URC paper

Topics: Economics, Macroeconomics, Investment Pages: 9 (3161 words) Published: January 26, 2014

Research methods – 3301

The European sovereign debt crisis has left the confederation that makes up the European Monetary Union (EMU) in shambles. Portugal, Ireland, Italy, Greece, and Spain in particular have experienced recessions to a degree that no other EMU country has experienced, due largely to each of these countries tremendous amounts of government debt. Fiscal instability in the region forced the governments of these countries’ to implement harsh austerity measures. However, the austerity has caused political unrest that has led to riots and anti-government protests. I posit that the financial and political unrest in the EMU has caused a decrease in foreign direct investment (FDI) to these five countries. Not knowing whether a country will be solvent in the future adds quite a bit of clout when Multinational Companies (MNCs) are looking to invest in a particular country. The lack of policy stability in the region will also cause a decline in FDI.

When the EMU started to falter in 2009, Greece was on course to have a debt-to-GDP ratio of 198%. This was clearly unsustainable and something had to be done, so the International Monetary Fund (IMF), the European Central Bank (ECB), and other members of the EMU stepped in and attempted to aid the Greek government in turning their economy around. Action was taken to save Greece from bankruptcy, but more importantly this was an attempt to stabilize the value of the Euro. By not stabilizing the value of the Euro the entire currency was at risk of severe devaluation. However, the citizens of Greece were opposed to the “bailout” because it imposed austerity in order to get them on a path to solvency. Riots quickly ensued that shook the political class in Greece causing them to rethink the harsh measures imposed by the IMF, ECB, and other EMU members.

Other countries in the region adopted the Greek model of success and have found themselves in similar economic circumstances. Greece was the tipping point for the European sovereign debt crisis and has had a domino effect on other confederation members, but not to the same extent. With Portugal, Ireland, Italy, Greece, and Spain on a decline economically, foreign investors will seek out emerging markets for their entrepreneurial endeavors as opposed to those on the decline. Intro

Financial and economic crises have occurred throughout history the first known documented crisis happened in 1830. The European Monetary Union is not the first region with financial woes. During the mid 1990’s East Asian countries experienced a similar situation that the Euro-Zone is currently facing. Much like the European financial crisis the Asian financial crisis began in one country and spread like a wildfire. In Asia the country that sparked the downturn was Thailand, while in Europe it was Greece. These two regions have countries that are economically tied together. This is important to note because crises of this sort can typically be contagious throughout a region, as we see in the case of the EMU as was observed in the East Asian crisis. “…Evidence indicates that a stronger trade linkage is associated with higher incidence of a currency crisis”(Salaheen 2005). This implies that countries that rely on import and export economies will be disproportionally vulnerable to currency crises, because of their economic interdependence. However propinquity is not the only commonality.

These regions also suffered from an unsound banking system (Cabalu, 1999). The banks were practicing excessively risky lending practices, which created a bubble that was bound to burst. This coupled with the Yen being pegged to the dollar made it difficult to float their currency, further complicating monetary policy. This caused strife for the East Asian countries, because as the US dollar goes down in value with respect to the Yen; they gained competitiveness in trade-weighted terms. When the US dollar appreciates with respect to the Yen the...

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