11-debt crisis in europe

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A STUDY ON

EUROPEANSOVEREIGN-

DEBT CRISIS


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INTRODUCTION:

The acute phase of the global financial crisis was short, lasting from the collapse ofLehman Brothers on September 15, 2008, to the day the Dow hit a trough on March 9, 2009.But, like a violent heart attack, the interruption of creditthe economys life bloodlasted

long enough to permanently damage the industrial countries at the center of the crisis. Thedamage took three main forms, each of which poses a major risk to the stability of the globaleconomy today: high and rising public debts, fragile banks, and a huge liquidity overhang thatwill need to be eventually withdrawn.

The Euro crisis, which strikes at the heart of the worlds largest trading block, containsonly two of the three fateful elementsproblematic sovereign debt in Greece and othervulnerable countries, and fragile European banks, which hold a large part of that debt.Monetary policy in the Euro area and in industrialized countries more generally, remainsexpansionary and, if anything, the crisis pushes back the time when tightening can occursafely. As a result of the problems in Europe, the world economy has become even more

exposed to the three mega-vulnerabilities.The European sovereign debt crisis (referred to by analysts and investment banking

professionals as The ESDC) is an ongoing financial crisis that has made it difficult orimpossible for some countries in the euro area to re-finance their government debt without theassistance of third parties.

From late 2009, fears of a sovereign debt crisis developed among investors as a resultof the rising government debt levels around the world together with a wave of downgradingof government debt in some European states. Concerns intensified in early 2010 andthereafter, leading Europe's finance ministers on 9 May 2010 to approve a rescue packageworth 750 billion aimed at ensuring financial stability across Europe by creating the

European Financial Stability Facility (EFSF).In October 2011 and February 2012, the euro zone leaders agreed on more measures

designed to prevent the collapse of member economies. This included an agreement wherebybanks would accept a 53.5% write-off of Greek debt owed to private creditors, increasing theEFSF to about 1 trillion, and requiring European banks to achieve 9% capitalisation. Torestore confidence in Europe, EU leaders also agreed to create a European Fiscal Compactincluding the commitment of each participating country to introduce a balanced budgetamendment.

While sovereign debt has risen substantially in only a few eurozone countries, it hasbecome a perceived problem for the area as a whole. Prior to May, 2012, the European

currency remained stable. As of mid-November 2011, the euro was even trading slightlyhigher against the bloc's major trading partners than at the beginning of the crisis. The threecountries most affected, Greece, Ireland and Portugal, collectively account for 6% of theeurozone's gross domestic product (GDP).

CAUSES:

The European sovereign debt crisis resulted from a combination of complex factors,including the globalization of finance; easy credit conditions during the 20022008 periodthat encouraged high-risk lending and borrowing practices; the 20072012 global financialcrisis; international trade imbalances; real-estate bubbles that have since burst; the 20082012global recession; fiscal policy choices related to government revenues and expenses; and

approaches used by nations to bail out troubled banking industries and private bondholders,assuming private debt burdens or socializing losses.

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To find the origin of the financial distress, researchers have to conduct and analyzefinancial records dated many years and possibly decades old. According to Zdenek Kudrna, a

political economist, the financial crisis was destined to happen due to the way the EuropeanUnion deals and make their trade policies. He argues that the European Union only takesaction after the facts. They only address a situation when it has already become a problem.

(1) RISING GOVERNMENT DEBT LEVELS

A number of "appalled economists" have condemned the popular notion in the mediathat rising debt levels of European countries were caused by excess government spending.According to their analysis, increased debt levels are due to the large bailout packages

provided to the financial sector during the late-2000s financial crisis, and the global economicslowdown thereafter. The average fiscal deficit in the euro area in 2007 was only 0.6% beforeit grew to 7% during the financial crisis. In the same period the average government debt rosefrom 66% to 84% of GDP. The authors also stressed that fiscal deficits in the euro area werestable or even shrinking since the early 1990s. US economist Paul Krugman named Greece asthe only country where fiscal irresponsibility is at the heart of the crisis.

