Blogs | February 8, 2012

Would a euro break-up be bad for the world economy?

Victor asks : Do you think that a break-up of the euro, if it happened, would be bad for the world economy as a whole?


Ian answers: The importance of the Eurozone crisis is shown by the huge number of political discussions and newspaper headlines (not to forget dinner party conversations) about whether the common currency can survive – and if not, what happens.

To answer your question in short, yes – I think a break-up of the euro would be bad for the world economy as a whole. The fallout would be felt at the global and country level as well as filtering through to individuals. So let’s take look at some of the macro-level implications (growth forecasts) and the micro-level implications (prospects for a cheap holiday in Greece).

What does a break up look like?
Of course the euro could well continue in its present form, with all the current 17 member states using the currency (launched a decade ago in 2002) for years to come. If there is a break-up, the range of scenarios includes partial break-ups, such as some countries dropping the euro or northern and southern blocks of countries forming two currency groups. A publication by the ING Economics Department lays out some scenarios and forecasts implications.

The numbers are scary
Nobody really knows exactly what effect a break up of the euro would have on the world economy but International Monetary Fund calculations give some ideas. The IMF looked at what might happen if current economic forecasts worsened, forcing countries and financial institutions to pay higher interest rates when borrowing money.

Even under this limited scenario, the size of the economy would be 2% less compared with current expectations about two years in the future. After five years, an effect would remain. In other words, the IMF says there would probably be a permanent loss of output and wealth. Under this scenario unemployment would likely rise due to the slowdown. If there was a euro break-up, things would be even worse.

Cheap holidays for all?
Greece, Spain and Portugal are amongst the Eurozone nations that could be directly affected by a break up of the euro. These countries are popular holiday destinations – so the question arises, is there a silver lining of cheaper vacations for people living elsewhere if these nations defaulted, left the euro and got their own currencies?

The answer is not simple. And the question may be seen by some to trivialise the seriousness of the situation. Cheaper holidays are possible but, firstly, we cannot be sure how exchange rates would move. Secondly, with the prospects of slowed growth and higher unemployment, we may not be in the financial position to capitalise on discount travel.

Beware the effect of confident predictions
The uncertainty of how a Eurozone crisis will unfold adds a further complication. Any forecasts made can only be guides, as outcomes could be worse or better. Nobody really knows. This issue of confidence carries a warning for managing personal finances.

Don’t be too trusting of expert comments presented as certain in news media because the high degree of confidence that can help an individual get quoted in the press can be dangerous in managing money. Conditions change and overconfidence can prove costly. Be wary of changing the way you manage saving and investing simply because of changing news flow.

Good financial basics helps manage your risks
With so much doubt about how the Eurozone debt problem will unfold, it could be more important than usual to maintain good financial habits. Know how much you earn and spend – lessons shared in the video Why the rich need to budget as well – and have (or build) a “rainy day” savings fund to use if an emergency strikes.

Learn a lesson from debt-ridden nations by reducing personal debt to a manageable level. Nobody can be sure how the situation in Europe will develop or exactly what the fallout will be for the world economy. But individuals can prepare by ensuring they are in good financial shape.

Click here to view the PDF.

EconomicsEurope

Ian Bright
Ian Bright

Senior economist at ING
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43 blogs

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