IX EU‘s Sovereign Debt Crisis

1. European Economic Integration - 110451-0992 - 2014 IX EU‘s Sovereign Debt Crisis European Recession Slowing Global Economy Austerity Europeeri OECD Greece and the EURO Governments across the region are taking action to eliminate unsustainable budget deficits Source: http://www.ft.com/intl/indepth/euro-in-crisis Prof. Dr. Günter S. Heiduk Kipper Williams

2. Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of economic Perspectives, 26(3), p. 51.

3. Government EDP debt in the Euro area countries, selected years (percentage GDP) Source:Lojsch et al (2011). The Size and Composition of Government Debt in the Euro Area, Occasional Paper Series, No 132, ECB, p. 17.

4. Source: EUROSTAT, News Release – Euroindicators, No 153-2013, p. 2.

5. Source: EUROSTAT, News Release – Euroindicators, No 153-2013, p. 3.

6. Eurozone, European and/or Global Debt Crisis? Source: Schmieding, H. (2013), The 2013 Euro Plus Monitor: From Pain to Gain, Berenberg, Brussels, p. 2.

7. The Share of Foreign Government Bonds in Bank’s Sovereign Bond Portfolios, 2011 Source:Gabor, D. (2012), The Power of Collateral: The ECB and Bank Funding Strategies in Crisis, p. 20.

8. Financial Imbalances and External Imbalances “A key predictor of a banking crisis is the scale of the preceding domestic credit boom….. The European periphery experienced strong credit booms, in part because joining the euro zone meant that their banks could raise funds from international sources in their own currency—the euro— rather than their previous situation of borrowing in a currency not their own (say, U.S. dollars or German marks or British pounds) and then hoping that exchange rates would not move against them. In related fashion, lower interest rates and easier availability of credit stimulated consumption-related and property-related borrowing. A related phenomenon was the increase in the dispersion and persistence of current account imbalances across the euro area….. (The) current account imbalances were quite small in the pre-euro 1993 –1997 period. But, by the 2003 –2007 period, Portugal (– 9.2 percent of GDP), Greece (– 9.1 percent), and Spain (–7.0 percent) were all running very large external deficits. Conversely, Germany ran very large external surpluses averaging 5.1 percent of GDP, while the overall euro area current account balance was close to zero.” Private Credit Dynamics Current Account Balances (% GDP) Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of Economic Perspectives, 26(3), p. 52.

9. EU‘s twin crisis Blundell-Wignall, A. and Slovik, P. (2011). A Market Perspective on the European Sovereign Debt and Banking Crisis, OECD Journal: Financial Market Trends, Vol. 20(2), p. 2. 9

10. The Risk of Contagion

11. It Started in the U.S. • 2007 US sub-prime crisis • 2008 Spillover to Europe • - Spain Burst of real estate bubble • - Irland Banking crisis • 2009 - Greek Correction of the budget deficit • from 6% to 12% • 2010 - Portugal Speculative attacks in domestic • financial markets • 2011 - Italy Fears of debt spiral • 2012 - France, Austria, ItalyDowngraded by US rating agency • 2012/2013 – Cyprus Banking crisis – exposure to Greek crisis

12. From National Crisis to Crisis of the Euro The brief characterization of the countries at risk shows that their crisis history differs in origin and course. The outcome is the same, namely a sovereign debt crisis. The common peg between these countries is the Euro. Therefore, it is obvious that the national crises merged into the crisis of the Euro Area, last but not least because the other Euro Area members - under the lead of Germany and France – are expected to demonstrate solidarity. The Euro Area members have to fear firstly internal contagion effects and secondly the collapse of the Euro as the symbol of integration of unequal countries. Germany’s and (former) France’s leaders set as their common priority a sustainable solution for the continuation of the common currency.

13. Macroeconomic Imbalances (1) Quarterly GDP, Change over Previous Quarter, in %, Selected Countries, Q3-2007 – Q1-2013 Q3-07 Q2-12 13 Source: Own calculations on OECD National Accounts Statistics.