(2) TRADE IMBALANCES

Commentators such asFinancial Times journalist Martin Wolf have asserted that theroot of the crisis was growing trade imbalances. He notes in the run-up to the crisis, from1999 to 2007, Germany had a considerably better public debt and fiscal deficit relative toGDP than the most affected eurozone members. In the same period, these countries (Portugal,Ireland, Italy and Spain) had far worse balance of payments positions. Whereas German tradesurpluses increased as a percentage of GDP after 1999, the deficits of Italy, France and Spainall worsened.

(3) STRUCTURAL PROBLEM OF EURO ZONE SYSTEM

There are critics that view the Euro zone crisis was inevitable, as there is structuralcontradiction within the euro system. In the euro zone system, the countries are offered tofollow a similar fiscal path, but they do not have common treasury to enforce it. That is,countries with same monetary system have freedom in fiscal policies in taxation andexpenditure. So, even though there are some agreements on monetary policy and throughEuropean Central Bank, countries may not or would not be able to follow it. This feature

brought fiscal free riding of peripheral economies, especially represented by Greece, as it ishard to control and regulate national financial institutions. Furthermore, there is also a

problem that the euro zone system has a difficult structure for quick response. Eurozone,having 17 nations as its members, require unanimous agreement for a decision making

process. This would lead to failure in complete prevention of contagion of other areas, as it

would be hard for the Euro zone to respond quickly to the problem.

(4) MONETARY POLICY INFLEXIBILITY

Since membership of the eurozone establishes a single monetary policy, individualmember states can no longer act independently, preventing them from printing money in orderto pay creditors and ease their risk of default. By "printing money" a country's currency isdevalued relative to its (eurozone) trading partners, making its exports cheaper, in principleleading to an improved balance of trade, increased GDP and higher tax revenues in nominalterms. In the reverse direction moreover, assets held in a currency which has devalued sufferlosses on the part of those holding them.

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(5) LOSS OF CONFIDENCE

Prior to development of the crisis it was assumed by both regulators and banks thatsovereign debt from the eurozone was safe. Banks had substantial holdings of bonds fromweaker economies such as Greece which offered a small premium and seemingly wereequally sound. As the crisis developed it became obvious that Greek, and possibly other

countries', bonds offered substantially more risk. Contributing to lack of information aboutthe risk of European sovereign debt was conflict of interest by banks that were earningsubstantial sums underwriting the bonds. The loss of confidence is marked by rising sovereignCDS prices, indicating market expectations about countries' creditworthiness.

EVOLUTION OF THE CRISIS:

In the first few weeks of 2010, there was renewed anxiety about excessive nationaldebt, with lenders demanding ever higher interest rates from several countries with higherdebt levels, deficits and current account deficits. This in turn made it difficult for somegovernments to finance further budget deficits and service existing debt, particularly wheneconomic growth rates were low, and when a high percentage of debt was in the hands offoreign creditors, as in the case of Greece and Portugal.

Some governments have focused on austerity measures (e.g., higher taxes and lowerexpenses) which has contributing to social unrest and significant debate among economists,many of whom advocate greater deficits when economies are struggling. Especially incountries where budget deficits and sovereign debts have increased sharply, a crisis ofconfidence has emerged with the widening of bond yield spreads and risk insurance on CDS

between these countries and other EU member states, most importantly Germany. By the endof 2011, Germany was estimated to have made more than 9 billion out of the crisis asinvestors flocked to safer but near zero interest rate German federal government bonds

(bunds).

While Switzerland equally benefited from lower interest rates, the crisis also harmedits export sector due to a substantial influx of foreign capital and the resulting rise of theSwiss franc. In September 2011 the Swiss National Bank surprised currency traders by

pledging that "it will no longer tolerate a euro-franc exchange rate below the minimum rate of1.20 francs", effectively weakening the Swiss franc. This is the biggest Swiss interventionsince 1978.

While ballooning public debt may be the clearest manifestation of the Euro crisis, itsroots go much deeper to the secular loss of competitiveness that has been associated with euro

adoption in countries including Greece, Ireland, Italy, Portugal, and Spain (GIIPS). Thesequence of events that led to the secular loss of competitiveness is depressingly similaramong the GIIPS countries:

The adoption of the euro was accompanied by a large fall in interest rates and a surge inconfidence as institutions and incomes expected to converge to those of Europesnorthern core economies.

