EURO CRISIS: THE REASONS BEHIND AND ITS IMPACT ON

THE STANDARD OF LIVING

To

Farzana Munshi, Ph.D.

Department of Economics and Social Sciences

66 Mohakhali, Dhaka 1212, Bangladesh

Associate Professor

BRAC University
 Abstract:

This paper is an initial attempt at understanding the reasons behind the infamous Euro Crisis and
its impacts. We mostly focus on the austerity plans and the protests that materialized for carrying
out the plans. This paper gather its information from scholarly articles and mostly from newspaper
articles of the BBC, Guardian, Telegraph, Washington Post and The Economist. Graphs and tables
have also been used to establish that the Euro Crisis led to decreasing standard of living among
the affected countries.

1. Introduction

The Eurozone crisis or the commonly named Euro Crisis was on the go since the 2009 and it has
been affecting the member countries of the Eurozone since then. Economists and financial pundits
fear that the crisis is going to linger in the economy and any sign of its retreat cannot be seen
immediately (The Economist, 2013). Many have divided the crises into three parts – the banking
crisis, the government debt crises and the growth and competitiveness crises. (Shambaugh, 2012
and Dreger, 2012). According to Mark (2012) without the assistance of the external forces several
countries of the Eurozone were unable to reimburse their huge government debts. In addition to
this the Eurozone banks had very less capital which made it difficult for them to meet the demands
of their depositors and thus they were forced to face liquidity difficulties. Moreover, the crisis
decelerated the economic growth across the Eurozone and made growth more imbalanced across
the countries (Shambaugh, 2012 and Massa, Keane, Kennan, 2012).

2. Literature Review

After the World War II concerns about preventing another war was growing and these concerns
gave birth to the formation of the European Union (EU) to prevent any form of hostility in between
the European countries. At the time of the promotion of the United States of Europe by Winston
Churchill and the removal of barriers to trade among European countries, the notion of sharing a
single currency by the member countries was always in the context made unambiguous in the late
1960s (BBC, 2012). Germany’s chancellor, Helmut Kohl and the French President, François
Mitterrand officially ended the rivalry between France and Germany and decided to merge the
monetary market of the Eurozone but they ignored the fact that each and every European country’s
economy was as divergent as its culture. The BBC documentary (2012) also mentions that he
signing of the Maastricht Treaty, also known as the Treaty on European Union, made the monetary
union formal. Monetary union was a political scheme which was dressed and sugar coated as an
economic motive. This decision faced had many contradiction at its core but no one spoke out of
the fear of causing friction between the countries. As Lord Lawson (2012), the Chancellor of
Exchequer – 1983 to 1989, states that it was a high risk gamble that should have never been played.

Euro was materialized at an apparently propitious period when the world was growing at
sustainable rate and which was predicted to last for a decade. Some countries qualifying for the
euro membership barely managed to meet all the criteria even in this hospitable economic
condition (BBC, 2012). The Economists and Financial Analysts ask the question: “How did they
manage to get in especially Greece?” The answer that was found and later published was that some
countries manipulated their books or more informally they “cooked” their books. In order to join
the euro club the countries had to have a budget deficit of 3% or less of GDP and the banks were
helping its governments to understate the actual figures (The Economist, 2012; BBC, 2012 and
Dreger, 2012). Greece was the most heroic of all, the country hired Goldman Sachs to undermine
its tremendous deficit to only 3%. With the Euro, Greece and some other countries which
previously had high default risk now had the same lower default risk as Germany and this enabled
them to borrow from foreign investors into risky ventures (BBC, 2012). Moreover, the real estate
marker in Ireland was flourishing and everyone was investing on buying lands and setting up
apartments and departmental stores (The Guardian, 2013). How did the Eurozone strayed to a crisis
from such an economic boom is a question that everyone asks.

According to BBC, Telegraph, Mark, Shambaugh, Massa, Keane and Kennan (2012) The leading
signs of an upcoming crisis was first seen around 2007 and 2008 in the United States when the
gigantic banks like Lehman Brothers failed and then the bank failures spread to the Britain causing
the Royal Bank of Scotland to collapse. These huge bank failures shook the global financial
economy but the final blow to the European Economy came in the 2009 when Greek’s new
government revealed that previous political party hid the actual government debts of around 300
million euro which is 129% if it’s GDP. To make matters worse the debt was growing because the
global recession slowed down tax payments. Publication of this scandal caused the security rating
firms such as Moody’s to rate Greece bonds and other securities to junk as there were narrow
chances of the debts being repaid. Lenders started to worry they might never be repaid so they
immediately stopped lending and were demanding for their debt to be repaid (The Economist,
2012). Greece was forced to ask the European Union and the international monetary fund to assist
bailouts for its banks. Not only the Greece but countries like Ireland, Portugal, Italy and Spain also
had to issue for bailouts (The Washington Post, 2012). The lenders to these countries also
abandoned them and they were left in the same catastrophic position as Greece. At this point the
Eurozone was sitting right on top the epicenter of a huge crises. The property markets and the
banking sectors were collapsing inevitably. The bailout assistance was received by those countries
at a shocking cost. The EU and the IMF enforced the countries to carry out austerity measures to
balance their budget (BBC, 2012). The countries’ governments’ slashed public spending, hiked
tax rates, cut down labor wages and forced a herd of abled workers out of job. These brutal
measures caused protests and riots leading to political unrest which again contributed to the crisis
(The Guardian, 2013, The Telegraph 2012 and BBC, 2012). Overall, the Eurozone was in a full-
fledged banking crises as the banks were not able to borrow and lend, they were also not able to
pay off their debts. The benefits of seigniorage and devaluing the currency to make exports cheaper
were not available to Greece, Italy, Spain, Portugal and Ireland as they all shared a common
currency with the rest of the Euro countries. Printing money meant to increase the money supply
for all the Euro countries and devaluing to make exports cheaper meant to make all the Euro
countries’ exports cheap. The European Union could not take the risk of causing the whole Euro
Zone to collapse. The only way the economy can improve is by quickly taking up harsh austerity
measures which balances the budget otherwise the currency Euro would collapse completely
(BBC, 2012).

