Q1. What is the future of euro zone?

Introduction

The collective group of countries which use the Euro as their common currency. The Euro zone came into being in 1999, and originally consisted of 11 countries. As of 2009, 16 countries were part of the Euro zone. The Euro zone does not include every country in the European Union (some countries are not yet using the Euro), and does not include every country who is using the Euro (to become part of the Euro zone, the country must use the Euro as its sole legal currency). As a currency union, monetary rules are created and maintained by the European Central Bank. The Euro zone currently consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. Of the 10 EU member states outside the Euro zone, seven states are obliged to join, once they fulfill the strict entrance requirements.

Discussion

The future of the Euro zone.

In the run up to the crisis meetings of May 2010, EU leaders witnessed a rapid loss of market confidence in government bonds. This loss of confidence not only affected bonds issued by the Greek government but also by several other Eurozone members. The default insurance premium on government bonds picked up rapidly for several countries, indicating that the market had revised its expectations about these governments’ ability and/or willingness to honour their outstanding debt. Country leaders reacted. Over the second weekend of May, they constructed what is known as the €750 billion rescue device. It consisted of the European Financial Stability Facility and additional guarantees provided through the IMF. In hindsight, some policymakers admit that the initial idea was that a European promise of support of this size would be sufficient to re-establish confidence among market participants. The hope may have been that market participants return to their prior expectations about government bonds, namely that holding these bonds was perfectly safe and that the bonds of different Eurozone members were almost perfect substitutes. A failed policy Now, one year later, it is clear that the plan has gone spectacularly wrong. In addition to the €110 billion rescue package for Greece, the governments of Portugal and Ireland had to be rescued. These countries have received considerable financial aid from the rescue facility while other countries such as Spain or Italy are candidates that may follow. Markets most definitely did not return to their old expectations. Indeed the insurance premiums for many of the relevant countries – including the ones rescued – are higher in May 2011 than they were in May 2010. Officially, Greece was supposed to return to the private capital market after a period of no more than three years. But rather than an improvement in credit worthiness during the last 12 months, we have seen a process of deterioration. Rather than preparing for a return to the private capital markets, Greece has entered into debt renegotiations about prolonging the help and easing the debt burden further. There is seemingly almost a consensus that Greece cannot reach a financially healthy situation without either a partial devaluation of its debt in the process of a default followed by a debt restructuring, or massive foreign transfers. Policy options going forward Many key players inside the Eurozone seemingly want to rule out state bankruptcy inside the Eurozone. Early on, the German Chancellor considered intergovernmental transfers or financial aid as the “ultima ratio”, where economists would consider a process of default and debt restructuring as the more adequate “ultima ratio”. We expect that the political process will drift further into this other direction, essentially further socialising financial responsibility, and generating a common pool as regards European government debt. European leaders may first try to implement fiscal sustainability via strengthening supervision and by a modified enforcement mechanism with sanctions for excessive government deficits, together with strict conditionality in case a country has to rely on fiscal aid from the newly installed European Stability Mechanism. We are convinced that this will not work. And once these attempts have failed, this could, directly or indirectly, lead to a dramatic expansion of the system of financial transfers between the member countries inside the Eurozone or the EU as a whole – a system in which a constant flow of funds from countries with sound public finances prevents some other countries from bankruptcy. Such a transfer system exists in a rudimentary version in the context of the common agricultural policy and in the context of cohesion funds as part of EU policy. This argument is frequently used to suggest that a transfer union is not a dramatic change, compared to the status-quo. But this argument drastically downplays such a change. To make this very transparent, it may be useful to get a feeling for the magnitude of the fiscal transfers we would observe if we simply scaled a system such as the system of intergovernmental transfers in Germany between the regions to the European level. Nobody, as far as we know, proposes such a system in the current state of affairs. And this thought experiment is, of course, not meant as a policy proposal here either. It is meant as an illustration of the excessively large sums that are at stake if the EU moved towards a transfers union of any kind. Conclusion A transfer union of the type described here is clearly not a desirable perspective. And the massive volume of transfers is also unlikely to be economically or politically viable. Although such a transfer union could be the logical endpoint of the path which European policymakers are currently pursuing, we consider a transfer union of this type as unlikely. A more likely outcome is a breakdown of the Eurozone prior to reaching this endpoint. One possible reason for this breakdown is a rise in political tensions among member countries. A second, more likely reason is the bond market’s possible loss of confidence in the sustainability of the Eurozone as whole. .

Submitted by:- Ankit Gupta (MBA sem 1 c)

Submitted To:- prof. Gurdeepak singh

friday,26,aug,2011