Moral Hazard in the Euro-Zone?

Briceño Avalos, Hernán Ricardo (2012): Moral Hazard in the Euro-Zone? Published in:

Abstract

The aim of this paper is provide us with empirical evidences and theoretical knowledge about how the compelling current Sovereign Debt Crisis in the periphery Euro-zone countries was triggered according with moral hazard theory, because the implicit and explicit externalization of risk cost for commercial financial institutions and/or banks. Different from traditional working papers that concentrated only on weak macroeconomic fundamentals and contagion effects as the main origins of the previous financial crises. In this way, this research is attempting to solve how moral hazard problem in the Euro-zone periphery countries after the introduction of the Euro currency as a global competitor of the U.S.A. Dollar caused and/or nurtured their fiscal and external unbalances. This after a short period of euphoria and wellbeing, with reduction of the interest rate and easily access to capital to finance unprofitable and risky biased businesses without appropriate banking regulation; ending up in a vicious circle between weak banking system and fiscal imbalances. After assessing thoroughly different related economic and financial statistics from the Euro-zone periphery countries Portugal, Ireland, Italy, Greece and Spain (PIIGS), such as ratio Short Term External Debt/Foreign Exchange Reserve as a moral hazard index, as well as Fiscal and External unbalances accounts, among others, making a comparison with some of the North-core Euro countries evolution, one of the first evidences is that the nowadays Sovereign Debt Crisis has been originated in the awkward circle between weak financial system and implicit guarantees provided by negligent governments without suitable public financial regulation and supervision; while politicians were differing necessary reforms as the fiscal union adoption in the region. All in all, future research about causes of the financial crises should be focused on the moral hazard problems rather that in traditional weak fundamentals; consequently, economy policymakers should come up with the possibility to explicitly and legally avoiding the direct and discretionary interventions of the Central Banks or Governments (Finance Ministers) with the aim to rescue or bailout broken commercial financial institutions under socialization programs of their debts.

• Item Type: MPRA Paper
• Language: English
• Keywords: Moral Hazard, European Monetary Union, Sovereign Financial Crisis, Financial Crisis
• Subjects: F - International Economics > F3 - International Finance > F30 - General; F - International Economics > F3 - International Finance > F31 - Foreign Exchange; F - International Economics > F3 - International Finance > F36 - Financial Aspects of Economic Integration

References

Akerlof, George A. (Aug., 1970). The Market for Lemons: Quality Uncertainty and the Market Mechanism. The Quarterly Journal of Economics, Vol. 84, No 3: 485-500.

Allen, Franklin and Carletti, Elena. (2009) The Global Financial Crisis: Causes and Consequences. University of Pennsylvania. Working paper.

Briceño Avalos, Hernán Ricardo (2003). Tipo de Cambio Cuasi-fijo y Posibilidad de Crisis Cambiarias: Solarizar o Dolarizar la Economía Peruana? Working paper.

Claessens, Stijn; Tong, Hui and Zuccardi, Igor (September, 2011). Did the Euro Crisis Affect Non-Financing Firm Stock Prices through a Financial or Trade Channel? International Monetary Fund, Working Paper.

Chang, Roberto (Aug., 2011). The Global Crisis and the Future of the Central Banks. Rutgers University. Peruvian Reserve Central Bank presentation.

Dadush, Uri; Aleksashennko, Sergey and other (2010). Paradigm Lost: The Euro in Crisis. Carnegie Endowment for International Pace. Washington DC.

Delimatsis, Panagiotis and Sauvé, Pierre (2011). Financial Services Trade after the Crisis: Policy and Legal Conjectures. Journal of International Economic Law 13 (3): 837-857.

De Haan, Jakob (May, 2012). The Future of European Monetary Union. Maastricht University Forum.

De Paula, Luis Fernando and Alves, Antonio J. (2003). Baking Behavior and the Brazilian Economy After the Real Plan a Post Keynesian Approach.

De Soto, Hernando. Who Owns This Mess? International Herald Tribune. Dec. 02, 2011. http://www.nytimes.com/2011/12/02/opinion/magazine-global-agenda-who-owns-this-mess.html?pagewanted=all

Diamond DW, Dybvig PH (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy 91 (3): 401–419.

Feldtein, Martin. The Political Economy of the European Economic and Monetary Union: Politicas Sources of an Economic Liabilities. NBER Working Paper series. 1996.