3. Methodology

The paper uses scholarly articles and articles from The Economist, BBC, Telegraph, Washington
Post and Guardian to review the literature and analyze the impacts of the crises. The analyses
mostly depend on the existing graphs and tables (all the graphs and tables are provided in the
Appendix) on the GDP, unemployment level, deficit, debt and interest rate. More extensive
analyses could have been done if data, graphs and tables on the Euro Zone income levels and tax
levels were available in a greater frequency. Availability of these data would have made this paper
and its finding more robust. Moreover, a simple linear regression analyses was done but the results
were not satisfactory to mention in the main body of this paper. Nevertheless the results are still
given in the appendix. All research has flaws and as beginners to the researching world our analysis
may also have flaws and any advice and comment to improve our research would be gladly
appreciated.

4. Analysis

The paper analyzes the unemployment level and the GDP changes before after the euro crises to
establish an understanding of what might be happening to the standard of living in the Euro Zone.
In order to explain the severity of the problem graphs of interest rates, deficit level and debt levels
are used.

The Guardian (2013) and BBC (2012) mentions the austerity measures of cutting wages,
decreasing public spending and increasing the tax rates have directly affected the standard of living
of the people. Protests and riots breaking out in Greece, Ireland, Spain and other similarly affected
countries are the sole evidences (BBC, 2012 and The Washington Post, 2012). As elaborated by a
tourist, Europe used to be a peaceful country without any vandalism or any graffiti in the walls,
homeless and beggars were a rare sight to the eye but recently this scenario has become very
common and it puzzles the tourist (The Telegraph, 2012). Besides the civil unrest protesting the
high unemployment, high taxes and low wages if we look in to some empirical evidence our
understanding would be nourished.

If we look at Graph 1 in the Appendix we can see that before the Global Financial Crisis in 2007
Euro Zone (Greece, Italy and Spain) countries along with United Kingdom had sustainable
constant GDP growth rate but after 2007 the growth rate plummeted to negative figures and it was
the worst in the year 2009. After 2009 with the previously explained several harsh austerity
measures some countries except the Greece were again able to balance their budget and start
economic growth, i.e. the GDP rose slowly.

Graph 2 shows the changes in the level of unemployment. After 2009, the final blow to Euro Zone
Crises, the unemployment level drastically rose. Spain had the highest level of unemployment and
then Greece. The reason behind this sharp increases in unemployment is again the cruel austerity
measures taken up by the governments. Spain let go off its workers the most and this might be
another reason why its GDP was able to improve faster than Greece.

Table 1 gives the GDP per capita data on Greece, Spain, Italy and Ireland. If GDP per capita is
assumed to measure the standard of living then the table reveals that the standard of living has
been drastically worsening after 2009. We see that for some countries such as Spain and Italy the
GDP per capita have risen slowly afterwards and this pattern again corresponds with the harsh
austerity measures.

These analyses provides an insight on the condition on the standard of living and it can be easily
predicted that the standard is not as promising as it was before 2007. Many private firms had to be
nationalized to save them from going bankrupt. These immediately led to the cut down of jobs
making people lose their source of income. The condition worsened when the government stopped
providing aids on heath, food and housing and when the tax rates rocketed sky high. All these
contributed to drastically decrease the income of the working population and coerced them to live
in troubled conditions.

The austerity measures improve the conditions of Spain and Italy but did not help Greece much.
Greece had enormous debts to recover and it would take more than austerity measures to improve
Greece’s condition. Graph 3 clearly shows the percentage of debt for the countries where we can
see that Greece’s condition is the worst as its debt is increasing faster than any of the other
countries. Graph 4 implies that except Greece all other countries are converging to a balanced
budget at an increasing rate. Greece’s pattern is ambiguous and it reflects that the situation would
not improve any time soon in the near future. Finally, Graph 5 of the interest rates show how deep
is the lending and borrowing crisis. After 2009, the interest rates of Greece, Ireland, Portugal,
Spain and Italy hiked up history breaking records but Germany and France’s interest rates were at
normal level. This also explains the acute and impeccable measures that France and Germany
undertook to firewall themselves from the crises. Due to rash and indecisive measures of the
European Union the crisis also worsened in the above mentioned countries.