14. Macroeconomic Imbalances (2) Unemployment Rate (Number of Unemployed as a Percentage of Total Labor Force), Selected Countries, 2007-2011, 2013 X X X X X 2013 14 Source: Own calculation on European Commission, 2011a; U.S.A.: United States Department of Labor

15. Macroeconomic Imbalances (3) Current Account Balance (as Percentage of GDP), Selected Countries, 1999-2012 15 Source: Kam and Shambough (2013), The Evolution of Current Account Deficits in the Euro Area Periphery and the Baltics, WP13/169, IMF,p. 19.

16. Fiscal Imbalances (1) Since 2007 the fiscal balance in most EU Member States as well as in the USA has worsened. Primary Deficit-GDP Ratio, Selected Countries, 2007-2011 Source: Own calculations on OECD Economic Outlook data.

17. Fiscal Imbalances (2) The global recession called in many countries for implementing fiscal stimulus packages. The drastic fiscal slump in Greece, Portugal, Ireland, Spain required external funding which contributed to a significant increase in the government debt. Government Debt-GDP Ratio for Selected Countries, 2007-2011 Source: Own calculations on OECD Economic Outlook data. Forecast 2012 (except U.S.A.): European Commission, 2011a. U.S.A: www.usgovernmentspending.com/federal_debt_chart.html

18. Fiscal Imbalances (3) There are still risks that burden the economies of the debt-ridden countries: increasing interest expenditures, high unemployment rates, current account deficits. Interest Expenditure, General Government (% of GDP), Selected Countries, 20072013 18 Source: Own calculation on European Commission, 2011a. 2011-2013: Forecast.

19. Policy Options to Deal with the Problem of Explosive Debt Scenarios • Cutting spending and raising taxes • Causing inflation to rise • No option as long as the monetary policy is in hands of the ECB • 3. Carrying out structural reforms • - Increasing labor market flexibility • - Reform of EU pension systems • - Improving competition policy: consistency of regulations and governance • Restructuring the level op outstanding debt • Potentially promising, if the primary deficit is small, the need for the • governments to return to the capital market is low, the amount of the • sovereign debt held by domestic banks is low.

20. Fiscal Response to the Global Crisis: 2009 Discretionary Stimulus, % GDP, Selected Countries

21. Government Support Measures to Financial Institutions, October 2008 - May 2010, in % of 2008 GDP The downfall of the US investment bank Lehman Brothers on September 15, 2008 changed the latest banking crisis into a global financial crisis. Because of the globally integrated financial markets, banks in Europe and Asia got instantly caught in this downward maelstrom. Central banks, primarily the FED and the European Central Bank (ECB), and governments reacted with money injections into the banking sector, bailouts and fiscal stimulus packages. Souce: Alter, A. and Schüler, Y.S. (2012). Credit Spread Interdependencies of European States and Banks during the Financial Crisis. Draft, 13.01.2012.

22. Interest Rates Spreads Mirror the Differences in Public Debt (1) Bailouts did not solve the crisis situation. The four countries’ performance regarding the fiscal consolidation did not lead to an easing of tensions. Higher credit default risks increased the interest rates of new government loans especially for Greece, Ireland, Portugal, Spain, and since the end of 2011 also for Italy. Spreads (in Basis Points) of 10-Year Euro Area Government Bond Yields to German Bonds, 2009-2011 Source: Arroyo, 2011, p. 15.

23. Interest Rates Spreads Mirror the Differences in Public Debt (2) Yields on Ten-Year Sovereign Bonds, Oct. 2009 to June 2012 (percent) Source: Lane, P.R. (2012), The European Sovereign Debt Crisis, Journal of economic Perspectives, 26(3), p. 57.

