Lecture 9

Question 1

Road to economic and monetary union

Answer 1

 1979 – 1999: European Monetary System with the European Exchange
Rate Mechanism (ERM)
 1992: Maastricht Treaty: convergence criteria or Maastricht criteria
 1997: Stability and Growth Pact
Two rules on fiscal discipline:
- annual budgetary deficits should not exceed 3% of national GDP;
- government debt should be no more than 60% of GDP.
 1st January 1998: European Central Bank (ECB)
 1st January 1999: adoption of the euro and of a single monetary policy
under the ECB

Question 2

why economic and monetary union?

Answer 2

Why give up control of
monetary policy?
* A single currency makes:
- trade easier b/w members;
- countries interdependent.
* Mundell’s Unholy Trinity.
* The role of ideas: the
triumph of monetarism
over Keynesianism.

Question 3

Governance ECB

Answer 3

The Governing Council is the
main decision-making body of
the ECB. It is formed by:
- 6 members of the Executive
Board;
- the 20 governors of the
national central banks of the euro
area countries.

Question 4

Key characteristics ECB

Answer 4

• The ECB’s primary objective is
  to maintain price stability
  [Article 127(1) of the TFEU];
• Inflation target: 2% over the
  medium term;
• The ECB is an independent
  institution (EU institutions and
  member states have no
  influence).

Question 5

EMU before eurozone crisis

Answer 5

A monetary union without fiscal and banking union

Question 6

From great recession to eurozone crisis, private or public debt crisis?

Answer 6

2007: housing bubble burst in the US;
 Banking crisis and sudden reduction of availability of
credit;
 Governments’ bailout (financial assistance) of financial
institutions in the US and Europe => private debt
became public debt;
 Increasing sovereign spreads as trust in the solvency
of government decreased.

Question 7

Trigger eurozone crisis

Answer 7

2009: The newly elected
Greek government revealed a
much higher budget deficit
than previously declared.

Question 8

Structural causes eurozone crisis

Answer 8

Balance of payment (BOP)
imbalances;
* The architecture of the
Eurozone itself:
 No lender of last resort;
 Monetary union without a fiscal
union;
 “Doom loop” between national
banks and governments

Question 9

Structural causes, eurozone crisis as a BOP crisis

Answer 9

With the adoption of the single
currency, countries in the periphery
were able to borrow at very low rates
* Banks in Europe’s core invested in
faster-growing countries in the
periphery.
Capital Flows Core ➡ Periphery
Borrowed capital mainly fed current
consumption => economic boom =>
bubble => burst & sudden stop =>
inability to repay debt

Question 10

Structural causes; architecture eurozone 1/3

Answer 10

The fragility of the Eurozone (De Grauwe, 2011)
 Eurozone countries issue debt in a currency over
which they have no control;
 It means that countries cannot force their national
central bank to provide liquidity (no lender of last
resort);
 As a result, countries are more exposed to selffulfilling market sentiments;

Question 11

structural causesl eurozone architecture 2/3

Answer 11

The Eurozone is a monetary union without a
fiscal union, necessary to offset the
distributional consequences of monetary policy
or provide a safety net and bailout troubled
states.

Question 12

Structural causes; eurozone architecture 3/3

Answer 12

The Eurozone is a monetary union without a
banking union, necessary to prevent the “doom
loop” between national governments and banks
(governments allow public debt to increase to
save national banks, which, in turn, hold their
own government’s debt).

Question 13

chosen option crisis resolution

Answer 13

Internal adjustment in debtor states, temporary financing and expansionary monetary policy

Question 14

Internal adjustment and temporary financing Greece

Answer 14

To avoid default, Greece was granted loans
by the Troika (IMF, European Commission
and the ECB) in exchange for austerity
measures (tax increases, reforms to enhance
competitiveness and public spending cuts in
categories such as pensions, unemployment
benefits, health and education);

Question 15

Monetary policy

Answer 15

In July 2012, ECB’s President
Mario Draghi announced to be
ready to buy governments’ bond
in the secondary market;
* Financial markets believed in
Draghi’s “Whatever it takes”
and borrowing costs returned to
pre-crisis level;
* The ECB implemented several
other unconventional measures
to keep interest rates down.
Despite some limited debt restructuring, the burden of
adjustment has almost exclusively fallen on debtor
countries, especially on the youth;
* In Ireland, Italy, Spain, Portugal and Greece

Question 16

Changes in economic governance

Answer 16

Fiscal discipline
 European Semester (ex-ante coordination of fiscal
policy);
 Fiscal Compact (2012) to foster budget discipline in
the EU;
 Creation of a permanent fund, the European Stability
Mechanism (ESM).

Question 17

Internal adjustment and temporary financing Portugal + ireland

Answer 17

• Ireland and Portugal’s bailout followed soon;
  However, confidence among creditors was not
  restored and sovereign spreads kept
  increasing, with Italy looking like a mortal
  threat to the euro.

Question 18

Changes economic governance banking union

Answer 18

• Banking Union
   Created in 2014, with a Single Supervisory
  Mechanism and a Single Resolution Mechanism
  (SRM) with a Single Resolution Fund for effective and

Question 19

Monetary policy and unemployment

Answer 19

unemployment has soared, gross domestic product (GDP)
has fallen and the debt-to-GDP ratio has increased;
* Inequality has risen, together with poverty and
homelessness, while mental illnesses and suicides have
increased;
* Last but not least, economic hardship has fueled populism
and anti-EU feelings.