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What Really Caused the Eurozone Crisis? Term Paper

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Updated: Jan 26th, 2021

Main points

Kash Mansori’s argument focuses on two possible causes of the eurozone crisis. He analyses what he refers to as a systemic cause. This view claims that the eurozone crisis occurred as a result of powerful outside forces. He associates it with massive capital flow bonanzas followed by sudden stops. This resulted in a financial crisis. The decisions taken by leaders could have been not right every time. However, they were not the main cause of the eurozone crisis.

Systemic causes claim that the deficits in a current account were necessary and unavoidable. Consequently, they created a surge in capital flows from eurozone countries. There was a common appreciation of real-time exchange rates, which were unavoidable as the mechanism through which the deficits in a current account took its course. He concludes that the euro triggered its crisis.

Local causes analyze the wasteful and irresponsible behaviors of governments and individuals in eurozone countries such as Portugal, Greece, and Ireland. The governments of these countries had large debts and investors lost confidence when the recession of 2009 reached them. Investors saw the inability of the eurozone countries in remaining solvency states. Subsequently, some withdraw from bonds trading. This action started the euro crisis.

Aspects of the current economic crisis

The excessive risk-taking in the eurozone during the global credit crunch cycle contributed to a financial crisis, an economic downturn, and a significant fiscal cost. The euro zones tried to avoid massive excesses. However, there were substantial problems in several countries of the eurozone, especially those that had large external imbalances. The government’s excessive spending led to unsustainable levels of debts and deficits that created an economic crisis. The crisis could also have occurred due to large current account deficits as a result of the capital flow bonanza. The crisis countries shared a common factor of running the largest current account deficits in the eurozone. The link between deficits and crisis is that when a country has a substantial average surplus, the crisis is likely to occur. However, countries with large fiscal deficits did not experience a crisis. The decline in capital flows created the crisis, not budget deficits.

Analysts believed that the crisis occurred as a result of governments’ profligacy. The governments took the advantages of the eurozone membership to increase their consumption and spending. There was a budget deficit growth in the eurozone countries. Analysts further argue that the post-euro adoption created a surge in capital flows, which resulted in a sudden stop of flows. This created account deficits resulting in a crisis. Therefore, investment opportunities in the Eurozone declined. The article observes that a crisis would still occur even if the eurozone countries were responsible enough from a macroeconomic perspective. The crisis resulted from spending on investments i.e. capital creation and a small amount on personal use. The financial crisis forced the eurozone countries to spend less on personal consumptions and more on investment opportunities. This cannot be attributed to the government’s lack of competence in the management of financial markets.

What is the role of regional or global imbalances?

The accumulation of regional imbalances accompanied large cross-border banking lows within the euro area. In several countries, the net external position of domestic residents towards foreign banks, measured on a location basis, rapidly deteriorated. This illustrates the close link between bank flows and changes in the overall dependence of domestic residents on external financing.

Conversely, the domestic banking sector has a substantial share of aggregate foreign assets and liabilities. This share increased rapidly in several deficit countries during the pre-crisis credit boom, notably in Greece where it rose. Net flows from large surplus countries to those with current account deficits and booming credit markets were particularly significant (Mansori 2011).

The increasing concerns about the credit risk led financial markets into confusion creating massive losses. This affected the economy and banking system that was relying on credit-fuelled growth. There was a lack of trust between banks. Reassessment of creditworthiness led to a sudden deterioration in access to foreign finances for banks in some Euro zone countries followed by strong deleveraging and disintermediation across borders. The interconnectedness between banking systems across countries and between sovereigns and banks has highlighted problems with local weaknesses spilling over across countries. Some banks resorted to taking excessive risks. They lowered their lending rates. This method was particularly strong in the euro area deficit countries, given the structure of the financial markets and a tendency for these feedback mechanisms to operate locally.

The role of currency markets

The effective euro rates of exchange fluctuated significantly during the crisis. A vital fluctuation occurred in the year 2010 when the traders lost confidence in the currency leading to a sale of excess currencies held by the governments. The depreciation of the euro in the currency markets benefited countries like Germany through their massive export shares against currencies in which the euro had fallen in value (Mansori 2011).

The relationship between the dollar and the euro is worth noting. The risk for the euro happens when medium-term appreciation pressures occur as a result of the weakness of the dollar pegs in many large emerging markets. The non-eurozone trading partners had some significant influence on effective rates of exchange during the crisis.

Works Cited

Mansori, Kash. “What really Caused the Eurozone Crisis?” Street blog, Web.

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