Domestic demand surged, bidding up the price of non-tradables relative to tradables andof wages relative to productivity.

Growth accelerated, driven by domestic services, construction, and an expandinggovernment, while exports stagnated as a share of GDP, and imports and the currentaccount deficit soared amid abundant foreign capital.

The result was that indebtedness: public, private, or both.

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(1) GREECE

In the early mid-2000s, Greece's economy was one of the fastest growing in theeurozone and was associated with a large structural deficit. As the world economy was hit bythe global financial crisis in the late 2000s, Greece was hit especially hard because its mainindustries shipping and tourism were especially sensitive to changes in the business cycle.

The government spent heavily to keep the economy functioning and the country's debtincreased accordingly.

(2) IRELAND

The Irish sovereign debt crisis was not based on government over-spending, but fromthe state guaranteeing the six main Irish-based banks who had financed a property bubble. On29 September 2008, Finance Minister Brian Lenihan, Jnr issued a one-year guarantee to the

banks' depositors and bond-holders. He renewed it for another year in September 2009 soonafter the launch of the National Asset Management Agency (NAMA), a body designed toremove bad loans from the six banks.

Irish banks had lost an estimated 100 billion euros, much of it related to defaultedloans to property developers and homeowners made in the midst of the property bubble,which burst around 2007. The economy collapsed during 2008. Unemployment rose from 4%in 2006 to 14% by 2010, while the federal budget went from a surplus in 2007 to a deficit of32% GDP in 2010, the highest in the history of the eurozone, despite austerity measures.

(3) PORTUGAL

A report released in January 2011 by the Dirio de Notcias and published in Portugalby Gradiva, had demonstrated that in the period between the Carnation Revolution in 1974and 2010, the democratic Portuguese Republic governments encouraged over-expenditure andinvestment bubbles through unclear Publicprivate partnerships and funding of numerousineffective and unnecessary external consultancy and advisory of committees and firms. This

allowed considerable slippage in state-managed public works and inflated top managementand head officer bonuses and wages. Persistent and lasting recruitment policies boosted thenumber of redundant public servants. Risky credit, public debt creation, and Europeanstructural and cohesion funds were mismanaged across almost four decades. Prime MinisterScrates's cabinet was not able to forecast or prevent this in 2005, and later it was incapableof doing anything to improve the situation when the country was on the verge of bankruptcy

by 2011.

(4) CYPRUS

In September 2011, yields on Cyprus long-term bonds have risen above 12%, sincethe small island of 840,000 people was downgraded by all major credit ratings agencies

following a devastating explosion at a power plant in July and slow progress with fiscal andstructural reforms. Since January 2012, Cyprus is relying on a 2.5bn emergency loan fromRussia to cover its budget deficit and re-finance maturing debt. The loan has an interest rateof 4.5% and it is valid for 4.5 years though it is expected that Cyprus will be able to funditself again by the first quarter of 2013.

POSSIBLE SPREAD TO OTHER COUNTRIES:

One of the central concerns prior to the bailout was that the crisis could spread toseveral other countries after reducing confidence in other European economies. According tothe UK Financial Policy Committee "Market concerns remain over fiscal positions in a

number of euro area countries and the potential for contagion to banking systems."

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(1) ITALY

On 15 July and 14 September 2011, Italy's government passed austerity measuresmeant to save 124 billion. Nonetheless, by 8 November 2011 the Italian bond yield was 6.74

percent for 10-year bonds, climbing above the 7 percent level where the country is thought tolose access to financial markets. On 11 November 2011, Italian 10-year borrowing costs fell

sharply from 7.5 to 6.7 percent after Italian legislature approved further austerity measuresand the formation of an emergency government to replace that of Prime Minister SilvioBerlusconi.

The measures include a pledge to raise 15 billion from real-estate sales over the nextthree years, a two-year increase in the retirement age to 67 by 2026, opening up closed

professions within 12 months and a gradual reduction in government ownership of localservices. The interim government expected to put the new laws into practice is led by formerEuropean Union Competition Commissioner Mario Monti.

