailout. The Spanish
government's debt sustainability was affecting the Spanish banks as they were the
government's debts biggest buyers of the liquidity infusions long-term refinancing
operation of the ECB. Domestic banks owned 30% of government bonds in mid-
2012. The doom loop was a due to the EMU weakness, specifically, not having a
banking union along with a centralized the European Union funded mechanism to bail
out banks.
2.5.3. Conclusion
This crisis has been a large problem regarding private sector debt that keeps growing,
mixed with irresponsible bank loans and investments, specifically from the Cajas, in
addition to being aggravated by current account imbalances and competitiveness.
Ultimately, the crisis exposed the country's economic model's weaknesses. Indeed,
despite Spain's remarkable progress and achievements over the previous 20 years, its
economy is still facing serious fiscal and competitive challenges. Regrettably, the
country's economic success before the crisis had a sense of complacency. This
allowed the adoption of the required structural reforms to be delayed. Except this was
not surprising; several economists recognized that Spain's economy was surviving on
borrowed time.
Surely, regardless of all the significant progress, the Spanish government still had
considerable ground to cover in order to be able to catch up with the European
Unions richer countries in addition to improving its economys competitiveness.
Considering the current productivity and income differentials with the richer
European Union countries, Spain has to carry on and intensify the reform process.
40
Spains economy suddenly collapsed and was a shock. However, in retrospect, it
shouldnt have been so surprising. The private sectors borrowing had an
unsustainable bubble in it that was waiting to burst, which was caused by policies
choices made during the previous ten years.
Countries that participated in using the Euro as their single currency did not turn out
to be the cure-all solution that everyone anticipated it to be. Adopting the euro caused
an abrupt decrease in real interest rates which assisted in the housing bubble and the
credit boom. Nevertheless, it also changed economic governance decisions.
Consecutive Spanish governments substantially ignored the EMU membership
implications and were unsuccessful in implementing the required structural reforms to
be able to ensure the fiscal policies' sustainability and to be able to control the unitary
labor costs. All these decisions led to an ongoing destruction of competitiveness, in
addition to record current account deficit, and an enormous fiscal deficit when the
global crisis hit the country.
Undeniably, the country's experiences showed that EMU and EU memberships did
not lead to the structural reforms' implementation necessary to handle these
challenges. Quite the opposite, Spain's economic boom was contributed to by EMU,
hence aiding in the necessary economic reforms' postponement. This challenge did
not seem to be a problem of the European institutions but turned out to be of national
policies. The economic reforms' process has to be led by private actors that would
follow a national process that is willing to complete them.
Spain's case is a necessary reminder that countries can only control relative labor
costs and fiscal policies when facing a monetary union situation. Spain turned out to
be weak in regards to both. It was unsuccessful in developing a suitable adjustment
system to be able to succeed when using a single currency. Also, it also ignored the
41
importance of the Euro membership's international constraints, and internal politics
choices have to be by each other.
On the contrary, Spains domestic policies and the importance of being a part of a
multinational currency union existed in an uneasy relationship with one another.
Spains worst economic crisis in modern history reached its tipping point by the crisis
that brought this discrepancy to the fore.
42
CHAPTER 3: PROCEDURES AND METHODOLOGY
3.1.Hypotheses
1. Free market capitalism was the main reason that led to the global financial
crisis
2. In 2007, Ireland witnessed its worst global financial crisis in regards to its
economy
3. Not only was Ireland significantly affected by the crisis, but it also has not
recovered from it until this day
3.2.Selected variables:
3.3.1. GDP
GDP (Gross Domestic Product) is the financial value of all the services and finished
goods produced by a country over a given period. GDP can be calculated quarterly,
although it is usually calculated annually. GDP consists of all public and private
consumption, exports fewer imports, investments, and government outlays that
happen within a defined area. Only speaking, GDP is used as a nation's measure of its
overall economic activity.
43
National debt is the term used when talking about a federal government's accrued
deficits.
Term an item or asset with the expectation that it will generate income or increase in
value in the future is an investment. Economically speaking, investment is used to
describe the purchase of goods that do not get consumed at the moment but rather will
be used in the future to generate wealth. About finance, an investment is a financial
asset purchased with the hope of it creating income later on or even to be sold for
more to create profit.
A deficit in a current account decreases a countrys foreign net assets by that amount
and a surplus in a current account increases it by the same amount. The two key
components of a countrys balance of payments are the capital account and the current
account.
A part of a country's debt that was borrowed from other nations plus interest must be
repaid is the same currency that it used to acquire them. This includes international
financial institutions, commercial banks, and governments. To be able to get the
necessary money, the country that borrowed might export and sell goods to the
country that it borrowed from.
