Euro Debt Challenges and Crisis Essay

Economic Questions

Part 1.

The European Central Bank (ECB) faced several challenges when implementing monetary policy in response to the 2007 crisis. First, ECB experienced difficulty in assessing and projecting the period of time that the monetary policy would have an effective impact. Second, there was difficulty in estimating and forecasting inflationary pressures (ECB, 2011). The third challenge was the high level of fragility of the financial markets in the European nations due to the impact of the crisis. Last, ECB was concerned with the effectiveness of the transmission system for the monetary policy due to concerns of spiraling public debts Euro Debt Challenges and Crisis Essay.

By mid-September 2008, the crisis led to a halt in the interbank trading. ECB responded by establishing measures meant to increase liquidity to the banks. To achieve this, ECB implemented its “enhanced credit support” strategy, which included measures such as covered bonds purchases, using foreign currencies to provide liquidity, long-term liquidity provision and collateral expansion (Rodríguez & Carrasco, 2016). In addition to the above policies, ECB reduced the main refinancing operations rate to 1 percent by May 2009, from 4.25 percent in July the previous year (Rodríguez & Carrasco, 2016). The ECB’s overall policy was appropriate since it would increase the amount of money in circulation and stimulate demand. However, ECB is criticized for late response and lack of aggressiveness in policy development and implementation.

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The measures by ECB improved the economic conditions of the European countries in the short-term. First, they facilitated economic recovery and stability in the most affected countries, such as Ireland, Greece and Portugal. The measures reduced the spread of public debts and helped to prevent impeding deflation, leading to stability of prices for commodities (Rodríguez & Carrasco, 2016. However, ECB was criticized for the lack of effective long-term measures Euro Debt Challenges and Crisis Essay.

Part 2.

Celtic Tiger was a phenomenon characterized by rapid economic growth in Ireland between 1997 and 2007. The most significant cause of the phenomenon was increased foreign direct investment in the country. Examples of the foreign multinational firms that invested in the country are Microsoft, Intel and Dell. One of the root factors that attracted foreign companies was low corporate taxation rate in the country, which ranged between 10 and 12 percent in the late 1990s (Donovan & Murphy, 2013, p. 27). The second factor was the presence of policies that supported business investment, such as presence of subsidies for the organizations. IDA Ireland provided investment capital to the organizations in need. Further, membership of Ireland in EU enabled it to access structural funds which it used to support development and business investments. (Donovan & Murphy, 2013, p. 28) Last, the number of tech-savvy young people entering the workforce in Ireland was high.

The death of Celtic Tiger occurred during the global financial crisis that peaked in 2008. Ireland was the first country in the European region to declare that its economy had entered a recession in September 2008. The recession followed a property bubble boom burst as well as the collapse in consumer spending. The crisis occurred as an extension to the economic problems that had occurred in the US. Iceland’s banking system collapse was also a major contributing factor (Zamora-Kapoor & Coller, 2014). Apart from Ireland, Iceland’s banking system and the global financial crisis with roots in the US caused recession in Spain and Greece. Similar to the case of Ireland, the crisis in Greece and Spain was characterized by low consumption, struggling banks, increased public debts, high unemployment, low economic activity and increased borrowings from ECB (Zamora-Kapoor & Coller, 2014). Unlike in Ireland, however, Greece and Spain experienced significant increase in social unrests, inequalities, weakening public institutions and political disaffection Euro Debt Challenges and Crisis Essay.

Question 2

Part 1.

Quantitative easing (QE) is a strategy in which the central bank purchases government bonds, mortgage securities and other assets from commercial banks. The money received by the commercial banks is used to lend to the individuals and businesses at lower interest rates. Eventually, this leads to an increase in the amount of money circulating in the economy. The money causes increase in investments and aggregate demand (Langdana, 2009, p. 17). Thus, QE helps to stimulate economic growth and that is why it was used by ECB and FED during the 2008 financial crisis.

Part 2.

Covid-19 significantly has affected global markets. The pandemic has led to drastic decline in the demand of most products. Demand decline has caused major reductions in the prices, as experienced in the oil industry. At the same time, demand many consumers and reduced spending to hedge against unexpected uncertainties due to the pandemic. In order to address the issue, expansionary fiscal policies are necessary (Harding, Greeley, Arnold, 2020). At the same time, the use of monetary policies should be limited. QE should not be considered an effective strategy considering that the situation is exceptional.

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Examples of expansionary monetary are reductions in payroll and personal income taxes reductions and taxes levied to firms and increase in government spending. Such strategies help to increase the amount of money held by businesses and individuals and hence, increase spending. In addition, monetary policy involving reduction in the interest rates is necessary. The central banks should reduce the lending rate to the commercial banks. The commercial banks should respond by reducing their lending rates. Thus, the amount borrowed will eventually increase. The strategy will also help to stimulate demand as spending by individuals and businesses increase Euro Debt Challenges and Crisis Essay.

However, the use of monetary policies may not be very effective in the end in addressing the possibility of recession. As well, QE, which also stimulates borrowing, should not be considered as an effective option to use at this moment. While reduction in interest rates by the banks may stimulate some of the individuals and businesses to borrow initially, most of them will be driven by the need to fill liquidity gap problems. Due to the uncertainty involved, most individuals and businesses would not be attracted by more loans for investments. In most countries, movement is being restricted (Harding, Greeley, Arnold, 2020). The labor market is affected to the extent that firms, especially in the service sector, are laying off workers. Even if businesses invest to add supply, the demand for their products will still be low. In response to the restrictions and uncertainties, firms are not willing to borrow money to make investments. Thus, it is not advisable to use QE as a way to stimulate borrowing amid the coronavirus pandemic crisis. The best option should be to focus on the expansionary fiscal and monetary policies with a focus on long-term planning Euro Debt Challenges and Crisis Essay.

References

Donovan, D., & Murphy, A. E (2013). The Fall of the Celtic Tiger: Ireland and the Euro Debt

Crisis. Oxfored: OUP Oxford.

European Central Bank (ECB) (2011). The global financial crisis and the role of central

banking. [Online] https://www.ecb.europa.eu/press/key/date/2011/html/sp110412.en.html [Accessed 24 April. 2020]

Harding, R., Greeley, B., & Arnold, M. (2020). Coronavirus: why central bankers say it is time

for fiscal stimulus [Online] https://www.ft.com/content/606f1c8c-5f96-11ea-8033-fa40a0d65a98 [Accessed 24 April. 2020]

Langdana, F. (2009). Macroeconomic Policy: Demystifying Monetary and Fiscal Policy.

Newark, NJ: Springer Science & Business Media

Rodríguez, C. & Carrasco, C. A. (2016). ECB Policy Responses between 2007 and 2014: A

Chronological Analysis and an Assessment of Their Effects. Panoeconomicus, 63(4), pp. 455-473

Zamora-Kapoor, A., & Coller, X. (2014). The Effects of the Crisis: Why Southern Europe? The American behavioral scientist, 58(12), pp. 1511–1516 Euro Debt Challenges and Crisis Essay .

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