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Rise of The Global Economy

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on 7 May 2015

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Transcript of Rise of The Global Economy

Benefits of the Euro:
1. Elimination of Exchange Rate volatility

2. Low inflation and long term interest rates








2. Lower transaction costs

ECON 2105
Rise of The Global Economy
EU founded in '57

Purpose was to have integrated common market for Member States

With globalization, need for closer economic and monetary co-operation

Euro was born when Maastricht Treaty was signed in '91
Brief History of the Euro
How it came to be
GFC
How the Euro Crisis Started
Merkel says "each Eurozone state looks out for themselves"

Greek government revealed large budget deficits

Fears over Greece's inability to finance debt

Fears spread to PIIGS

Skouras: Root of crisis is in "unfinished construction of Euro"
Benefits from stable exchange rates and low transaction costs:
Optimum Currency Areas
Alphandéry says "full-fledged" currency union only requires self-correcting market in a region

Questionable OCA
1) North & South have different economic links
Exposure to asymmetric shocks
Imports vs Exports

2) Limited labour mobility
Cultural differences & language barriers
Labour market reforms

3) Neither right fiscal mechanisms nor federal budget to control shocks
Can't adjust inflation rates individually
No fiscal union, capital movement restricted
Outlooks
Future Benefits for New Members?
Current state:
Eurozone economic growth slows, now in deflation

European Fiscal Compact
Established in December '11 during the European Summit

Greece becomes debt sustainable?
Greek government debt crisis officially forecast to end in 2015
However, assumption is that it will meet primary surplus target of its bailout program in '15 and '16

Introduction of QE
Enter Economic and Monetary Union (EMU) 2.0 (including ESM).

Integrate themselves into cross-border production chains

E.g. Croatia already very 'euroised'
Labour Reforms
Increase bond buying
Money Supply Increases
Stimulates the Economy
Economic Growth within the Eurozone
Easing of dismissal rules

Financial incentives/tax breaks

More flexible term of contract
Low inflation rates among Eurozone members

Credibility gains for members with low market credibility

Increased competition among Eurozone members
Bond Yield Decreases

Long Term Interest Rates increases
Imports vs Exports
North relies on saving, trade surpluses & export-led growth

South has high consumer spending, weak public finances & borrowings (debt)

Crisis > Default risk > Contagion > Bear market > Euro depreciation > Cheaper exports

Thus, crisis benefits North, not South
END
Credit Ratings & Market Sentiment
Euro strongly linked to credit ratings - spill-over effects (contagion)

Greek & Irish bond downgrades -> Depreciation -> Bailouts -> Appreciation -> Rising debt levels accompanied by negative ratings -> Depreciation -> Reduce consumption, investment & aggregate demand

CRAs fueled rising debt in EU (Gartner & Griesbach 2012)

Rating announcement a self-fulfilling prophecy (Baum et al. 2014)

Utzig (2010) raises questions on how CRAs can be regulated
Conclusion
"It depends"

"Structural reforms" are just "magic economy improving dust", but maybe there can be something less ambiguous in the next 10 years

QE, if it works, should only be good in the short term, but long-term effects unknown

Germany seems determined to keep the Eurozone together

But everyone has a limit, and Germany can't simply sign blank cheques for indebted nations forever

Can North & South monetary credibility gap remain as it is in the future?

Would markets be prepared or react to another crisis in the future?

Can criteria of OCA be fulfilled eventually, especially political & fiscal union? Can Greece finally establish its own fiscal discipline?

Question
Will the Euro exist in its current form 10 years from now?
Agenda
Brief History of Euro

How the Euro Crisis Started

Benefits of the Euro

Costs of the Euro
Labour Reforms
Imports vs Exports
Optimum Currency Area

Market Sentiments

Outlooks

Conclusion
http://ec.europa.eu/economy_finance/publications/publication13486_en.pdf
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