44
3.4.5. Medium and long term debt maturity
The term medium debt maturity is a holding period asset or investment horizon that is
by nature an intermediate. The personal preferences of an investor and the asset class
that is under consideration define if the time is considered medium term. In regards to
fixed-income markets, bonds having a five to ten year maturity period are medium-
term bonds.
When referring to long-term debt, we are referring to financial obligations and loans
that are over a one year period. Regarding a company's long-term debt, we are
referring to leasing requirements and financing that are due over a period greater than
one year. Long-term debt can also apply to government: where long-term debt is also
presented in countries.
3.6.Data Sources
This thesis's practical nature causes it to be very dependent on sources of data being
used to elaborate and explain in the analysis. Therefore, it has been extremely crucial
to use these reliable sources of information to be able to make the right inferences.
Internationally renowned sources have been used throughout this thesis to come up
with the tables and charts, such as the Organization for Economic Co-operation &
45
Development (OECD), IMF, World Bank, and central banks of countries that were
being analyzed. The same can be said for data projections in regards to primary
surpluses, debt levels, and the likes in the future, to be able to ensure the greatest
precision and credibility when analyzing calculations or data. In general, the years
from 2000 to 2015 were used to derive all the information in this paper. However,
some of it is a bit older and even longer since some of the debt levels reach as far as
2017.
3.7.Data limitation
There has not been much concern in regards to data limitations since international
databases that were used are very abundant. Nonetheless, this paper does not include
any data that has not been obtained through a reliable source. At times, this caused
concerns and even difficulties, but top priority has been given to the quality of data
being used. The same sources were employed in this paper to make it easier to
compare data, whether about different countries or years being discussed, but at the
same time, there was the need to use other sources to get more data necessary. This
stands true for short-term interest rates, credit growth, central bank balance sheets,
housing prices, and debt levels being used for the purpose of sustainability
calculations.
46
CHAPTER 4: IRELAND: CRISIS, RECOVERY, AND
POTENTIAL FOR NEW CRISIS
4.1.Introduction
The study focused on the eurozone area. And by using appropriate data, in chapter 2,
we analyzed Greece and Spain's crises mainly based on IMF official data.
Several theoretical models have been brought forward to explain the banking and
currency crises and the relation between them both. Stoker (1994), Frederic S.
Mishkin (2011), Velasco's models (2007), Reinhart (2011), Frankel (1996), etc...
Regarding Greece, structural reform is vital to her recovery and should take advantage
of the support of euro zone countries.On the other side, Spain recovery is on the right
path. Indeed, strict reform in fiscal forms is vital.
Ever since 2008, Ireland has suffered from a severe financial crisis described as both a
significant economic adjustment and a systematic banking crisis. Before the crisis, it
has been documented that Ireland's unstable domestic imbalances are due to the credit
boom and protracted property.
Based on Data until 2011, Laeven and Valencia (2012) projected that Ireland ranks as
one of the last expensive banking crisis since 1970 in an advanced economy, even
though its crisis had not been resolved yet. This conclusion was based on cumulative
gross fiscal costs, output losses, and increases in its government debt from an example
of 147 systemic banking crises from 1970 to 2011. Ireland's case turned out to be the
sole country currently going through a systemic crisis that portrayed in the top 10
across all the before mentioned three metrics across this sample period. The state had
invested 63 billion of capital in the Irish banking system as of July 2012.The future
performance of the domestic financial system and the Irish economy remain uncertain
until today.
47
4.2.Why Studying Ireland Matter
Current and potential investors had concerns in regards to the Irish governments being
able to avoid failing to fulfill financial obligations.
There has always been uncertainty in Irish's economic statistics, but using the euro as
its currency gave them a significant advantage regarding investors' reservations due to
the euro being managed and administered by the European Central Bank (ECB).
The European sovereign debt also referred to as the Eurozone crisis took place in
2008 and went into a downward spiral from there. Worldwide economies were in a
state of panic for the future of the Eurozone. The first member to receive financial aid
from the International Monetary Fund and the European Union was Greece. Ireland
followed a few months later.
As described by Laffan (2003, p. 251), the late 2008's banking crisis focused on two
institutions, the Irish Nationwide Building Society ( the supposedly unrelated
48
organization where Anglo's CEO conducted personal business) and the Anglo-Irish
Bank. There was uncertainty from the beginning and lack of agreement regarding
whether other Irish banks' problems were remote as severe. They had several
advantages, for example, Anglo's earlier success and high profile placed it as a
business model for competitors.
