Euro Area Overview‏: May 7, 2013

This overview gives a brief presentation of the main aspects of the euro area economy.

The euro area came into existence on 1 January 1999 when the euro was officially launched in 11 EU member states. The euro area now comprises 17 member states and accounts for almost 20% of world GDP - second only to the United States of America.

Prior to the launch of the euro, many critics warned that a monetary union would not work without a fiscal union. The Stability and Growth Pact, which among other things stipulates that government debt should be below 60% of GDP and government deficit below 3% of GDP, was supposed to work as a safeguard ensuring that member states implemented prudent fiscal policies. Fiscal slippage did however take place in a number of countries including France and Germany but the Council failed to apply sanctions. Following the financial crisis, which caused a substantial deterioration in government budgets, the euro area as a whole now breaches both the debt and deficit limits.

The financial crisis became a debt crisis when revisions of Greek budget data in the autumn of 2009 showed that the fiscal situation was substantially worse than previously thought. Greece was granted a EUR110bn EU/IMF package in May 2010. In the meantime, the debt crisis had become contagious. In an attempt to stop the crisis, on May 9, 2010 the EU and the IMF presented rescue funds (EFSF) totalling EUR750bn, and the ECB announced that it would begin to purchase government bonds in the secondary market. Ireland, which had a government budget deficit of 32% of GDP in 2010 caused by one-off expenditures for bank rescues, was the first country to receive a EUR85bn rescue package with contributions from the new funds in November 2010. Portugal received a EUR78bn rescue package in May 2011, and Greece was allocated EUR130bn in a second rescue package in February 2012.

The euro area and the private sector also agreed on private sector involvement (PSI) in the form of debt restructuring, including a 53.5% haircut on Greek government bonds. Collective Action Clauses (CAC) were included in Greek law in last minute changes in order to secure a high participation rate. During the summer of 2012, Spain was granted up to EUR100bn in financial assistance to the country’s banking sector funded via the EFSF. In December 2012, the government received the first disbursement of close to EUR39.5bn. In March 2013, a EUR10bn bailout deal for Cyprus was agreed by the Eurogroup. The deal included PSI through losses on deposits above the EUR100,000 deposit guarantee threshold. An initial agreement that included losses for deposits below the threshold was rejected by the Cypriot parliament. Even though Cyprus is described as unique, the risk of bank runs in other countries may have increased as depositors might fear that bank deposits have become less secure.

Substantial fiscal tightening in the PIIGS countries has resulted in a reduction in budget deficits, but has also caused severe recessions. At the EU summit on 21 July 2011, it was agreed to enhance the capabilities of the EFSF by increasing its actual lending capacity to EUR440bn and allowing it to purchase government bonds in the secondary market (based on ECB analysis) and for EFSF funds to be used for recapitalisation of banks. The European Financial Stability Mechanism (EFSM), which has EUR60bn administered by the European Commission, has also contributed to the rescue packages as does the IMF, which has committed EUR250bn.

To Read the Entire Report Please Click on the pdf File Below.