Essay on "Europe Debt Crisis the Maastricht Treaty Produced"

Essay 11 pages (3410 words) Sources: 7

[EXCERPT] . . . .

Europe Debt Crisis

The Maastricht Treaty produced a set of criteria which were to be met by countries seeking to join the Eurozone and adopt the euro as their currency. During the initial evaluation, Greece failed to meet the criteria, but later gained entry by way of fraud. The current economic crisis has exposed Greece and created a sovereign debt crisis in that country. Other economies have also suffered, in particular Ireland and Spain, which both face deflation and sky-high unemployment.

The situation in Greece is the worst of the three, with its debt achieving junk status as the interest rate on the 10-year note breaking the 10% barrier. The result is that each of these countries will be forced to face potentially years of debilitating deflation and unemployment in order to bring costs into line and restore those countries to international competitiveness. Stronger Eurozone countries will also suffer, as they will be forced to make transfers to weaker nations in order to maintain the stability of the currency union.

Introduction

In December 2009, Fitch downgraded the rating on Greece's long-term debt from A- to BBB+, marking the beginning of the Euro debt crisis. Greece has become the poster child for the problems in the Eurozone as a result of this crisis, but it was not alone in having difficulties. The Greek government, faced with an increased cost of borrowing, was forced to respond with austerity measures to get its deficit under control in order to demonstrate to bond markets that it could meet its obligations. These measures brought significant protest from the Greek people. More austerity measures were introduced, but even these could not stave off the need for a bailout, funded primarily by Germany (Wearden, 2010). The crisis in Greece is the most intense in Europe, but other Euro countries -- most notably Span and Ireland -- have also come under threat of similar crisis. Unlike Greece, however, those other two have not required bailouts, though they have seen their borrowing costs increase over the course of 2010 (Krugman, 2010). This paper will study the Eurozone debt crisis, with particular attention to the cases of Greece, Spain and Ireland. An attempt will be made to explain the nature of the crisis, and what the ramifications are of the increase in sovereign risk in these three countries.

Joining the Eurozone

The first distinction that needs to be made is between the European Union and the Eurozone. The European Union is a political body that attempts to streamline trade between its members and provides a consistent environment with respect to the governance of trade outside of the bloc. Within the European Union, sixteen of the twenty-seven constituent states have adopted a single currency, known as the Euro. These countries form the Eurozone. This distinction is critical because the nature of the common currency is one of the reasons why economic commentators are most concerned about the debt situations in Greece, Spain and Ireland.

The first of the three countries to join the European Union was Ireland, in 1973. Greece joined in 1981 and Spain followed in 1986. When the Euro was created, Ireland and Spain were among the founding members of that currency zone. Their currencies were pegged to the Euro in 1998 and when the Euro came into existence in 2002, Ireland and Spain adopted the common currency. Greece's ascension into the Eurozone came later. The drachma was first pegged to the Euro in 2000, and Greece was able to adopt the Euro upon its inception in January 2002.

The steps that Greece undertook to enable it to join the Eurozone were dramatic, and included steep cuts in inflation and interest rates. While the Greek government hailed this achievement at the time, there were problems, particularly concerns with the ability of Greece to maintain the strength of its economy (Wearden, 2010). Greece had been left out of the Eurozone initially in 1999 because it had failed to meet the strict economic criteria for inclusion. At the time, investors worried that Greece's inflation rates were still too high, as was its level of public debt (BBC, 2001). These criteria are known as the Maastricht Criteria, a reference to the Maastricht Treaty that in 1992 signaled the intention to create a common European currency.

The Maastricht Criteria

The Maastricht Criteria were the set of economic conditions that countries had to meet in order to join the Eurozone. The criteria are, as defined in Article 121(1) of the European Community Treaty, as follows:

1. "The achievement of a high degree of price stability; this will be apparent from a rate of inflation which is close to that of, at most, the three best-performing Member States in terms of price stability." This was defined as being a rate of inflation that does not exceed by more than 1.5 percentage points of the three best-performing member states."

2. "The sustainability of the government financial position; this will be apparent from having achieved a government budgetary position without a deficit that is excessive, as determined in accordance with Article 104 (6)." This was defined as a deficit to GDP ratio no greater than 3%.

3. "The observance of the normal fluctuation margins provided for by the exchange-rate mechanism of the European Monetary System, for at least two years, without devaluing against the currency of any other Member State."

4. "The durability of convergence achieved by the Member State and of its participation in the exchange-rate mechanism of the European Monetary System being reflected in the long-term interest-rate levels." This was defined as the country having an interest rate that does not exceed by more than 2 percentage points that of the three best-performing members. (European Central Bank, 2010).

Greece met the third condition by virtue of having tied its currency to the Euro on January 1, 2000, allowing it to adopt the Euro when the first European notes and coins were released on January 1, 2002. Greece initiated an austerity program in order to cut inflation and interest rates in time for 1999, when those numbers would be examined for consideration of entry into the Eurozone. In 1998, when Greece was not admitted for entry into the Eurozone, it had an inflation rate of 5.2%, a deficit to GDP ratio of 4% and long-term interest rates of 9.8%. These figures were significantly above those of other nations being admitted into the Eurozone and as a consequence Greece was rejected (Antweiler, 2001).

The wording of the criteria allows for some flexibility, however. Admittance to the Eurozone need not be based on strict meeting of the entry criteria, but rather on a demonstration of fiscal stability. If a nation falls outside the Maastricht Criteria, but can demonstrate that these figures are moving in the right direction strongly, it can be admitted. It has been intimated that both France and Germany had temporary deficits above the 3% criteria, but that this was forgiven in order to ensure the strength of the new currency (BBC, 2004). Indeed, if the deficit criteria are not met, then a debt criterion must be met, set at 60% of GDP. While France and Germany sat around that level, many countries that were admitted to the Eurozone were well above that level, including Belgium (122.2%), Italy (121.6%) and the Netherlands (72.1%) (Antweiler, 2001). The debt criteria, then, was largely overlooked as a means by which to judge the public finances of the countries applying for membership to the Eurozone. Greece, however, had a very high level of public debt in 1997 of 108.7%, the third-highest of all candidates.

In 2004, Greece revealed that it had fudged some of the numbers that were used to allow it to become admitted into the Eurozone. In particular, its level of deficit in 1999 -- the year being measured -- was 3.38%, well above the 3% threshold. This represented an improvement, however, and the European Central Bank decided not to take action against Greece at the time, even though its deficit had ballooned in the interim as a result of the cost of hosting the 2004 Summer Olympic Games (BBC, 2004). By 2004, the Greek deficit had hit 5.3% of GDP and the total debt had hit 112% of GDP. Among the causes were that military spending was not included in the budget and some debt -- including that used to fund public services -- was hidden from the budget as well (BBC, 2004, 2).

For their part, Ireland and Spain met the Maastricht Criteria in 1998 and were allowed to join the Eurozone immediately. Ireland had inflation of 1.2%, a budget surplus, and long-term interest rates at 6.2%, well below the target of 7.8%. Spain had an inflation rate of 1.8%, a deficit of 2.6% of GDP and long-term interest rates of 6.3% (Antweiler, 2001). At the time, these countries looked as stable as any other in the Eurozone. Although each had government debt over 60% of GDP, their figures were not out of line with those… READ MORE

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