AMITY UNIVERSITY AMITY SCHOOL OF BUSINESS

THE EURO CRISIS

SUBMITTED TO: PRIYANK BADOLA

SUBMITTED BY: KOMAL CHAUDHARY ENROLL. NO. A3906409268 E-04

ACKNOWLEDGEMENT

Any attempt at any level cannot be satisfactorily completed without the support and guidance of learned people. I have deep sense of gratitude to everyone who all supported me, for I have completed my project effectively and moreover on time. I owe a great thank to my faculty guide Mr. Priyank Badola for giving me moral support and guiding me different matters regarding the topic. He had been very kind and patient while suggesting me the outlines of this project and correcting my doubts. I would also like to thank my parents who helped me a lot in gathering different information, collecting data and guiding me from time to time in this project. Thank you Komal Chaudhary

RESEARCH METHODOLOGY
In this study, only secondary data will be used to collect data and establish the points of concern. Source of data: secondary data sources (journals, internet, newspapers) will be used in this work.

RESEARCH OBJECTIVES: To understand the causes of the Euro Crisis. To study the impact of this crisis on the European nations and the rest of the world. To provide policy recommendations.

RESEARCH DESIGN: The research is going to be descriptive, as it explains or describes the event of crisis in Europe. DATA SOURCE: Collection of data:
The collection of data is a tedious task. For conducting any sort of research data was needed. So for my research, there was plenty of secondary data in newspapers, some journals, on internet, etc which has been taken into consideration. Various articles, news and information in other forms have been used to be included in the report.

LIMITATIONS OF THE PROJECT

The major limitation of the project is that only the secondary data is used for the purpose of research. No primary data has been collected. All the information relating to causes, impacts, solutions and other related factors/matter have not been included in the project report.

INTRODUCTION
The recent recession affected not only household pocketbooks and budgets but also the financial status of governments at all levels. National government debtboth U.S. and foreignhas garnered headline attention and concerned investors and creditors. When a governments outlays exceed its tax receipts in a given fiscal year, it runs a deficit and may have to borrow money to make up the difference. Sovereign debt is the accumulation of such borrowing from foreign and domestic creditors. If creditors are unsure whether a national government is able or willing to repay its debts, then the government may have to pay a higher interest rate on the bonds it issues to entice buyers. If a government is unable to issue bonds to cover its debts, then it must resort to other means: cutting expenditures, raising taxes, or borrowing from international agencies such as the International Monetary Fund. Greece and a few other European countries currently find themselves in this situation. Is the United States close to a similar debt crisis? Greeces government debt is exceptionally large. Its gross debttogross domestic product (GDP) ratio is nearly 115 percent. This means its debt is greater than its annual GDP. After Greece joined the European Union (EU), investors assumed the EU would not allow Greeces debt to exceed the Maastricht treaty limit. As a result, Greece was able to borrow funds at low interest rates normally available only to more creditworthy countries. Oddly, the same reason that Greece was able to accumulate this debtjoining the EUmay also be the reason it defaults on this debt. When Greece adopted the euro, it ceded control over monetary policy to the European Central Bank and is prohibited from devaluing its currency as a means of reducing the real value of its debt (a tactic used throughout history by many countries). Greece is not alone: Portugal, Ireland, Italy, and Spain also face excessive debt because of their high spending and accumulated borrowing. (The group, along with Greece, is somewhat harshly referred to as PIIGS.) In recent years, the U.S. government has also acquired substantial debt. Its fiscal year 2009 gross debtto gross GDP ratio reached 82 percent. Although U.S. debt has been increasing, it may not foreshadow a Greekstyle crisis. The sharp increase in the U.S. deficit has been largely due to the recent deep recession and financial crisis. When GDP decreases, government tax receipts also decrease; at the same time, government spending increases to finance programs such as

unemployment benefits. The United States recently implemented two major fiscal stimulus plans to boost the economy. As the U.S. economy recovers, the deficit should fall as government revenues increase and recessionary spending decreases. According to the Congressional Budget Office, the U.S. deficit-to-GDP ratio was 9.9 percent in fiscal year 2009 and projected to decrease to 4.1 percent by 2012. In comparison, Greece had a deficit-to-GDP ratio of 13.5 percent in 2009, which is projected to be 15.4 percent by 2012. This projection drops to 6.5 percent if Greece implements its promised austerity measures. In the meantime, the United States should be able to avoid a Greek-style debt crisis. Because the United States is the worlds largest economy, investors continue to perceive U.S. debt as a stable, valuable source of revenue and have been willing to purchase U.S. bonds at relatively low interest rates. Although the United States does not have the same fiscal problems as Greece, there are still issues of concern. High sovereign debt levels levy an undue burden on a countrys citizens, specifically in the form of lower GDP growth and higher taxes.