24. Do Markets Believe in Contagion: Who is Next?

25. The “PIGS+1“

26. The Case of SPAIN In order to enter the Euro Area, Spain had to fulfil the convergence criteria of the Maastricht Treaty. The government reduced the budget deficit and achieved the first surplus in 2005. From 1998-2007 the average deficit ratios had been significantly lower than the average of the Euro Area. The public net debt ratio declined from 57% of GDP in 1998 to 26.5% of GDP in 2007. The Central Bank reduced the long-term interest rates to meet the respective Maastricht criteria. The favourable borrowing conditions motivated more and more young people to take a mortgage to purchase homes. Furthermore, the demand for housing increased because of immigration. In the years 2000-2007, approximately 730,000 people a year immigrated to Spain. Prices of houses increased considerably and demand for loans as well. The average level of household debt tripled since the beginning of this century. The intransparent structure of the Spanish banking system masked up the growing lending to the real estate market even after the beginning of the crisis in 2007. The gap between increasing supply and decreasing demand in the real estate market after 2007 resulted in a sharp decline of housing prices, bankruptcy of unlisted regional saving and loan banks and construction firms, growing unemployment in the construction industry, increasing government expenditures on unemployment benefits, decreasing tax revenue, and finally the reversal of the budget surplus of 2% of GDP in 2006 into a deficit of 8.5% of GDP in 2010. Beginning 2010, the run on the banks forced the government to bail out regional savings and loan banks. Estimations on bad loans range from 40 billion Euros to more than 100 billion Euros. The housing market is estimated to reach balance of supply and demand not before 2017. This negative perspective puts further pressure on housing prices. Banks are forced to offer huge discounts for selling their real estate assets.

27. The Case of Ireland Similar to Spain, Ireland had been one of the above-average performing economies in the EU. From 1998 – 2006 the pre-crisis public deficits corresponded closely to the respective average ratios of the Euro Area. Similar to Spain, during this period Ireland’s public debt/GDP ratios declined. But its competitiveness was built on fragile, while wage-sensitive, exports. Funding of infrastructure projects by EU’s Cohesion Policy, increasing wages, tax reductions and a sharp decline of interest rates after joining the Euro Area fuelled the construction and housing sector and resulted in a property and construction bubble. Despite warnings with respect to the sustainability of Ireland’s growth, banks continued to ease loan conditions due to weak bank regulation. They funded the increasing loan demand by extensive foreign borrowing. The U.S. sub-prime crisis fully struck Ireland’s banks, especially the Anglo Irish Bank. The government decided to rescue this bank and to introduce a system-wide bank guarantee. The burst of the bubble instantly led to a sharp fall in tax revenue. Spending could not have been reduced at the same speed. Therefore, the budget deficit exploded in 2008.

28. The Case of Portugal In December 2009 the IMF stated that Portugal’s exposure to the global economic crisis is enhanced by its pre-existing, home-grown problems such as low productivity growth, large gap in competitiveness, and high levels of debt (IMF, 2009). In contrast to Spain, Ireland and Greece, Portugal’s banking sector did not experience similar bank crashes, predominantly because of the absence of a property bubble and stricter bank regulations. The increasing public deficit ratios between 1998 and 2006 raised the susceptibility towards economic shocks. The public debt/GDP ratio also increased but till 2007 remained under the Maastricht criteria threshold of 60%. It has to be noted that the debt burden ratios turned out to be higher than in Spain, Ireland, and even Greece.

29. The case of Greece In contrast to Spain and Ireland, the crisis in Greece has its main roots in long-term deficits in its budget and current account. Compared to the aforementioned Euro Area members, Greece experienced by far the highest increase in and the highest ratios of its budget deficit between 1998 and 2006. Since the introduction of the Euro in 2001 the budget deficit averaged 5% of GDP per year until 2008. During the same period of time the Euro Area average amounted to 2% of GDP only. The public debt/GDP ratio climbed between 1998 and 2006 from 72% to 80%. The former government managed to hide the total amount of the budget deficit in order to fulfil the Maastricht convergence criteria for joining the Euro Area. Statistical revisions in the negative direction undermined the confidence of actors in financial markets. “The roots of Greece’s fiscal calamity lie in prolonged deficit spending, economic mismanagement, government misreporting, and tax evasion” (Sandoval et al., 2011, p. 4). According to the former Prime Minister George Papandreou, inefficient allocation of money resulted from corruption, cronyism and clientalistic politics. The current account deficits averaged 9% per year compared to the Euro Area average of 1%.