(2) SPAIN

As one of the largest eurozone economies, the condition of Spain's economy is of

particular concern to international observers, and has faced pressure from the United States,the IMF, other European countries and the European Commission to cut its deficit moreaggressively. Spain's public debt was approximately U.S. $820 billion in 2010, roughly thelevel of Greece, Portugal, and Ireland combined.

After the announcement of the EU's new "emergency fund" for eurozone countries inearly May 2010, Spain had to announce new austerity measures designed to further reduce thecountry's budget deficit, in order to signal financial markets that it was safe to invest in thecountry. The Spanish government had hoped to avoid such deep cuts, but weak economicgrowth as well as domestic and international pressure forced the government to expand oncuts already announced in January.

(3) BELGIUMIn 2010, Belgium's public debt was 100% of its GDPthe third highest in the

eurozone after Greece and Italy and there were doubts about the financial stability of thebanks, following the country's major financial crisis in 20082009. In November 2010financial analysts forecast that Belgium would be the next country to be hit by the financialcrisis as Belgium's borrowing costs rose.

(4) FRANCE

France's public debt in 2010 was approximately U.S. $2.1 trillion and 83% GDP, witha 2010 budget deficit of 7% GDP. By 16 November 2011, France's bond yield spreads vs.Germany had widened 450% since July, 2011. France's C.D.S. contract value rose 300% in

the same period.(5) UNITED KINGDOM

According to the Financial Policy Committee "Any associated disruption to bankfunding markets could spill over to UK banks." The UK has the highest gross foreign debt ofany European country (7.3 trillion; 117,580 per person) due in large part to its highlyleveraged financial industry, which is closely connected with both the United States and theeurozone.

A Euro collapse would damage London's role as a major financial centre because ofthe increased risk to UK banks. The pound and would likely benefit, however, as investorsseek safer investments. The London real estate market has similarly benefited from the crisis,

with French, Greeks, and other Europeans buying property with capital moved out of theirhome countries, and a Greek exit from the Euro would likely increase such transfer of capital.

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THE EURO CRISIS AND THE DEVELOPING COUNTRIES:

(i) EXPORTS

The Euro crisis is likely to deduct at least 1 percent of growth, and potentially muchmore, from Europea market that consumes more than 27 percent of developing countries

exports, In addition, the euro has already devalued more than 20 percent against the dollarsince November 2009 and the two could reach parity before the crisis is over. A lower eurowill sharply reduce the profitability of exporting to the European market and will alsoincrease competition from Europe in sectors ranging from agriculture to garments and low-end automobiles.

(ii) TOURISM AND REMITTANCES

A lower euro will reduce the purchasing power of European tourists traveling todeveloping countries, and the value of remittances originating from Europe.

(iii) DOMESTIC COMPETITION

At the same time, a lower euro may provide opportunities for consumers and firms toimport from Europe at a lower cost.

(iv) CAPITAL FLOWS

The Euro crisis will force the European Central Bank to maintain a very low policyinterest rate for the foreseeable future. Similarly low rates in Japan and the United States,combined with low growth in Europe, may lead even more capital to flow to the fastest-growing emerging markets. This will lead to inflation and currency appreciation pressures, aswell as increase the risk of asset bubbles and, eventually, of sudden capital stops in emergingmarkets.

POLICY REACTIONS:

(i) EU EMERGENCY MEASURES

European Financial Stability Facility (EFSF)- On 9 May 2010, the 27 EU member statesagreed to create the European Financial Stability Facility, a legal instrument aiming at

preserving financial stability in Europe by providing financial assistance to eurozonestates in difficulty. The EFSF can issue bonds or other debt instruments on the marketwith the support of the German Debt Management Office to raise the funds needed to

provide loans to eurozone countries in financial troubles, recapitalize banks or buysovereign debt.

European Financial Stabilisation Mechanism (EFSM)-On 5 January 2011, the EuropeanUnion created the European Financial Stabilisation Mechanism (EFSM), an emergencyfunding programme reliant upon funds raised on the financial markets and guaranteed

by the European Commission using the budget of the European Union as collateral. Itruns under the supervision of the Commission and aims at preserving financial stabilityin Europe by providing financial assistance to EU member states in economic difficulty.The Commission fund, backed by all 27 European Union members, has the authority toraise up to60 billion and is rated AAA by Fitch, Moody's and Standard & Poor's.