EURO CRISIS
From late 2009, fears of a sovereign debt crisis developed among fiscally conservative investors concerning some European states, with the situation becoming particularly tense in early 2010. This included eurozone members Greece, Ireland, Spain and Portugal and also some EU countries outside the area. Iceland, the country which experienced the largest crisis in 2008 when its entire international banking system collapsed has emerged less affected by the sovereign debt crisis as the government was unable to bail the banks out. In the EU, especially in countries where sovereign debts have increased sharply due to bank bailouts, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU members, most importantly Germany. While the sovereign debt increases have been most pronounced in only a few eurozone countries they have become a perceived problem for the area as a whole. In May 2011, the crisis resurfaced, concerning mostly the refinancing of Greek public debts. The Greek people generally reject the austerity measures and have expressed their dissatisfaction through angry street protests. In late June 2011, the crisis situation was again brought under control with the Greek government managing to pass a package of new austerity measures and EU leaders pledging funds to support the country. Concern about rising government deficits and debt levels across the globe together with a wave of downgrading of European government debt created alarm in financial markets. On 9 May 2010, Europe's Finance Ministers approved a comprehensive rescue package worth 750 Billion (then almost a trillion dollars) aimed at ensuring financial stability across Europe by creating the European Financial Stability Facility (EFSF). In 2010 the debt crisis was mostly centered on events in Greece, where the cost of financing government debt was rising. On 2 May 2010, the eurozone countries and the International Monetary Fund agreed to a 110 billion loan for Greece, conditional on the implementation of harsh austerity measures. The Greek bail-out was followed by a 85 billion rescue package for Ireland in November, a 78 billion bail-out for Portugal in May 2011, then continuing efforts to meet the continuing crisis in Greece and other countries.

This was the first eurozone crisis since its creation in 1999. As Samuel Brittan pointed out, Jason Manolopoulos "shows conclusively that the eurozone is far from an optimum currency area". Niall Ferguson also wrote in 2010 that "the sovereign debt crisis that is unfolding...is a fiscal crisis of the western world". Axel Merk (FT) argued in a May 2011 article that the dollar was in graver danger than the euro.

CAUSES OF THE EURO CRISIS

CAUSES
Rising government debt levels

In 1992, members of the European Union signed the Maastricht Treaty, under which they pledged to limit their deficit spending and debt levels. However, a number of EU member states, including Greece and Italy, were able to circumvent these rules and mask their deficit and debt levels through the use of complex currency and credit derivatives structures. The structures were designed by prominent U.S. investment banks, who received substantial fees in return for their services and who took on little credit risk themselves thanks to special legal protection for derivatives counterparties. A number of "appalled economists" have condemned the popular notion in the media that 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 economic slowdown thereafter. The average fiscal deficit in the euro area in 2007 was only 0.6% before it grew to 7% during the financial crisis. In the same period the average government debt rose from 66% to 84% of GDP. The authors also stressed that fiscal deficits in the euro area were stable or even shrinking since the early 1990s. US economist Paul Krugman named Greece as the only country where fiscal irresponsibility is at the heart of the crisis. Trade imbalances

Commentators such as Financial Times journalist Martin Wolf have asserted that the root of the crisis was growing trade imbalances. He notes in the run-up to the crisis, from 1999 to 2007, Germany had a considerably better public debt and fiscal deficit relative to GDP 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 trade surpluses increased as a percentage of GDP after 1999, the deficits of Italy, France and Spain all worsened. More recently, Greece's trading position has improved; in the period November 2010 to October 2011 imports dropped 12% while exports grew 15%. Monetary policy inflexibility

Since membership of the eurozone establishes a single monetary policy, individual member states can no longer act independently. Paradoxically, this situation creates a higher default risk than faced by smaller non-eurozone economies, like the United Kingdom, which are able to "print money" in order to pay creditors and ease their risk of default. (Such an option is not available to a state such as France.) By "printing money" a country's currency is devalued relative to its (eurozone) trading partners, making its exports cheaper, in principle leading to an improving balance of trade, increased GDP and higher tax revenues in nominal terms. In the reverse direction moreover, assets held in a currency which has devalued suffer losses on the part of those holding them. Loss of confidence