The analysis can be concluded to judge that the Euro Zone crisis is severe and it is significantly
affecting the standard of living. The countries most affected by this crisis are Greece, Ireland,
Spain, Italy and Portugal. Conditions in Spain, Italy and other countries except Greece have
improved significantly due to the enforced cruel austerity measures and the bailouts of the banks
and private firms (The Guardian, 2013). Why did not the Greece’s economy improve like others?
It is because Greece was the worst of all that hid away its enormous debts and it also borrowed the
most after joining the Euro. Greece’s economy is still in considerable turmoil and if other steps
besides the austerity measures are not taken soon then Greece might have to leave the Euro
currency and live the rest of its existing economic life as the black sheep of Europe (BBC, 2012).

5. Conclusion

The literature review explains the reasons behind the sixteen countries adapting to a single
currency, the euro. It reviews how the Euro Zone crisis built up to be as it is now. The direct
impacts of the crisis in certain countries caused the condition to be worsened. The finding states
that the standard of living of those certain countries plummeted but later sign of improvements
were seen. Greece showed very little or almost no signs of improvement and main reason behind
it is the way Greece cooked its books to meet the Euro terms. Greece could not reach a balanced
budget and it was struggling to pay off its debts. Moreover, the banking crisis and the financial
crisis contracted the lending and borrowing rates to a very low rate and at this low rate the level of
investment was very low. These low investments in turn made real economic activity stagnant and
ultimately led to the decrease of the GDP.

The paper uses only the secondary data for analysis but primary data could be collected through
various channels to make the analysis and findings more robust. Moreover, sufficient and high
quality data were not available which also hampered the analysis. Cumulative data with all the
euro zone countries would have helped the most to make it a more robust paper. In addition to
these if data on the income levels and the tax rates before and after the crisis were present then an
extensive dynamic regression analysis could have been done to support the claims empirically.

Moreover, the general understanding and findings from this paper is the reasons behind the Euro
Crisis and the tentative condition of the standard of living of the Euro Zone countries: namely
Greece, Spain and Italy.
 References
BBC. (2012). BBC Business . Retrieved from BBC Business:
http://www.bbc.co.uk/news/business-17219160
BBC (Director). (2012). The Great Euro Crisis [Motion Picture].
Bootle, R. (2012). The Telegraph. Retrieved from The Telegraph:
http://www.telegraph.co.uk/finance/comment/rogerbootle/10165316/We-cant-wave-
goodbye-to-the-euro-crisis-just-yet.html
"CNBC-Europe's Economic Crisis-What You Need to Know-Mark Thoma-June 13, 2012".
Finance.yahoo.com. Retrieved 2012-07-07.

Dreger, N. (2012). The Euro Crisis and Political Risks Affecting Retirement Income Programs.
Society of Actuaries(57), 1 - 10.
Economist, T. (2012, November 12). A very short history of the crisis.
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http://www.economist.com/news/leaders/21578386-euro-zone-desperately-need-boost-
no-news-bad-news-sleepwalkers
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 Appendix
The source of graphs 1, 2, 3 and 4 - http://www.bbc.co.uk/news/business-13361934

Graph 1: % Change in GDP with respect to year

Graph 2: % Change in unemployment level with respect to year
Graph 3: % change in debt levels with respect to year
Graph 4: % change in Budget Deficit with respect to year
Source of Graph 5: http://www.mygovcost.org/2011/12/28/the-euro-in-retrospect/

Graph 5:
Source of Table 1:
http://databank.worldbank.org/data/views/reports/tableview.aspx?isshared=true
&ispopular=series&pid=3
Table 1: GDP per capita of Greece, Ireland, Italy and Spain.

Regression Analyses:
We considered GDP (current US$) as the dependent variable and the exchange rate of
EUR/USD as our independent variable. The data on GDP has been collected from the World
Bank Data Bank and the exchange rate data have been calculated from ONADA Data Bank
The sources are:
http://databank.worldbank.org/data/views/reports/tableview.aspx
http://www.oanda.com/currency/historical-rates/

Our regression Equation is as follows:

➢ GDP = B1 + B2(Exchange Rate)

From the regression using the data we find:

➢ GDP = -11529451327728.7 + 20646797990855.2 (Exchange Rate)

The regression gives a negative intercept and a positive slope. Meaning that when exchange rate
is zero the GDP would be a negative figure and when the exchange rate increases by 1 unit the
GDP would increase by a positive figure.
The finding is not satisfactory as more accurate tests could have been done using a dynamic
model and using logarithms but the lack of availability of data do not allow us to do so. For this
we keep the regression part from the main body and include it in the appendix
The data used are given below: