Turbulent Times in the Euro Zone

Abstract

Newspaper headlines and editorials revealed the intense attention the euro zone had received in the last few months. The current crisis occurred shortly after Greece announced that its 2009 budget deficit was 13% of GDP—twice as high as previously predicted. For some, this was the beginning of the end for the euro zone. Could it lead to the demise of the euro altogether? Others insisted that expelling Greece might be necessary. In tune with headlines at the time, the exchange markets did not display much confidence in the euro. By summer 2010, the euro had lost at least 10% of its value against the dollar since the beginning of 2010. Financial markets were nervous. What should EU leaders do help stave off a major crisis? Excerpt UVA-GEM-0100 Apr. 6, 2011 Turbulent Times in the Euro zone Newspaper headlines and editorials revealed the intense attention the euro zone had received in the last few months. A wide range of opinions prevailed, and there was much advice circulating. The current crisis occurred shortly after Greece announced that its 2009 budget deficit was 13% of GDP—twice as high as previously predicted. For some, this was the beginning of the end for the euro zone. Time magazine in February 2010 openly wondered: “Will it lead to the demise of the euro?” Others, including some German officials, did not go quite that far, but they insisted that expelling Greece might be necessary. Some observers saw the Greek predicament as indicative of a larger issue. One Harvard professor called it a symptom of “a fiscal crisis of the Western world.” His assessment found many echoes. Some commentators saw the United States as the next Greece. In tune with these headlines, the exchange markets did not display much confidence in the euro. By summer 2010, the euro had lost at least 10% of its value against the dollar since the beginning of 2010 (Exhibit 1). Financial markets were nervous. Some observers wondered whether one could rationalize the sudden depreciation of the euro in terms of either the prevailing interest rate differentials between Europe and the United States or the current account deficits for both economic regions and trends in price levels in both countries. Exhibits 2 to 4 show these indicators, which are commonly used to assess the short-, medium-, and long-term movements of exchange rates. Finally, after much delay, the leaders of the European Union (EU) decided it was time for action. On May 9, they came out with a plan that would display European unity. In anticipation of the plan's release, the Daily Telegraph wrote “Europe Prepares Nuclear Response to Save Monetary Union.” French President Nicolas Sarkozy used very strong language: . . .