Franco, Gustavo (1995). The Real Plan. Working paper presented at Seminar “Economics and Society in Brazil: New trends and perspectives”. Chicago.

Gil-Diaz, Francisco (1997). The Origin´s of Mexico 1994 Financial Crisis. The Cato Journal. Vol. 17. No 3. http://www.cato.org/pubs/journal/cj17n3-14.html.

Gruben, William and Kiser, Cherry (1999). Brazil the First Financial Crisis of 1999. Southwest Economy, Federal Reserve Bank of Dallas.

Hillman, Robert W. (1992). “Limited Liability and Externalization of Risk: A. Comment on the Death of Partnership”. 70 Washington University. Law Quarterly 477.

Holman, Jill A. (2001). Is the Large U.S. Current Account Deficit Sustainable? Federal Reserve Bank of Kansas City. Economic Review. First Quarterly.

Hornbeck, J.F. (June, 2000). The Argentine Financial Crisis, a Chronological of Events.

Jehle, Geoffrey and Reny, Philip (2000). Advanced Microeconomic Theory. Second Edition. The Addison-Wesley Series in Economics.

International Monetary Fund (2004). Guidelines for Foreign Exchange Reserve Management. Washington D.C.

Jones, Erick (2009). The Euro and the Financial Crisis. Survival, Vol. 51, No 2, April – May 1999. Pp. 41-54.

Licona Michel, Angel (Dec., 2011). Política Económica y Crecimiento en México: Cinco sexenios en búsqueda de la estabilidad. International Conference: “Rethinking Socio-Economic Transformation in Latin America”. Seoul, South Korea.

Mankiw, Gregory (2001). Principles of Economics. Second edition. Harcourt College Publishers.

Michael Bailey and Heinz Stecher (2000). Working paper. Oxfam GB.

Misekell, Raymond and Zinser, James (1973). The Nature of the Savings Function in Developing Countries: A Survey of the Theoretical and Empirical Literature. American Economic Association. Journal of Economic Literature, Volume 11, No 1. Pp. 1-26.

Mundell, Robert (1961). A Theory of Optimum Currency Area. The American Economic Review. Vol. 51, No. 4, (Sep. 1961), pp. 657-665.

Nelson, Rebecca; Belkin, Paul, and Mix, Derek (August, 2011). Greece´s Debt Crisis: Overview, Policy Responses, and Implications. Congressional Research Services.

Ossa Scaglia, Fernando (1997). “Some extensions: Tariffs, Power Parity Purchase and Exchange Policy”. Economía Monetaria Internacional. VI Chapter. Pontifical Catholic University of Chile. Second edition. Santiago, Chile. Pp. 213-242. http://www.fas.org/sgp/crs/row/R41167.pdf

Radelet, Steven and Sachs, Jeffrey (1998). The Onset of the Asian Financial Crisis. Working paper. Harvard Institute for International Development.

Rothschild, Michael and Stiglitz, Joseph (Nov., 1976). “Equilibrium in Competitive Insurance Market: An essay on the Economics of Imperfect Information”. The Quarterly Journal of Economics. Volume 90. No 4: 629-649.

Sandoval, Lazaro; Beltran, Erika; Ulziikhutag, Sodgerel, and Zorigt, Temuun (2011). “The European Sovereign Debt Crisis: Responses to the Financial Crisis”. George Mason University. New Voice in Public Policy. Volume V. Spring 2011.

United Nations Conference on Trade and Development and the United Nations Economic Commission for Europe (Oct., 1998). Working paper. Geneva. http://www.twnside.org.sg/title/1998-cn.htm

Varian, Hall (2010). Intermediate Microeconomic: A modern approach. University of California at Berkeley. Eight edition.

World Bank. Global Development Debate. What are the Development Challenges in a Post Crisis World? Jun., 2010. http://developmentdebates.ning.com/group/developmentdebates

World Bank Institute (October, 2010). Global Development Debate. How to Manage Capital Flows. http://developmentdebates.ning.com/page/global-development-debate-on

Zewuster, Marijke (May, 2012). Country Risk and European Debt Crisis. Maastricht University Forum.

Zhuang, Juzhong and Dowling, Malcolm (Oct., 2002). Financial Crisis: What can an Early Warning System Model Tell us? Asian Development Bank.