Norway seems to be the country that was least affected by this banking crisis,
excluding nonperforming loans (NPL), whereas amongst the Nordic countries,
Finland was the most affected country, and not in a positive way. The Finnish and
Swedish crises had much more severe impacts than that of the Norwegian banking
crisis, and this was due to several reasons. Drees and Pazarbaiolu emphasize the
truth that the corporate sector in the last 2 countries had majorly borrowed in foreign
currency before the crises and the succeeding depreciations of all of the 3 currencies
from 1986 to 1992 significantly impacted these borrowers12. Another major factor
was timing difference since Finland's, and Sweden's banking crises took place during
12
Drees, B. and C. Pazarbaiolu, (1995), The Nordic Banking Crises: Pitfalls in Financial
Liberalization, Working Paper No. 95/161, International Monetary Fund.
49
an extreme economic downturn, whilst the banking crisis in Norway became systemic
when recovery signs were already emerging in the real economy 13
Pretax profit/loss figures in Ireland caused the year of 2010 to be its peak year for
their leading domestic banks which matched other countries approaches. As a
percentage of Gross Domestic Product, Ireland's loan losses were the highest in 2010
that were almost double compared to Finland.
The Irish banks joined the crisis with a strenuous exposure to lending, in regards to
property, financed with short-term wholesale funding. Weak internal credit risk
management along with supervisory shortcomings increased the susceptibility to
credit risk14. Solvency concerns were raised due to the extent of the credit risk, which
negatively affected the Irish banks' funding positions during the crisis.
Moreover, Ireland's banks greatly relied on income from net interest for earnings
before the crisis; what drove interest income on lending was not margin, but volume.
Banks lost a chief source of revenue when transactions in the commercial property
and mortgage markets thinned from 2007. Another factor that helped compress
margins was higher funding costs.
13
Sandal, K. (2004), The Nordic banking crisis in the early 1990s - resolution methods and fiscal
costs, in Moe, T., J. Solheim and B. Vale (eds), (2004), The Norwegian Banking Crisis, Occasional
Papers No. 33, Norges Bank.
14
Honohan. P. (2009), Resolving Irelands Banking Crisis,' The Economic and Social Review, Vol.
40, 2, pp.207-231.
50
4.5.Credit and Deleveraging
Examining Table 3 significant declines in lending can be seen in all 4 of the countries
being compared during the banking crisis.
According to McKinsey, the period after Sweden's and Finland's crises was classified
as declining into a "Belt Tightening" archetype, where GDP grows faster than credit
stock or a decrease in total outstanding credit. In the average case across all stages in
this category, there was growth slowness to 2% per annum from 21% growth year on
in the period before the crisis. In these steps, deleveraging usually starts around 2
years into the crisis; while GDP recovers quite quickly, further deleveraging is caused
by muted credit growth during the period that follows15. If we look at Japan, for
example, we can see that it reflects a situation where the domestic economy is the
only one that does not resort to deleverage when the private sector gearing reduction
was offset by the public debt to GDP ratio increased. The deleveraging period lasts,
on average, about six to seven years according to McKinsey (2010); the same finding
where reached by Reinhart and Reinhart.16
What is evident in this situation is the major increase in regards to the Irish ratio
before the peak. From the peak in 2009, the Irish rate only suffered a 9.6% decrease,
where it had witnessed a 143% increase in the decade before that.
Compared to the experience of the other four countries, the scale of the ratio increase
was much larger. If we use the international experience as a guide, it is possible that
this rate can continue to decrease for several years. Research shows that even though
economic output might recover quite fast after an extreme banking crisis, Ireland's
credit growth can remain frail for some time.
4.6.Economic Indicators
Table 4: Irelands annual GDP growth
15
McKinsey Global Institute (2010), Debt and deleveraging: The global credit bubble and its
economic consequences, McKinsey & Company, London and Washington DC.
16
Reinhart, C. and V. Reinhart (2010), After the Fall NBER Working Paper No. 16334, September.
51
2008 -2.2
2009 -5.6
2010 0.4
2011 2.6
2012 0.2
2013 1.4
2014 5.2
Source: world Bank open data
Over the past two years, Ireland has experienced an extraordinary rebound. When the
bubble burst in real estate in 2008, domestic banks needed government support. One
of the European countries that were hugely affected by this economic crisis was
Ireland. Between 2007 and 2009, output contracted by about 8 percent. Following that
in late 2010, an ambitious and wide-ranging series of reforms began with the help of
the financial assistance of the EU-IMF program. The ground was laid for the ongoing
recovery due to the Irish authorities' commanding ownership of the reforms and their
successful implementation. In 2014 and 2015, they aided in turning Ireland's economy
into the fastest growing one. The changes under this EU-IMF program focused mainly
on restoring fiscal sustainability, and financial sector repair17.