Brussels Agreement- On 26 October 2011, leaders of the 17 eurozone countries met inBrussels and agreed on a 50% write-off of Greek sovereign debt held by banks, afourfold increase (to about 1 trillion) in bail-out funds held under the EuropeanFinancial Stability Facility, an increased mandatory level of 9% for bank capitalisationwithin the EU and a set of commitments from Italy to take measures to reduce itsnational debt. Also pledged was35 billion in "credit enhancement" to mitigate losses

likely to be suffered by European banks. Jos Manuel Barroso characterised thepackage as a set of "exceptional measures for exceptional times".

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(ii) ECB INTERVENTIONS

The European Central Bank (ECB) has taken a series of measures aimed at reducingvolatility in the financial markets and at improving liquidity.

In May 2010 it took the following actions: It began open market operations buying government and private debt securities,

reaching 219.5 billion by February 2012, though it simultaneously absorbed the sameamount of liquidity to prevent a rise in inflation. According to Rabobank economistElwin de Groot, there is a natural limit of 300 billion the ECB can sterilize.

It reactivated the dollar swap lines with Federal Reserve support. It changed its policy regarding the necessary credit rating for loan deposits, accepting

as collateral all outstanding and new debt instruments issued or guaranteed by theGreek government, regardless of the nation's credit rating.

(iii) EUROPEAN STABILITY MECHANISM (ESM)

The European Stability Mechanism (ESM) is a permanent rescue funding programmeto succeed the temporary European Financial Stability Facility and European Financial

Stabilisation Mechanism in July 2012.On 16 December 2010 the European Council agreed a two line amendment to the EU

Lisbon Treaty to allow for a permanent bail-out mechanism to be established includingstronger sanctions. In March 2011, the European Parliament approved the treaty amendmentafter receiving assurances that the European Commission, rather than EU states, would play 'acentral role' in running the ESM. According to this treaty, the ESM will be anintergovernmental organisation under public international law and will be located inLuxembourg.

Such a mechanism serves as a "financial firewall." Instead of a default by one countryrippling through the entire interconnected financial system, the firewall mechanism canensure that downstream nations and banking systems are protected by guaranteeing some orall of their obligations. Then the single default can be managed while limiting financialcontagion.

(iv) EUROPEAN FISCAL COMPACT

In March 2011 a new reform of the Stability and Growth Pact was initiated, aiming atstraightening the rules by adopting an automatic procedure for imposing of penalties in caseof breaches of either the deficit or the debt rules. By the end of the year, Germany, France andsome other smaller EU countries went a step further and vowed to create a fiscal union acrossthe eurozone with strict and enforceable fiscal rules and automatic penalties embedded in theEU treaties. On 9 December 2011 at the European Council meeting, all 17 members of theeurozone and six countries that aspire to join agreed on a new intergovernmental treaty to putstrict caps on government spending and borrowing, with penalties for those countries whoviolate the limits. All other non-eurozone countries apart from the UK are also prepared to

join in, subject to parliamentary vote. The treaty will enter into force on 1 January 2013, if bythat time 12 members of the euro area have ratified it.

(iv) ECONOMIC REFORMS AND RECOVERY

Increase Investment- Instead of austerity, Keynes suggested increasing investment andcutting income tax for low earners to kick-start the economy and boost growth andemployment. Since struggling European countries lack the funds to engage in deficitspending, German economist and member of the German Council of Economic Experts PeterBofinger and Sony Kapoor of the global think tank Re-Define suggest financing additional

public investments by growth-friendly taxes on "property, land, wealth, carbon emissions andthe under-taxed financial sector". They also called on EU countries to renegotiate the EU

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savings tax directive and tosign an agreement to help each other crack down on tax evasionand avoidance.

Increase Competitiveness- To improve the situation, crisis countries must significantlyincrease their international competitiveness. Typically this is done by depreciatingthe currency. Since eurozone countries cannot devalue their currency, policy makers

try to restore competitiveness through internal devaluation, a painful economicadjustment process, where a country aims to reduce its unit labour costs.