30. The case of Italy Italy’s late appearance on the map of severely crisis-stricken European countries is obviously due to the pure size of its economy. Finally, the exposure to the global economic crisis dismantled the long-standing structural weaknesses (IMF, 2010). Low productivity, inefficient and expensive public services – to a large extent responsible for the high deficit -, out-dated infrastructure, rigid labour markets are the main shortcomings of Italy’s economy. Up to now, the banking sector did not need substantial government capital injections. Low confidence in the crisis management forced the former Prime Minister Silvio Berlusconi to resign. At the beginning of December 2011, the new Prime Minister Mario Monti quickly worked out an austerity package of Euro 30 billion that had been accepted by Italy’s Senate on December 21, 2011.

31. The case of Cyprus “After more than a week of messy negotiations, the Troika (made up of the European Union, the International Monetary Fund and the European Central Bank) and the government of Cyprus agreed on a bailout package for Cyprus on 24 March. Cyprus is set to receive a €10 billion loan, on the condition that it shrinks its financial sector and implements austerity policies. Private bank deposits above €100,000 will be taxed at 40% in order to raise the additional €5.8 billion needed to stabilise the country’s de facto bankrupt banks. Euro banking crisis chapter four Cyprus has become the fourth European nation to fall victim to a banking crisis that was caused by irresponsible lending and lax financial regulation – following on the heels of Iceland, Ireland and Spain. Cyprus’ status as a de facto tax haven also played a role in attracting huge amounts of foreign deposits, mainly from Russia and the UK, which inflated the banking sector to such an extent that lending reached 900% of Gross Domestic Product (GDP) in 2011.” Todoulos, C. and Elmers, B. Cyprus – the next chapter of dysfunctional EU debt crisis management, eurodat, 28 March 2013 http://eurodad.org/1545029/

32. Multidimensional crisis? In Europe, those countries were hit first by the financial crisis where governments since the beginning of the decade have been trapped in budget bottlenecks. But also formerly healthy government budgets came under heavy pressure of the financial burden of the stimulus packages. Public revenues could not cover the additional expenses, firstly because of the huge sudden amount due, and secondly because of the declining tax income. The sovereign debt crisis coupled with a currency crisis emerged in many countries as a new type of twin-crisis. This situation was getting even worse when credit-rating agencies downgraded sovereign bonds, especially in several Euro Area member countries. Downgrading hits its preliminary peak on January 13, 2012 when one credit-rating agency lowered the credit-worthiness of nine Euro Area countries. Shortly afterwards, this agency also downgraded the European Financial Stability Facility (EFSF).

33. Country Pre-crisis situation (budget, debt) Origins of crisis Type of initial crisis Development of crisis U.S.A. High budget and current account deficit, even though strong overall competitiveness Housing and banking sector Banking crisis Sovereign debt crisis Spain Better than Euro Area average Housing and banking sector Banking crisis Sovereign debt crisis, currency crisis Ireland Similar to Euro Area average Banking sector, low competitiveness Banking crisis Sovereign debt crisis, currency crisis Portugal Lower than Euro Area Budget deficit, low competitiveness Budget crisis Sovereign debt crisis, currency crisis Greece Lower than Euro area average Budget deficit, current account deficit, low competitiveness Budget crisis State crisis, currency crisis Italy Between core and periphery Euro Area members Budget deficit Budget crisis Sovereigndebtcrisis, currencycrisis Primary Origins and Developments Toward the Sovereign Debt Crisis

34. Itimmediatelycatcheseverbodyseyethatthetrendof bankliabilitiesas well ashouseholddebtincreasedstronger thanthegovernmentdebt, especiallysince 2002. Source: Paul de Grauwe http://www.voxeu.org/index.php?q=node/5062

35. Do wefightthe wrongenemy in the Eurozone? Source: Paul de Grauwe http://www.voxeu.org/index.php?q=node/5062

36. When generalizing the path of the crisis the following sequencing • seems to be plausible: • - Pre-crisis phase: Real-estate bubble or “optimism bubble” • First crisis phase: Banking crunch or sudden decline in • competitiveness resulting in fast increase of • current account deficit or structural budget • imbalances • Second crisis phase: Unexpected recession, drastic drop of tax • income, increasing budget deficit • Third crisis phase: Stimulus package, increasing debt, time lag • in re-structuring public revenues and • expenditures • Fourth crisis phase: Sovereign debt leads to solvency at risk, flight of • capital, currency crisis • - Sixth crisis phase: Political crisis? See Greece after the latest elections