Prior to development of the crisis it was assumed by both regulators and banks that sovereign debt from the eurozone was safe. Banks had substantial holdings of bonds from weaker economies such as Greece which offered a small premium and seemingly were equally sound. As the crisis developed it became obvious that Greek, and possibly other countries', bonds offered substantially more risk. Contributing to lack of information about the risk of European sovereign debt was conflict of interest by banks that were earning substantial sums underwriting the bonds. The loss of confidence is marked by rising sovereign CDS prices, indicating market expectations about countries' creditworthiness. Furthermore, investors have doubts about the possibilities of policy makers to quickly contain the crisis. Since countries that use the euro as their currency have fewer monetary policy choices (e.g., they cannot print money in their own currencies to pay debt holders), certain solutions require multi-national cooperation. Further, the European Central Bank has an inflation control mandate but not an employment mandate, as opposed to the U.S. Federal Reserve, which has a dual mandate.

EVOLUTION OF THE EURO CRISIS

EVOLUTION OF THE CRISIS

In the first weeks of 2010, there was renewed anxiety about excessive national debt. Frightened investors demanded higher interest rates from several governments with higher debt levels or deficits. This in turn makes it difficult for governments to finance further budget deficits and service existing high debt levels. Elected officials have focused on austerity measures (e.g., higher taxes and lower expenses) contributing to social unrest and significant debate among economists, many of whom advocate greater deficits when economies are struggling. Especially in countries where government budget deficits and sovereign debts have increased sharply, a crisis of confidence has emerged with the widening of bond yield spreads and risk insurance on credit default swaps between these countries and other EU member states, most importantly Germany. Greece: In the early-mid 2000s, Greece's economy was strong and the government took advantage by running a large deficit, partly due to high defense spending amid historic enmity to Turkey. As the world economy cooled in the late 2000s, Greece was hit especially hard because its main industriesshipping and tourismwere especially sensitive to changes in the business cycle. As a result, the country's debt began to pile up rapidly. In early 2010, as concerns about Greece's national debt grew, policy makers suggested that emergency bailouts might be necessary. EU politicians in Brussels have long turned a blind eye and gave Greece a fairly clean bill of health, even as the reality of economics suggested the Euro was in danger. On 23 April 2010, the Greek government requested that the EU/IMF bailout package (made of relatively high-interest loans) be activated. The IMF had said it was "prepared to move expeditiously on this request". The initial size of the loan package was 45 billion ($61 billion) and its first installment covered 8.5 billion of Greek bonds that became due for repayment. On 27 April 2010, Standard & Poor's slashed Greece's sovereign debt rating to BB+ or "junk" status amid fears of default. The yield of the Greek two-year bond reached 15.3% in the secondary market. Standard & Poor's estimates that, in the event of default, investors would lose

3050% of their money. Stock markets worldwide and the Euro currency declined in response to this announcement. On 1 May 2010, a series of austerity measures was proposed. The proposal helped persuade Germany, the last remaining holdout, to sign on to a larger, 110 billion EU/IMF loan package over three years for Greece (retaining a relatively high interest of 5% for the main part of the loans, provided by the EU). On 5 May, a national strike was held in opposition to the planned spending cuts and tax increases. Protest on that date was widespread and turned violent in Athens, killing three people. On 2 May 2010, the Eurozone countries and the International Monetary Fund agreed to a 110 billion loan for Greece, conditional on the implementation of harsh austerity measures. The Greek bail-out was followed by a 85 billion rescue package for Ireland in November, a 78 billion bail-out for Portugal in May 2011, then continuing efforts to meet the continuing crisis in Greece and other countries. The November 2010 revisions of 2009 deficit and debt levels made accomplishment of the 2010 targets even harder, and indications signal a recession harsher than originally feared. Japan, Italy and Belgium's creditors are mainly domestic institutions, but Greece and Portugal have a higher percent of their debt in the hands of foreign creditors, which is seen by certain analysts as more difficult to sustain. Greece, Portugal, and Spain have a 'credibility problem', because they lack the ability to repay adequately due to their low growth rate, high deficit, less FDI, etc. In May 2011, Greek public debt gained prominence as a matter of concern. The Greek people generally reject the austerity measures, and have expressed their dissatisfaction through angry street protests. In late June 2011, Greece's government proposed additional spending cuts worth 28 billion (25bn) over five years. The next 12 billion euros from the Eurozone bail-out package will be released when the proposal is passed, without which Greece would have had to default on loan repayments due in mid-July.

