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The Euro Area Debt Crisis

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  1. Introduction
  2. Origin of the Euro Area Sovereign Debt Crisis
  3. Failure of Economic Tools in the Recovery Process
  4. Implications of the European Sovereign Debt Crisis
  5. Measures to Overcome Sovereign Debt Crisis
  6. Conclusion

Over the past decade, productivity in most economies, both in central and peripheral countries has doubled beyond the initial estimates. This has partly been the contribution of implementing robust investment tools and informed investor on maximizing returns.However, the implications of the five-year (2007- 2012) global financial crisis has discredited the appropriateness of individual economic systems to ignite recovery and restore investor confidence. In particular, the peripheral economies have suffered in the 2010 sovereign debt crisis with several concerns emerging on their normalization ability after a financial catastrophe. The current financial crisis in the Euro area has generated a challenging contagion context for many economies, with multiple factors working towards complexity during real time decision making.The debt crisis in the developed economic systems has attracted financial analysts and economists to scrutinize the origin, present consequences and challenges ahead. Firstly, the origin of the debt crisis is associated with the heightened complacency evident in Europe in the longest period of great moderation with less of macro volatility

[...] Measures to Overcome Sovereign Debt Crisis With the contagious nature of the debt crisis spreading to other economic sectors, the economists have proposed and implemented measures meant to correct the underlying weaknesses. To start with, countries worst hit by the turmoil have implemented a voluntary debt restructuring to correct the underlying vulnerabilities during high dependency in foreign debt borrowing. For instance, the Greece authorities have initiated negotiations to incorporate special credit enhancement features to replace the sovereign bonds with debt swaps such cofinancing schemes (Institute of International Finance, 2012). [...]


[...] Owing to the declining benchmark interest rates of downgrading government bonds, banks witnessed depressing profitability. Equally, with the financial costs rising in the unstable economies, financial institutions were raising their lending rates to hedge against unforeseeable risk in their assets. This led to shifting the debt burden from the policy failures to affect customers in the real economy (Allen & Moessner, 2012). Moreover, the downgrading of the sovereign debt notes heightened the vulnerability of the affected nations as faced complex economic challenges that the existing economic policies could not settle adequately. [...]


[...] Here, the fiscal compact seeks to prevent macroeconomic inequalities where a far-reaching fiscal pillar is established alongside stability-oriented regulatory policy. This would protect the member states from transitory tensions arising in the economies with a more shared decision making environment guaranteeing joint control of deficit management. Conclusion Foreign dependency to solve the budgetary deficit plunged periphery economies into a debt crisis. Although the debt crisis arose during the widespread financial crisis affecting global economies, the contagion effects in Europe were immense given the weak financial sectors. [...]


[...] This manifested itself as overdependence on foreign capital support for domestic consumption rather than utilize productivity-based investment to secure economic stabilization. Failure of Economic Tools in the Recovery Process With the primary mandate of the monetary and fiscal tools being maintaining stability in the economies, the aforementioned factors worked against the intended objective. Firstly, eliminating the exchange risk and the inflation risks in the individual economies led to undifferentiated pricing of the government bonds. This ignored the basic facts that different segments of the Euro-system were facing dissimilar conditions. [...]


[...] Subsequently, the contagion consequences were disastrous to the weakening economic systems. To begin with, sovereign debt problems hampered banks' access to finance in member states making it difficult for them to tap into long-term debt markets (ECFIN, 2010). Here, banks were witnessing an inverted trend owing to the loss of investors' confidence in the market where the state had turned to foreign borrowing to meet the fiscal shortfalls. In action too, were the increasing costs of issuing bonds in the volatile market therefore, which THE EURO AREA DEBT CRISIS discouraged potential investors from such risky investment atmosphere. [...]

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