37. Policy Options • Fiscalconsolidation/austerity: Increasetaxes, cutgovernment • spending • Debtrestructuring: Lowerpaymentsforborrower • via renegotiatingthedebt • Inflation: Reducingthe “real“ valueof • thedebt • Growth: Structuralreforms; investment • Financial repression: Forcingthe private sectorto • buygovernmentbondsat • artificiallylowinterestrates

38. Which way is the right one? Austerity policy Bailout policy? Banking union? Common Fiscal Policy? ECB bond buyer? Expansionary policy? Moving toward social union? Rule-based sanktions?

39. European Commission‘s Proposals BANKS Strengthen the banking system, including stronger supervision at the EU level PROGRAMS Financial assistance for countries in difficulty (but with conditions attached) Banking Union? FIREWALL A permanent mechanism (ESM) to stem the risk of contagion to other countries Fiscal Union? RULES Stronger, more effective fiscal rules and greater coordination of economic policies

40. Vicious circle of crisis? FINANCIAL STRESSES and ECONOMY SLOWING ? FINANCIAL CRISIS 2008 EURO SOVEREIGN DEBT CRISIS ECONOMIC CRISIS 2009 POLICY RESPONSE: STIMULUS SURGE IN GOVERNMENT DEBT

41. Governing the Sovereign Debt Crisis • In the EU the core activities on the supranational and national level are • aiming at rescuing banks from getting bankrupt (mainly in 2008/2009) and • financing governments’ debt (since 2009). • Within the Euro Area the rescue of the “systemic” banks • and the maintenance of the public solvency are the top short-term priorities. • Crisis prevention • Stricter bank regulations • It became evident that stricter global bank regulations are not in the • interest of the U.S. and British governments because of the political • power and economic importance of the financial centers of New York • and London. The new Basel III Accord will introduce tighter • requirements for bank capital and liquidity. Furthermore, banks have • to pass “stress tests”. The rules will be put into force in 2013. • The controversial discussion in the EU on the role of the ECB in • financing of governments concluded that the Lisbon Treaty • prohibits the ECB being a lender of last resort to governments.

42. Stricter budget rules • Maastricht Treaty convergence criteria seem to lack enforcement and • sanctions mechanisms. • Fiscal Stability Treaty: intergovernmental treaty which was signed by • all of the member state of the EU European Unio except Czech Republic • and the United Kingdom on 2 March 2012. The treaty will enter into • force on 1 January 2013, if by that time 12 members of the euro area • have ratified it. The treaty requires its parties to introduce a national • requirement to have national budgets that are in balance or in surplus. • General government budgets shall be balanced or in surplus. The annual • structural deficitmust not exceed 0.5% of nominal GDP. Countries with • government debt levels significantly below 60 % and where risks in terms • of long-term sustainability of public finances are low, can reach a structural • deficit of at most 1.0 % of GDP. • The European Court of Justice would fine a country up to 0.1 % of GDP • if this was not done a year after ratification. • Once a country has ratified the Treaty it has another year, until 1 January • 2014, to implement a balanced budget rule in their binding legislation.31 • Only countries with such rule in their legal code by 1 March 2013 will be • eligible to apply for bailout money from the European Stability Mechanism • (ESM).The aim is to incorporate it into EU law within five years of its entry • into force.30

