Understanding the European Debt Crisis – Part Two

The European Union (EU) is an economic and political union of 27 sovereign (i.e. independent) member countries located primarily in Europe. The EU was created after World War II with the goal of fostering peace, economic cooperation and prosperity for its member countries. The EU has a combined population of over 500 million people and comprises about 25% of the world economy. The Council of the European Union is the EU’s main decision-making body, and each EU member country takes a turn to hold the Council Presidency for a six-month period. Every Council meeting is attended by one minister from each EU country.

 The Eurozone consists of seventeen European Union member countries including France, Germany, Greece, Ireland, Italy, Portugal, and Spain, that have adopted the euro (€) as their common currency. The United Kingdom is an EU member but is not part of the Eurozone. The European Union with a population and GDP that exceeds that of the United States is an important political and economic factor in the world.

In order to impose fiscal discipline, member countries of the Eurozone must agree to comply with the Stability and Growth Pact (SGP), adopted in 1997, which specifies the maximum amount of debt that members can carry. Specifically the Pact stipulates that each member have an annual budget deficit no higher than 3% of GDP (this includes the sum of all public budgets, including municipalities, regions, etc), and a public national debt must not exceed 60% of GDP. However, as the investor community later found out, several Eurozone members violated those debt covenants by borrowing larger amounts with less ability to repay the loans. Still, the Council of Ministers whose responsibility is to enforce the Pact, failed to impose sanctions on these members.

However, as the investor community later found out, many members had been consistently running deficits substantially in excess of 3%, and the Eurozone as a whole has a debt percentage exceeding 60% of GDP.

The Monetary Policy of a country or region is a set of tools designed to expand or contract the money supply circulating in the economy. The goal of a sound monetary policy is to maintain price stability, low inflation, keep unemployment low and foster steady economic growth. In most economies, the institution responsible for formulating and implementing monetary policy is called the central bank. The Federal Reserve Bank serves as the central bank of the United States. The monetary policy of the countries in the eurozone is managed by the Eurosystem which consists of the European Central Bank and the central banks of the individual eurozone members. Generally speaking, the European Central Bank formulates the monetary policy and the central banks of the members apply that policy within their countries.

Because there are a number of the EU member states that are not part of the eurozone, the European System of Central Banks (ESCB) is the system of central banks consisting of the ECB and the central banks of all member states, both inside and outside the Eurozone.

Now that we have discussed the structure of the European Union and the Eurozone, as well as the role of key financial institutions within those organizations, the next blog entry will explain the nature and implications of the debt issues confronting those European states.

 

This blog entry is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.

 

About the author

John Spoto, CFP®

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