Address Current Account Imbalances- Regardless of the corrective measures chosen to solvethe current predicament, as long as cross border capital flows remain unregulated inthe euro area, current account imbalances are likely to continue. Either way, many ofthe countries involved in the crisis are on the euro, so devaluation, individual interestrates and capital controls are not available. The only solution left to raise a country'slevel of saving is to reduce budget deficits and to change consumption and savingshabits. For example, if a country's citizens saved more instead of consuming imports,this would reduce its trade deficit. It has therefore been suggested that countries withlarge trade deficits (e.g. Greece) consume less and improve their exportingindustries. On the other hand, export driven countries with a large trade surplus, suchas Germany, Austria and the Netherlands would need to shift their economies moretowards domestic services and increase wages to support domestic consumption.

PROPOSED LONG-TERM SOLUTIONS:(i) EUROBONDS

A growing number of investors and economists say Eurobonds would be the best wayof solving a debt crisis, though their introduction matched by tight financial and budgetarycoordination may well require changes in EU treaties.

(ii) EUROPEAN MONETARY FUND

On 20 October 2011, the Austrian Institute of Economic Research published an articlethat suggests transforming the EFSF into a European Monetary Fund (EMF), which couldprovide governments with fixed interest rate Eurobonds at a rate slightly below medium-termeconomic growth (in nominal terms). These bonds would not be tradable but could be held byinvestors with the EMF and liquidated at any time.

(iii) DRASTIC DEBT WRITE-OFF FINANCED BY WEALTH TAX

To reach sustainable levels the Eurozone must reduce its overall debt level by 6.1trillion. According to Boston Consulting Group (BCG) this could be financed by a one-timewealth tax of between 11 and 30 percent for most countries, apart from the crisis countries(particularly Ireland) where a write-off would have to be substantially higher. The authorsadmit that such programs would be "drastic", "unpopular" and "require broad political

coordination and leadership".

(iv) DEBT DEFAULTS AND NATIONAL EXITS FROM THE EUROZONE

In mid May 2012 the financial crisis in Greece and the impossibility of forming a newgovernment after elections led to strong speculation that Greece would have to leave theEurozone shortly. This phenomenon had already become known as "Grexit" and started togovern international market behaviour. Economists have expressed concern that the

phenomenon may well become a typical example of what is called a self-fulfilling prophecy.

POLICY RECOMMENDATIONS:

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(A) GREECE, IRELAND, ITALY, PORTUGAL, AND SPAIN

Implement fiscal consolidation to stabilize the debt-to-GDP ratio within threeyears.

Structural reforms designed to rebalance the economy toward the tradable sectorsand increase competitiveness are essential.

Distribute the adjustments in a transparent and fair way to ensure that specificgroups do not feel unjustly hit, and that the most vulnerable are protected.

Improve the human capital base. This will improve productivity and help thecountry regain attractiveness with foreign investors.

Implement a systematic approach to correct deficiencies in the business climate,especially in starting a business, paying taxes, and getting credit.

(B) EURO AREA

Maintain an expansionary monetary policy that errs on the side of growth for anextended period.

Explicitly promote a weak euro.

Give member states the right to review other members annual budgets and maineconomic indicators, such as GDP growth, productivity growth, the balance of

payments.

Allow European governmentsnot just the European Commission and the IMFto discuss, propose, and monitor action taken by the GIIPS, as well as agree onappropriate sanctions.

Tighten the criteria for admission to the Euro area.

Implement requirements that existing members and members-to-be release timely,reliable, and comparable data on macroeconomic indicators

(C) GERMANY AND OTHER SURPLUS COUNTRIES

Expand domestic demand by about 1 percent of the Euro areas GDP over threeyears in order to offset the deflationary impact of fiscal adjustments in the GIIPS.

Accept slightly higher inflation to keep the aggregate European rate in the 2percent range.

(D) THE REST OF THE WORLD

Rely more on domestic demand.

Look to the global lender of last resort, in the form of the IMF, when significantresources, broader expertise, and distance from regional politics are needed.

If support packages are needed, ensure that they are of sufficient size to reassuremarkets.

(E) DEVELOPED COUNTRIES

Maintain stimulus efforts in the short term. Strong economic growth is the bestlong term debt reduction strategy and the global recovery is still dependent ongovernment support.