43. 2. Crisis control/mitigation: “rescue (banks)”, “stimulate (economy)”, “clean-up (government’s budget)”. European banks were hit much harder by the crisis than the banks in the U.S.A. and in the Pacific. Between July 2007 and March 2009 approximately 3.23 trillion US$ of market value in the global banking sector was destroyed. European banks lost 75% of their market value As long as banks’ undercapitalization cannot besolved by systemic changes, the fragility and vulnerability will continue. The largest part of commitments and outlays had been allocated to debt and asset guarantees. Purchasing bad assets had not been in the forefront of rescue activities. One of the still unsolved questions is related to the consequences of the restructuring of the banking sector. The crisis has increased the market share of large banks. More banks may reach the size of too-big-to-fail, but at the same time the size of too big to be saved. The discussion on separating universal banks into investment and retail banks may mitigate this problem. Another unsolved question concerns the participation of banks in funding government debt. Despite strong reservations, at the end of 2011 the ECB injected almost 500 billion Euro in loans into the banking sector at a 1% interest rate. More than 500 banks took this money. The sudden increase in liquidity may motivate banks to buy European sovereign bonds. At the end of 2011 the EC stated that “European countries also undertook significant interventions to stabilize their financial sectors. Together, the EU countries injected nearly €300 billion worth of capital into financial institutions and extended €2.5 trillion worth of guarantees. The EU adopted new rules on hedge funds and private equity, and as of January 2011 a new financial supervision system is in place for the 27 Member States.

44. In late 2008 the European Commission took the initiative to propose a European Economic Recovery Plan (EERP) – adopted on December 08, 2008 - aiming to swiftly stimulate demand and boost consumer confidence as well as to prepare the European economy for the future challenges of tougher competition on the global markets (European Commission, 2008). On the one hand, the plan addresses the current causes of the crisis that result from insufficient competitiveness (Greece, Portugal, Ireland), on the other hand the measures should build-up a protective barrier against future recessions. According to the EC’s intention, the plan should guarantee a “counter-cyclical macro-economic response to the crisis in the form of an ambitious set of actions to support the real economy” (European Commission, 2008, p. 6). The immediate endowment of 200 billion Euro is financed by budgetary expansion of the Member States (170 billion Euro) and the EU (30 billion Euro). Member States are explicitly allowed to break the rules of the Stability and Growth Pact for two to three years. The different crisis histories made it inappropriate to design and implement a “one size fits all-strategy”. The plan has been criticized by economists because of its Keynesian approach.

45. In spring 2010 the increasing sovereign debt in the Euro Area called for a new response. The EU Member States agreed to establish the European Financial Stability Facility (EFSF) aiming to regain financial stability. In order to achieve this goal the EFSF provides temporary financial assistance to the members of the Euro Area that are in economic difficulties (EFSF, 2012). The guaranteed commitment is fixed at Euro 780 billion and borrowing limit at Euro 440 billion. The EFSF framework came into force on 18th October 2011. The scope of activities includes issuance of bonds or other debt instruments on the market to raise funds, interventions in the debt primary and secondary market, actions based on a precautionary programme, financing the recapitalization of financial institutions through loans to governments. The financial assistance is linked to appropriate conditionality. The EFSF is part of a wider rescue net which also includes the Euro 60 billion European Financial Stabilisation Mechanism (EFSM) and a Euro 250 billion package from the IMF. The EFSM is authorized to raise funds by the European Commission which are guaranteed by the EU budget.The Member States share is in accordance with their share in the paid-up capital of the ECB. In the middle of January 2012 one credit rating agency downgraded the EFSF to “AA+”. This did not cause a deterioration of the position of the EFSF on the financial market. After June 2013 the EFSF will not be actively present in the financial market, but it will continue in an administrative capacity until all outstanding bonds have been repaid. After controversial discussions the Euro Area member states agreed on leveraging the EFSF in early 2012 by firstly providing a partial protection certificate to a newly issued bond of a member state. After initial issuance, the certificate could be traded separately. Secondly, the creation of one or two Co-Investment Funds would allow the combination of public and private funding.

46. IRELAND rescue In November 2010, agreement on the first loan to Ireland could be achieved aiming to safeguard financial stability in the Euro Area and the EU as a whole. The Euro 85 billion program is financed by Euro 17.5 billion from Ireland, Euro 22.5 billion from IMF, Euro 22.5 billion from ESFM, Euro 17.7 billion from EFSF and bilateral loan from UK, Denmark and Sweden. The conditions require an immediate strengthening and comprehensive overhaul of the banking system(Euro 35 billion), an ambitious fiscal adjustment and growth enhancing reforms especially in the labour market. In 2011, the EFSF in total issued Euro 8 billion. The program foresees a 3-year Euro 3 billion issuance in 2012. PORTUGAL rescue The agreement on Euro 78 billion rescue program for Portugal was achieved in May 2011. The program is equally financed by the IMF, EFSM and EFSF. The three year program is focussing firstly on restoring fiscal sustainability by strengthening budgetary discipline, reforming the health system as well as the public administration, privatizing public assets, secondly on growth and competitiveness enhancing reforms of the labour market, network industries, housing and services sectors, and thirdly on measures to ensure a balanced and orderly deleveraging of the financial sector and to strengthen the capital of banks. In 2011, the ESFS in total issued Euro 8 billion. In 2012, a three years Euro 3 billion issue will be placed.

