Tuesday, 13 September 2011

What's going on with the Eurozone?

There are 17 countries in the Eurozone and the problem with that are the differences in their economies (people often call it two-speed Eurozone). In the first quarter of 2011 the economic growth of these countries reached 0,8% (0,5% in the UK) and was influenced by impressive 1,5% growth in Germany, 1% in France and 0,8% in Greece. On the other hand, there are countries, for example Portugal, which fell into recession after two consecutive quarters of negative economic growth. 

What has contributed to the German, French and Greek economies surging ahead?
In the Europe’s biggest economy, Germany, the key factors of high economic growth were strong domestic demand, investment boom and, a higher than ever measured, rise in exports (especially to China and emerging countries in Eurozone) and imports. What is extremely important, as explained by George Osborne, the Chancellor of the Exchequer of the UK: “Germany shows what you can do if you fix the roof while the sun is shining”. Before the crisis in 2008/2009 they have implemented many reforms, which now gave them a huge advantage over other countries in the Eurozone. Cutting public spending, raising VAT and implementing labour reforms in good times saved them in bad times.

In France, the economy grew by 1% due to higher spending and investments. According to the economy minister of France, Christine Legarde, manufacturing had been a particularly stong driver of growth.

Greek growth could be partly explained by adjustments to the previous quarter’s data and higher exports.

Why is there such a north-south divergence in growth within the eurozone?

- dependence on tourism

- problems in one country cause the neighbours’ economy to slow down (Spain and Portugal for example)

- more industrialised countries, such as Germany or France, export more expensive goods to other parts of the world

What is the most suitable monetary policy for those countries growing more strongly?

Increasing interest rates would probably cause those countries do growth faster and higher. It would encourage people to save money more rather than spend it. It would also increase the value of the the euro and reduce inflation.

What is the best direction for interest rates and hence the value of the euro for countries, such as Spain, Italy and Portugal?

For these countries the best thing to happen is a reduction of interest rates and the value of the Euro. A decrease in interest rates lowers the cost of borrowing and that leads businesses to increase investment spending, and households to buy more goods. 

’The UK economy would be in a worse position if it were a member of the eurozone’. What are the arguments (a) for and (b) against this statement?

a) 1. Many differences between the members of Eurozone make it more unpredictable (2-speed zone)

2. The UK’s would be more connected to fluctuations of Euro caused by problems in southern European countries.

3. Interest rates would be set by the ECB and are the same in the whole zone (in terms of, for example, different times of recovery).

b) 1. Lower transaction costs, which improve export and import rates.

2. The growth in Germany, the biggest British trade partner in the EU, could improve the situation in the UK.

What is the relationship between interest rates, the exchange rate and growth?

If interest rates go up there is higher incentive for investors from abroad to put money in this country, which would cause a higher demand for currency and higher exchange rates. Increase of the value of the currency would decrease exports and possibly reduce or slow down economic growth.

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