Restrain spending and/or increase taxes as soon as a robust recovery is established.

(F) UNITED STATES

Accept a lower euro.

Expand the resources available to the IMF.

Expand the Feds currency swap operations. Use moral suasion to push for necessary adjustments within Europe.

(G) DEVELOPING COUNTRIES Rely less on exports to the industrial countries and more on South-South trade.

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Match the currencies of foreign liabilities with those of export proceeds andreserve holdings.

Moderate the inflow of portfolio capital and encourage the more stable form offoreign direct investment instead.

Allow the currency to appreciate if the external surplus is large and capital inflows

are significant. Closely monitor and tightly regulate the operation of foreign banks and their links

with domestic banks.

Either allow the exchange rate to float, or institute tight capital controls if theexchange rate is pegged.

COMMENTARY:

"The euro should now be recognized as an experiment that failed", wrote MartinFeldstein in 2012. Economists, mostly from outside Europe, and associated with ModernMonetary Theory and other post-Keynesian schools condemned the design of the Euro

currency system from the beginning and have since been advocating that Greece (and theother debtor nations) unilaterally leave the eurozone, which would allow Greece to withdrawsimultaneously from the eurozone and reintroduce its national currency the drachma at adebased rate.

Economists who favor this radical approach to solve the Greek debt crisis typicallyargue that a default is unavoidable for Greece in the long term, and that a delay in organisingan orderly default (by lending Greece more money throughout a few more years), would justwind up hurting EU lenders and neighboring European countries even more. Fiscal austerityor a euro exit is the alternative to accepting differentiated government bond yields within theEuro Area. If Greece remains in the euro while accepting higher bond yields, reflecting its

high government deficit, then high interest rates would dampen demand, raise savings andslow the economy. An improved trade performance and less reliance on foreign capital would

be the result.

However, there is opposition in this view. The national exits are expected to be anexpensive proposition. The breakdown of the currency would lead to insolvency of severaleuro zone countries, a breakdown in intrazone payments. Having instablity and the publicdebt issue still not solved, the contagion effects and instability would spread into the system.Having that the exit of Greece would trigger the breakdown of the eurozone, this is notwelcomed by many politicians, economists and journalists.

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REFERENCES

Bibliography:

1. Lewis, Michael (2011-09-26). "Touring the Ruins of the Old Economy".New York Times.Retrieved 2012-06-06.

2. Anand, M.R.; Gupta, GL; Dash, Ranjan (2012). The Euro Zone Crisis Its Dimensions andImplications. REPEC. pp. 22. Retrieved 6 June 2012.

3. Lewis, Michael (2011).Boomerang Travels in the New Third World. Norton. ISBN 978-

0-393-08181-7.

4. "Cross-Border Resolution of Failed Banks in the European Union after the Crisis: Business

as Usual". Papers.ssrn.com. 2012-02-09. Retrieved 2012-05-14.

5. "NPR-The Giant Pool of Money-May 2008". Thisamericanlife.org. Retrieved 2012-05-14.

6. Sponsored by. "The Economist-No Big Bazooka-29 October 2011". Economist.com.

Retrieved 2012-05-14.

7. Portugals Unnecessary Bailout The New York Times.

8. Hadjipapas, Andreas; Hope, Kerin (14 September 2011). "Cyprus nears 2.5bn Russian

loan deal". Guardian. Retrieved 13 March 2012.

Websites Accessed:

https://www.eiu.com

www.CarnegieEndowment.org

www.Carnegie-mec.org

www.CarnegieEurope.eu

www.ec.europa.eu/economy_finance/publications

http://ec.europa.eu/commission_2010-2014/rehn/headlines/news/2010/05/20100511_en.htm

http://www.ft.com/cms/s/0/54f4983e-e637-11de-bcbe-00144feab49a.html#axzz159SQMSyK

www.ft.com/cms/s/0/643daffa-d57a-11df-8e86-00144feabdc0.htm

http://www.economist.com/node/17093339

http://www.guardian.co.uk/business/2010/may/08/debt-crisis-merkel-sarkozy-euro-protection-plan

http://www.economist.com/node/16216363?story_id=16216363

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