47. GREECE rescue • First package • In May 2010, Greece got a Euro 110 billion loan within the • framework of the newly established EFSF. The Euro Area Member States contributed Euro • 80 billion and the IMF Euro 30 billion to this first Greek bailout. The financial support was • provided under strong policy conditionality. The latter allows the IMF/EU to check Greek’s • performance each quarter. In 2010, Greece has to reduce the fiscal deficit by 5 percentage • points. Measures reducing the deficit include an increase of the VAT, increase in excise • taxes on fuel, cigarettes and drinks, a windfall tax, a property tax, near abolition of 13 • and 14th month pay in the public sector, cut of Christmas and Easter bonuses, cuts in • pensions, reducing early retirement. • Second package • March 2012, Eurozone Finance Ministers agreed on a Euro 130 billionrescue after Greek • governmentagreedtocommittoconsiderablebudgetcutsas well astoforce private • bondholders to waive part of their claims. The IMF contributes Euro 28 • billiontothebailoutpackage. • Commitmentsofthemainstakeholdersare: • Bugetcuts: Reducingthepublicdebtto 120.5% of GDP by 2020. • Permanent surveillanceby an increased European presence. • Approximately Euro 100 billiondebtwritten off bybanksandinsurers (swapbondsfor • longer-dated securities at lower interest rates). • Private sectorholdersofGreekdebtagreedtowrite-down 50% ofthe nominal value • whichmakesuparound 70% loss on thenetpresentvalueofthedebt.

48. 3. Crisis resolution The agreement on the establishment of a permanent crisis resolution mechanism – the European Stability Mechanism (ESM) - was achieved in June 2011. The summit on January 31, 2012 clarified legal details. UK did not sign the treaty. Czech Republic did not sign the treaty at that date because of constitutional reasons. The ESM has to execute the same tasksas the EFSF. The ESM was established on 27. Sept. 2012 as an international organisation. The total subscripted capital will be Euro 700 billion with an effective lending capacity of Euro 500 billion. According to the latest information there seems to be discussions aimed at combining the ESFS with the ESM instead of replacing the ESFS by the ESM. If the IMF provides a third Euro 500 billion funding, the total available backstop fund will increase to Euro 1.5 trillion. The adequacy of this ceiling will be reassessed in spring 2012. TO SUM UP In principle, the EU and the U.S.A. are facing a similar economic situation: fiscal deficit, sovereign debt crisis, economic recession. The governance strategies differ sharply: Whereas in the EU common efforts of the EU, ECB and IMF to finance budget deficits of the four crisis countries are strongly conditioned on fiscal consolidation, the U.S. government turns its primary attention to spur growth by introducing new stimulus measures.

49. European Stability Mechanism Bailout in total since 2008 (Euro billions) Cyprus I + II 12.5 Greece 245.6 Hungary 15.6 Ireland 67.5 Latvia 4.5 Portugal 78.0 Romania 19.6 Spain I 41.4 ______ Total 484.6 Distribution of contributions Germany (27.1464%) France (20.3859%) Italy (17.9137%) Spain (11.9037%) Netherlands (5.7170%) Belgium (3.4771%) Greece (2.8167%) Austria (2.7834%) Portugal (2.5092%) FInland (1.7974%)

50. “Especially the Eurozone needs not only monitoring the government budget debts and deficits, but also monitoring the private sector imbalances, in particular private debt levels. The issue here is how this monitoring can be made effective so as to avoid new crises. One can have doubts whether this can be achieved without a further transfer of sovereignty to European Institutions.” Paul de Grauwe