The recovery created many jobs and helped the economic rebalancing process. The
creating of full-time employment was continuous across sectors and regions; which
led to a major decrease in unemployment rate that reached less than 9 percent and a
decline in youth and long-term unemployment Corporate and output profits rose,
which proved to be stronger than ever expected tax revenues, chiefly through flowing
corporate income tax receipts, moreover, aided in over attaining nominal fiscal
targets. (See figure 13)
17
See Annex 1
52
Source: central statistics office- European commission-2016
The actors that helped turn the current account into noteworthy surplus were strong
export growth and regained competitiveness. Banks returned to profitability through a
robust macroeconomic environment which made the deleveraging process possible.
Ireland's main challenge was to guarantee balanced and durable growth in the future.
(See figure 14).
53
Source: Central Statistics Office- European commission-2016
During past years, active deleveraging has continued by companies. The economic
recovery has aided this process, which has resulted in corporate profits and earnings
increase. The decrease in debt ratio also benefited from nominal GDP's surge. In
general, corporate indebtedness remained high, but this was primarily caused by the
huge multinational corporate segment, whose debt involves lower risks to the
domestic economy. Ireland's firms have started their recovery phase although some
companies still face deleveraging needs.
Even though households still face additional deleveraging needs, they have also
reduced their debt. They are typically more advanced when compared to firms, in the
deleveraging process. Nevertheless, those that heavily borrowed during the time of
the housing market bubble still need to deleverage further (See figure 15). While the
balance of outstanding amounts' mortgage accounts witnessed a decline, two-thirds of
total balance is accounted for by long-term arrears. Bankruptcy schemes and personal
insolvency are used relatively less, access to collateral was still difficult. In general,
the debt ratio in the private sector, including households and companies, has
significantly declined.
54
Figure 15: Household net worth
The debt ratio of the gross government fell noticeably. The average maturity of the
public debt was averagely 13 years and has low-interest rates (figure 16). Moreover, a
factor that should further reduce debt is the planning to sell off shares owned by the
government.
With recovery, non-performing loans fell even more; however, the ratio is still
amongst the highest when comparing all of the euro areas. Resolution mechanisms
remain complex and lengthy for commercial and mortgage loan arrears (figure 17).
Long-term mortgage arrears' high rate points to remaining dilemmas in handling the
most troubled debtors. Establishing functional central credit registry to support
flexible lending practices for the future was a complicated process and was pushed
back again.
55
Figure 17: non-performing loans in Ireland and the euro area
Even though financial access was still challenging for some, SME's conditions were
improving. They reported higher job creation, profits, investments, and turnover. On
the other hand, domestic banks reported a reserved increase in credit lending and
demand. However, commercial financial sources remain heavily used. Higher credit
risk along with strong lending market resulted in higher interest rates when compared
to the euro are average. Furthermore, SMEs still heavily relied on bank loans and only
have limited access to financing sources other than banks. In the meantime, using
government funding initiatives in support of SMEs was improving, but was still
suboptimal. (Figure 18)
Figure 18: SME credit demand and interest rates on SME loans
56
Source: Central Bank of Ireland, European central bank
Unemployment fell below the European Union's average, but households' low work
intensity and long-term unemployment remain areas of concern.(figure 19)
57
Sustainability, cost-effectiveness, and equal access remain critical challenges in
regards to the healthcare system. The healthcare's broad reform is surrounded by
significant uncertainty as the model for universal health insurance is in a quandary.
Progress has been witnessed in distinct strands of changes, but information systems
and financial management remain weak. Imbalanced access is endured as an issue and
the spending on pharmaceuticals continued to influence cost effectiveness.
Using the SPSS we will test there a relation between GDP and the following variables:
- Unemployment Rate
- Current Account Balance
- Inflation Rate
Figure20: GDP vs. Current Account Balance Rate Figure21:GDP vs. Unemployment
Rate
From the correlation table (Table) one can conclude the following:
59
Mean Std. Deviation N
60
Table6:Correlations
Current Account
GDP (%) Balance Unemployment Inflation Rate
N GDP (%) 16 16 16 16
Unemployment rate 16 16 16 16
Inflation Rate 16 16 16 16
From the coefficient table (table ), one can conclude the following:
61
Table7: Coefficientsa
Unstandardized Standardized
Coefficients Coefficients Collinearity Statistics
Current Account
.820 .218 .581 3.759 .003 .952 1.050
Balance
This implies that 72.70% of the total variation in GDP is explained by the multiple
regression equation containing current account balance, unemployment and inflation
rate. The remaining 27.30% may be explained by other variables such as consumption
and investment, medium and long term debt maturity and others.
