Euro zone Convergence, divergence and then what Harvard Case Solution & Analysis

Euro zone Convergence, divergence and then what Case Solution


The case title is about to determine the euro zone rate in next years by considering the periphery change in long rate as compared to core rates. European Monetary Union (EMU) was developed in 1990, and it observed that the convergence in interest rates would lead to an economic downturn in whole Europe. The protagonist, Arturo Rodrigo has determined the Euro zone convergence is the development process in which per capita GDP increases of lower income economy countries than the high-income economies. Euro rates decreased harshly as compared to German rates, and it resulted in an increase in borrowing because of decrease in borrowing costs.

The hedge fund protagonist has to make two important decisions. Firstly; to decide the long-term Euro rates would like a path in next few years based on the German rates that showed declining interest rates since two years, that deviation would persist as a "new normal", or the trend would be reversed. Secondly, to observe how the rates change from the core rates due to the spread of long-term rates between Greece, Spain, and Ireland.

The establishment of EMU in 1999 was expected for economic integration and convergence in Europe. However, the increase in sovereign debt crisis and macroeconomic differential led to financial crisis. Therefore, the company or organization had to increase the demands in order to increase the per capita GDP. The GDP can grow through an increase in strong global demand or decline in interest rates that would lead to high growth potential.

Therefore, the purpose of the case is to determine that whether dramatic divergence would remain consistent, or a convergence would occur. He has to take reasonable steps to identify the factors that show the impact on long terms interest rates based on an assumption such as; decrease in German interest rates or higher rates or increase in spreads of euro zone rates.

Analysis, evaluation of findings and recommendations:

History shows that the first European integration occurred in 1957, when six countries of Eurozone signed the Treaty of Rome which include: Germany, Belgium, Luxemburg, Italy, and Netherlands in order to develop a European Union and to remove tariffs in trading among these six countries and impose tariffs on non-members' countries. Due to lack of supernatural powers in fiscal matters, they decided to appoint politicians as the minister councils. Limiting powers led to generate low GDP that is 1% of European Commission’s (EC) Budget. EU was unable to raise tax and borrow debt. Another integration problem occurred with Exchange rate mechanism (ERM) that limited currency fluctuations in 1979, a criterion was set for entering a candidate country; that it must have limited fluctuations in exchange rate.

EU developed the European Currency Union (ECU) that shows the GDO and weighted average trade of members’ countries that was considered as accounting item rather than currency. The integrated companies system was not in synchronization, which led to stress for countries of squeezing the monetary policy while others are losing at the same time. As Europe was facing these issues repeatedly, EU members signed the Maastricht treaty in 1992. In order to become a member of EU, the countries had to qualify by completing the independence criteria from European Central Bank (ECB) to improve the performance regarding inflation and the interest rate that would help to increase the GDP.

Another perquisite of integration is inflation differentials, which have increased after the introduction of common currency. Hence, the economy slowed down and changing behavior of inflation rates resulted in adoption of single currency that is Euro in whole euro zone...............

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