The European Sovereign Debt Crisis

What is it? For many years, low interests rates have made borrowing in Europe cheap. Many European countries have taken advantage of this opportunity: Greece, Spain and Ireland (which had systematically deregulated banks and implemented corporate tax incentives) all experienced intense economic growth. In early 2010, the new government in Greece discovered that Greek debts had been misrepresented. They were in fact three times larger than the amount reported, prompting investors to demand higher rates. These increased costs for borrowing made Greek debts unmanageable and forced Greece to request a bailout.

The uncertainty sparked by the situation in Greece continued to ripple through Europe, bursting the real-estate bubbles in Spain and Ireland. Portugal, in contrast to Greece, Spain and Ireland, did not experience growth due to easy credit; instead, it suffered greatly from trade losses due to competition from Asia and Eastern Europe. It accumulated large debts, which similarly became unmanageable as investors raised rates. These events have led to the recent breakdown in Europe and the subsequent bailouts by the European Union and the IMF, amounting to $145 billion for Greece and $113 billion for Ireland. The world is watching as Spain and Portugal navigate this rocky road and attempt to bring down their deficits.

Why is it important?

The crisis has affected many of Europe’s banks, and it has forced substantial cuts in government spending, a condition of the bailout plans. Without the ability to devalue their currencies to prop up exports, weaker economies seem to be heading on a downward path. Stronger economies, such as Germany, have been forced to take on risk and have essentially become the lender of last resort for the weaker ones.

This crisis threatens the survival of the euro as a single currency system. At the recent World Economic Forum in Davos, Switzerland, German Chancellor Angela Merkel stated that the euro “is more than a currency; it is Europe. If the euro fails, Europe fails.”

What is our angle?

There are great divisions among economists surrounding what actions would remove uncertainty for the euro. In this issue, we present two views regarding how the European Monetary Union should go about resolving the European Sovereign Debt Crisis and what this crisis means for the future of the EMU.

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