From the VIF (Variance Inflation Factor), in the coefficients table, one can conclude
that there are no collinearity problems since all VIFs (1.050, 1.904 & 1.917) are
below 10.
Table8:Model Summaryb
62
[F=10.661, P-value=0.001], P-value=Sig=0.001=0.05.
According to the p-value, F calculated falls into the critical region (Accept H1). Therefore
one can conclude that the final multiple regression equation is statistically significant and
may be used for prediction purposes.
Table 9:ANOVAb
Total 240.101 15
Since the difference is only 6.8%, this might be an indication that the sample size
(from 2000 till 2015) to the number of variables in question is adequate.
63
4.8.Conclusion
Financial crises that lead to international rescues are by no means joyful, and Ireland
was no exception. There were substantial economic costs that were unevenly
distributed. Emergency lenders worried about being paid back; therefore, help comes
with severe and often resented political conditions. Modifications and recovery goals
are usually difficult to achieve. "Fondly" is not the word that comes to mind when
countries that face crisis would use to describe their experiences. The Eurozone crisis'
management did not help. There was uncertainty surrounding Greece that spilled over
in regards to its debt restructuring. There was official talk taking place regarding the
option of leaving the Euro or taking a "temporary holiday" even if it was driven by
other countries' problems. This affected the market sentiment towards Ireland.
Incorrect assumptions about fiscal multipliers failed stress tests and the on and off
progress in regards to banking union made things difficult unnecessarily.
Given that, the European Union and its institutions benefited from the situation by
learning from the experience. Creating a banking union under the control of a single
supervisor synchronized deposit insurance, which is a resolution mechanism that had
the ability to recapitalize distressed banks directly, and a devoted resolution fund
probably best symbolizes this fact. The idea being, that removing supervision out of
national authorities' hands, at least in part, will reduce capture problems and even
strengthen surveillance for future times. A well-specified and sufficiently funded
resolution mechanism prevents national authorities from feeling forced to
implementing an Irish-style guarantee in the future. More great banks Eurozone deep
moderate fears or concerns of uncontrollable contagion and the flowing of financial
chaos from isolated bank failures. Achieving this progress in reality and not just
symbolically will now necessitate giving that supervisor real teeth, allowing the ESM
to take on significant credit risk amounts, and fully funding the resolution fund.
64
CHAPTER 5: CONCLUSION AND
RECOMMENDATIONS
The economic activity is affected by the financial crisis in many ways. For example, a
dominant currency attack, due to a decrease in the domestic currency, will lead to an
expand in the tradable goods sector, in addition to a remarkable spur growth through
the correction of the value of the currency, and the competitiveness increase of the
exchange rate.
The financial crisis that the USA faced in 2007 expanded worldwide and affected all
kind of countries. As a result of this crisis, corruption was spread in the economy
viewing its weaknesses. Greece, one of the concerned countries, for example, should
be grateful to Europe for her support about the discussions held concerning the
exclusion of Greece from the European Common Currency. The decision of the
prohibition should have been made a long time ago in 2001 when Greece chose the
Euro currency as a local currency.
As for Spain, the recklessness of banks in loans and investments helped in the growth
of the private sector debt. Spain's growth used to depend mainly on the domestic
industry during 2000, In particular, the construction. Tax incentives favored
developers, property owners, and bankers.
Through this crisis, Spanish proved how weak it was in controlling the labor costs,
fiscal policies and maintaining the monetary union.
For a policy analysis perspective, this paper aimed to illustrate the historical and
comparative context of the Irish financial crisis. The crisis highlighted the gaps the
65
government has when monitoring systemic risks. The government tried to use the
laissez-faire approach, which was influenced by Wall Street but failed miserably.
To prevent such crisis, some regulations should apply that capitalism needs to abide
by. Eliminating some regulations would also facilitate the wealth inequality.
In conclusion, the stronger the supervision, the overlooking and the regulations, the
better to deal with risk management more effectively.
From the analysis of the governments role and the leading causes of financial crisis
the following was recommended:
1) The Irish government has to observe the fluctuations in the asset price carefully.
2) To guarantee financial stability, money and credit should have a large impact on
the central banks monetary policy strategies.
3) Cooperation and collaboration between central banks are needed to deal with a
future crisis.
66
APPENDICES:
67
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