Lessons from the Eurozone crisis

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The Eurozone crisis has resulted in an uncertain outlook for the global economy.

News Perspectives by Prosper Chitambara

The Euro area faces three interlocking crises that together challenge the viability of the currency union.

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There is a banking crisis — where banks are undercapitalised and have faced liquidity problems.

There is a sovereign debt crisis — where a number of countries have faced rising bond yields and funding challenges.

Lastly, there is a growth crisis — with both a low overall level of growth in the Euro area and an unequal distribution across countries. Crucially, these crises are connected.

Bailouts of banks have contributed to the sovereign debt problems, but banks are also at risk due to their holdings of sovereign bonds that may face default.

Weak growth contributes to the potential insolvency of the sovereigns, but also, the austerity inspired by the debt crisis is constraining growth.

Finally, a weakened banking sector holds back growth while a weak economy undermines the banks.

There are fears that the Eurozone crises may be spreading to some of the region’s biggest economies through the contagion effect.

As the Eurozone crisis spreads, it will have a big impact on the global economy and on developing countries.

The main channels for the transmission of the crisis to developing countries is through declining commodity prices, dwindling investment, weak export earnings, declining remittances and pressures on the current account.

There have also been concerns about a slowdown in the US as it struggles to boost growth and tackle stubbornly high rates of unemployment. As a result, the global outlook is expected to remain highly uncertain and volatile.

The risk of contagion is great when countries are more closely integrated because policy options by national governments are often limited.

The first lesson is on the need to move slowly with respect to monetary union.

Trying to operate a single currency without social, economic and political integration is likely to fail as evidenced by the Eurozone crisis.

Euro-area countries pursued different structural policies and as a result competitiveness differentials widened throughout the decade, leading to substantial imbalances within the Euro area.

Already, there is talk on the establishment of a single currency in SADC and the AU.

The developments in the EU however will call for caution and prudence.

The Eurozone crisis has also created an opportunity for the rethinking of macroeconomic policy.

Macroeconomic objectives should be redefined so that the emphasis is on fostering employment creation and supporting economic growth rather than on price stability alone.

There is also a need to integrate short-term fiscal and monetary policies, which are powerful and versatile instruments, with long-term development objectives.

Developing countries should also move away from pro-cyclical macroeconomic policies to anti-cyclical policies.

It is necessary to exercise restraint, in the deregulation of domestic financial sectors, and hasten slowly with capital account liberalisation or retain the option of capital controls.

The reason why China has escaped the Global Financial crisis relatively unscathed is becauses she has successfully staved off any pressures from International Financial Institutions (IFIs) to liberalise her domestic currency (the RMB).

Increased employment can provide a sustainable solution to the crisis and in the process deliver growth with equity.

Institutional mechanisms should be developed, with representation and participation, in order to implement international collective action.

In sum, it is essential to return a developmental approach to macroeconomic policies, which is based on an integration of short-term counter-cyclical fiscal and monetary policies with long term development objectives.
This should shift the focus from the financial sector to the real economy, from the short-term to the long-term and from equilibrium to development.

Economic growth with full employment should be the fundamental objective of macroeconomic policies.

The macroeconomic policy stance in a pro-poor strategy is determined, first of all, by the need to achieve rapid, sustained, broad-based and employment-intensive growth.

If an economy’s growth path does not create sufficient jobs or livelihood opportunities, people are deprived of more than a livelihood.

They are also robbed of opportunities to develop their abilities, thereby undermining their dignity and self-respect.

A pro-poor macroeconomic policy should target those sectors in which the poor are engaged and aim to remove constraints (e.g. poor credit availability, weak extension services, unnecessary bureaucracy for SME formation) and create an investment and employment generating environment for the private sector. It should be inclusive.

Chitambara is a research economist with the Labour Economic & Development Research Institute of Zimbabwe (LEDRIZ) & member of the Zimbabwe Economics Society (ZES). These New Perspectives articles are co-ordinated by Lovemore Kadenge, president of the ZES. E-mail: kadenge.zes@gmail.com and cell: +263 772 382 852

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