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European Debt Crisis: Fiscal Union Perspective


European countries have been facing a very acute financial crisis over the years. It has led some of these countries to go to the extent of not being able to finance their government debts without the help of third-party states. Some of the most affected countries include Greece, Italy, and Portugal among others.

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Before this crisis, it was assumed that both, the regulators and banks which had debts from the European area were safe until 2009 when fears about the financial crisis started to develop among investors due to the rising government debt (“Germany agrees 50bn Euro Stimulus”). Though it affected just a few of those countries it was being seen as a crisis of the whole community since they are known to have trade unions.

Causes of this crisis included:

The globalization of the European country’s finances (they have a common currency) despite this crisis has remained stable (“Germany agrees 50bn Euro Stimulus”). Good credit terms thus encourage borrowing and spending. International trade imbalance which according to the Financial Times writer Martin Wolf Germany had a better public debt and fiscal deficit relative to GDP as compared to other countries like Portugal, Italy, and Greece had the worst Balance of Payments (“The eurozone crisis explained in 5 simple graphs”).

There was also slow growth in the economy which forced the countries to borrow to boost their economies. A lot of countries are stepping into bailout the countries which had financial crisis by assuming their debts.

Use of fiscal policy to curb this problem

Aggregate Demand = Consumption+ Investment+ Government Spending+ Export-Import, shows the total level of expenditure, hence fiscal union policy is the change of level of taxation and government spending which is used to encourage the level of the economic activity and the gross domestic product (Riley).

Measures of fiscal policy include:

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A cut in government spending will lead the government to avoid debt in quite a profound margin. In this, there is a possibility of lowering the government borrowing hence reducing a huge percentage in accumulative debts. An increase in taxation is yet another way to reduce the rate of debt. When the taxation policy is raised, goods imported in a country are reduced, and also borrowing is greatly discouraged due to the expenses incurred during such a transaction (Taylor). The introduction of new taxes reduces the borrowing rate and consequently, the national debt is reduced by a great margin. Introducing such policies is good for the economy if the national debt is maintained at a reasonable level.

Benefits of fiscal policy

It’s used to reduce the rate of inflation in the case of European countries that had fewer borrowing fees, which encourages borrowing and the amount of money in circulation. It stimulates the rate of economic growth in a period of recession and financial crisis. It stabilizes economic growth avoiding the boom or the burst in the economic cycle. The use of fiscal policy in an economy directly reduces the aggregate demand hence curbing inflation which is caused by excess demand (Taylor). Inflation causes the depreciation of the euro currency and hence the reduction of the price of commodities due to excess demand. To avoid this kind of situation is in the country’s best interest.

Limitations of using fiscal unions

It may discourage employees in a country to work extra hours since the more they work the more taxes they have to pay to offset the government debt.

If not well used by the policymakers of a certain country, there is a possibility of inflation since the aim is to increase aggregate demand which may be accompanied by rapid growth in the economy (Taylor). Once the government decides to reduce its spending, it cannot just stop at once because it will take time for the policy to be fully implemented, for example, government spending in road construction.

Services that fully depend on the government may be adversely affected since the government decides to reduce its spending.

The use of fiscal policy depends on other components of aggregate demand and so if the government majors on the taxes only, it may face resistance from those other components. In the case of expansionary fiscal policy, cutting of taxes, and increase in government spending will lead to a deficit in the budget, hence there is a need for higher taxes in the future to offset them.

Increased government spending can lead to a face out of private investments (crowding out) hence decreasing the private sector, for example, if the government increases its spending through borrowing, it can lead to an increase in the interest rates in the banks, hence the private investors will not be able to borrow to finance their businesses. If the size of the multiplier is big then the government should increase the leakages otherwise there will be an increase in the injections.

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The use of fiscal policy by the European countries has not been as perfect as it was expected, but it can give the country’s economy lots of care to meet its needs.

In the European Union stimulus plan 2008, among the many European nations, Germany was one of the countries with a better economy, the perceived failure of the member country economy led to a deficit in its exports though it could replace some of the exports demand they decided to use the stimulus and had taxes levied on transport education which seemed to be doing well (Madura). Countries like Greece and Portugal are still trying to apply the fiscal measures which are also doing well as per their expectation and in the future, these countries are expected to come out of their financial crisis, attract investors, have a balanced economy of payments.

It was only 6% of the European GDP that was affected and with the stimulus which can correct up to 1.2% then a lot is expected from the European countries in terms of economic growth and relief of their burden of debts (Madura). The aggregate demand which is also the gross domestic product is important for every countries economy. Europe’s response to the global economic setback in the year 2008 was not unique to the country only. These effects were felt all around the globe as it was an incident that almost crumpled the entire economic structure globally.

Europe faces the challenge to put into effect policies that can be beneficial to the economic recovery after a very difficult period of economic meltdown. The response put in place determines the extent and level of recovery a country can achieve in a bid to ensure its citizens of economic survival.

Works Cited

“Germany agrees 50bn Euro Stimulus”. BBC News, 2012. Web.

Madura, Jeff. International Financial Management, 9th Ed. Connecticut: Cengage Learning, 2010. Print.

Riley, Geoff. “AS Macroeconomics / International Economy”. Tutor2u. 2006. Web.

Taylor, John. Macroeconomic Policy in a World Economy. New York: On Line Edition, 1999. Web.

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“The euro zone crisis explained in 5 simple graphs”. The Christian Science Monitor. Web. 2012.

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