Archive for the ‘economics’ Category

The Consequences of Greece Leaving the Eurozone

Wednesday, January 21st, 2015

Although the reputation of the Greek economy has been mostly shattered over the past four years, the Economist recently published an article warning that it would be imprudent for the EU and Greece to cut ties at this point.

Examining the article

Context: Greece is holding an election on January 25th to decide whether or not to withdraw from the EU. A withdrawal would entail Greece installing its own currency (the drachma), severing the ties between the EU Central Bank and its own, and becoming fully responsible for domestic monetary and fiscal policy.

The Economist notes that the drachma would rapidly depreciate against the Euro, which is logical due to the current weakened state of the Greek economy. This is good because it could help kick-start the Greek trade and tourism industries. A weak drachma means exports will be cheaper and national production will rise. Furthermore, wealthy EU citizens would enjoy a high level of purchasing power if they take their six weeks of guaranteed vacation in Athens. However, the Economist warns this process could be very messy in the short-term, as the country must redenominate a significant portion of its debts and assets. A weak Greek economy may not be able to withstand a volatile economic shock, and the citizens could face stagnation or hyper inflation as the drachma becomes worthless.

Furthermore, a significant change could completely undermine the faith of foreign investment. This would make it impossible for Greece to borrow money to pay off currently held foreign debts. If the drachma depreciates as expected, the Greek government could be forced to default on all foreign debts held, and domestic debts would be settled at well below value.

In reality, Greece has been on the road to economic recovery. The government has run surpluses the past two years, and international trade is starting to rebalance. The Economist believes that a withdrawal would be detrimental to both the Greeks and the EU, and I agree. When we wonder about the economic stability of the EU, the Greece example shows that its stability is unlikely be challenged by the weakest economies. Instead, we should focus on the incentives the strongest economies gain by remaining members of the trade bloc.

What is economic sustainability? How can we attempt to measure financial sustainability?

Monday, January 12th, 2015

Let’s start with the basics:
Economic sustainability is a multifaceted goal. It requires economic stability, a favorable business environment, and free market competition. Source.

So what is economic stability?

Economic stability refers to an absence of excessive fluctuations in the macroeconomy. An economy with fairly constant output growth and low and stable inflation would be considered economically stable. An economy with frequent large recessions, a pronounced business cycle, very high or variable inflation, or frequent financial crises would be considered economically unstable. However, financial stability and economic stability are two different situations, though they may cause each other. A financial system is stable when it dissipates financial imbalances that arise endogenously or as a result of significant adverse and unforeseeable events. When stable, the system absorbs shocks primarily via self-corrective mechanisms, preventing the adverse events from disrupting the real economy or spread over to other financial systems. Source

Potential data to measure economic stability:
– Absolute variation levels of key economic indicators: unemployment, inflation, interest rates, GNI/capita, etc. High levels of fluctuation (which we’d need to define) suggests systematic turmoil that needs to be addressed. Creditors are less likely to lend when there are high levels of economic uncertainty (from Krugman).

What is a favorable international business environment?
On the international scale, a country wants to encourage foreign investment by easing the barriers to invest, while maintaining enough control over the domestic currency to prevent ‘runs’ or ‘panics’ that can cause an economy to crash. Do the European Union trade regulations, both internal and external to the EU, facilitate this objective?

Potential data:
– We need to examine the balances of trade. Are net imports/exports constantly fluctuating? Is the Euro overvalued or undervalued for some member nations, hurting their trade? Do central banks have large enough currency reserves to assure investors that the system can handle shocks? This source provides several important data types that we should examine to evaluate the entire financial system of the EU.

In conclusion:
Financial sustainability is derived from economic stability. Without economic stability, creditors are unlikely to provide enough liquidity to investors for economic growth. To examine economic stability, we need to measure the historic and current volatility of basic economic indicators and purview regulatory laws (and their enforcement) to ensure the system promotes investment, free trade, and optimal finance.