The crisis that developed in Greece in April last year brought the critical issue of sovereign debt accumulated by the European countries back in prime focus. Although the Greece & Ireland concerns have been temporarily patched up by rescue packages, optimism on the state of other countries particularly Portugal, Italy and Spain is not high. Portugal is seen as the next country in line to request for a bail-out package with the sovereign bond yields rising abnormally in recent times.
Europe is trapped in a very slippery situation currently. It is faced with two major economic issues – Firstly, there is the huge amount of sovereign debt it has accumulated over time and secondly, there is still a long way before the effects of the recession are over. The policy solutions to these issues – bringing down large government budget deficits (which require contractionary fiscal policies) and stimulating the economy during a cyclical economic downturn (which requires expansionary fiscal policies) are at odds with each other. A mix of tax increases and spending cuts to lower the debt levels can lead to higher unemployment and hinder the recovery in the Euro zone. Further, it will be very difficult for the governments to garner public support for its austerity measures with the economy in its current state.
The impact of the crisis has been felt not only in the European region but also in the extensive geographies which have trade relations with them. This crisis has posed a large number of questions which are yet to be answered. The decisions about policy matters like fiscal tightening, rescue package, austerity measures, future of euro has to be evaluated after analyzing the plenty of consequences that can occur in each case. We did a research on the options available for the Eurozone and the level of impacts they are likely to cause. Further, at the business manager level it is always important to be aware and be prepared of the possibilities that can develop in the euro zone.
A straight forward method to enhance the competitiveness of countries affected by the countries is to impose wage cuts on the labour force. This can lead to additional exports, boost long term growth and revive employment. But this solution may provide counter-productive since decreasing wages also means a declining domestic market. The marginal increase in exports can be overweighed by the decline in domestic consumption.
Eurozone survival depends on a lot on correcting the imbalances existing between the highly competitive countries with large current account surpluses and the likes of Greece, Ireland, Portugal and Spain which are suffering from large deficits. Hence there has been a strong call for help to countries like Germany to boost demand and thereby growth in Southern Europe. But critics in Germany are arguing that the trade surpluses should be a means of strengthening its defences against an uncertain future.
The European commission should be given more power to rein in countries that deviate from the deficit targets. The Stability and Growth pact should be sacrosanct and should not be violated by even the major countries in the Euro zone. Also needed are stricter rules, backed if necessary by financial penalties, political sanctions such as a suspension of voting rights and even the option of expulsion. The Euro zone has to maintain credibility in the eyes of the US, China and other global partners and the financial markets in particular. Doubts also persist about the effectiveness of the latest proposals, expected to take effect next year, for enhancing budgetary surveillance. However, France and Germany are of the view that the system must avoid interfering into the powers of the individual parliaments, which diminishes the effectiveness of the proposals. So the current question is whether governments will ever submit to rules that foresee automatic punishments for fiscal indiscipline.
The European Central Bank could engage in a much more expansionary policy by buying lots of government debt. One thing to consider is that if the European Central Bank indulges in buying the government bonds, it would necessarily lead to inflation.
One drastic step is for a country to leave the Eurozone completely. This would likely require abandoning the euro, issuing a national currency, and allowing that currency to depreciate against the euro. It is considered that a new national currency depreciated against the euro would spur export-led growth in the country and offset the contractionary effects of austerity. But since the governments’ debt is denominated in euro, leaving the Euro zone in favour of a depreciated national currency may raise the value of debt in terms of national currency and put pressure on other vulnerable European countries. Additionally, some argue that a departure from the Euro zone would be economically catastrophic and have serious ramifications for political relations among the European states and future European integration.
Europe has so far bailed out the two countries – Greece and Ireland which has requested for assistance. It may also do the same to countries like Portugal and Spain which are next in line. But, it should be kept in mind that countries like Germany and France which are economically stronger than the rest and are the major contributors for the rescue fund won’t be able to cover all of Europe’s debt. A fiscal growth miracle is nowhere to be seen and pumping money is not an option with its inflationary risks. Although not pretty, the only path left is that of debt restructuring or default.
To make matters worse, the rate at which Europe’s average age has increased is a serious cause of concern. The ratio of elderly to the working population is further set to increase sharply because birth rates are low and people are living longer. Europe has to abandon the welfare state concept it has been following over these years to survive this crisis. It has to stop bailing out every country that is in trouble and start looking at the option of allowing governments to restructure or default on their debt.
This is Preview only. If you need the solution of this assignment, please send us email with the complete assignment title: ProfessorKamranA@gmail.com