On 13 June 2011, Standard and Poor's downgraded Greece's sovereign debt rating to CCC, the lowest in the world, following the findings of a bilateral EU-IMF audit which called for further austerity measures. After the major political parties failed to reach consensus on the necessary measures to qualify for a further bailout package, and amidst riots and a general strike, Prime Minister George Papandreou proposed a re-shuffled cabinet, and asked for a vote of confidence in the parliament. The crisis sent ripples around the world, with major stock exchanges exhibiting losses. Greeces first adjustment plan was launched in March 2010 with 80 billion in support from the European governments and 30 billion from the IMF. This adjustment program hoped to reestablish the access to private capital markets by 2012. However it was soon found that this process would take longer than expected. In July 2011 there was a new package instilled in which an extra 109 billion in support of Greece which included a large privatization effort. Some believe that this will cause more debt for Greece. With this new package it is projected that there will be a 3.8% decline in 2011 but a .6% growth in 2012, following with a 3.5% increase in 2013, where it will eventually plateau in 2015 at 6.4%. Some experts argue the best option for Greece and the rest of the EU should be to engineer an orderly default on Greeces public debt which would allow Athens to withdraw simultaneously from the eurozone and reintroduce its national currency the drachma at a debased rate. Economists who favor this approach to solve the Greek debt crisis typically argue that a delay in organising an orderly default would wind up hurting EU lenders and neighboring European countries even more. At an extraordinary summit on 21 July 2011 in Brussels the euro area leaders agreed to lower the interest rates of EU loans to Greece to 3.5%. In the early hours of 27 October 2011, Eurozone leaders and the IMF came to an agreement with banks to accept a 50% write-off of (some part of) Greek debt, the equivalent of 100 billion. The aim of the haircut is to reduce Greece's debt to 120% of GDP by 2020.

Spread beyond Greece The government surplus or deficit of Belgium, Greece, France, Hungary, Iceland, Italy, Portugal, Spain and the UK against the Eurozone and the United States (2001-2011). One of the central concerns prior to the bailout was that the crisis could spread beyond Greece. The crisis has reduced confidence in other European economies. Ireland, with a government deficit in 2010 of 32.4% of GDP, Spain with 9.2%, and Portugal at 9.1% are most at risk. According to the 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." Ireland: The Irish sovereign debt crisis was not based on government over-spending, but from the state guaranteeing the six main Irish-based banks who had financed a property bubble. On 29 September 2008 the 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 soon after the launch of the National Asset Management Agency (NAMA), a body designed to remove bad loans from the six banks. Irish banks had lost an estimated 100 billion euros, much of it related to defaulted loans to property developers and homeowners made in the midst of the property bubble, which burst around 2007. Ireland could have guaranteed bank deposits and let private bondholders who had invested in the banks face losses, but instead borrowed money from the ECB to pay these bondholders, shifting the losses and debt to its taxpayers. NAMA purchased over 80 billion euros in bad loans from the banks as the mechanism for this transfer. 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 of 32% GDP in 2010, the highest in the history of the euro zone, despite draconian austerity measures. By September 2010 the banks could not raise finance and the bank guarantee was renewed for a third year. This had a negative impact on Irish government bonds, government help for the banks rose to 32% of GDP, and so the government started negotiations with the EU, the IMF and three nations: the United Kingdom, Denmark and Sweden, resulting in a 67.5 billion "bailout"

agreement of 29 November 2010. Together with additional 17.5 billion coming from Ireland's own reserves and pensions, the government received 85 billion, of which 34 billion were used to support the country's ailing financial sector. In return the government agreed to reduce its budget deficit to below three percent by 2015.. In April 2011, despite all the measures taken, Moody's downgraded the banks' debt to junk status. The Euro Plus Monitor report from November 2011 attests to Ireland's vast progress in dealing with its financial crisis, expecting the country to stand on its own feet again and finance itself without any external support from the second half of 2012 onwards. According to the Centre for Economics and Business Research Ireland's export-led recovery "will gradually pull its economy out of its trough". As a result of the improved economic outlook, the cost of 10-year government bonds, which has already fallen substantially since mid July 2011, is expected to fall further to 4 per cent by 2015. Portugal: A report released in January 2011 by the Dirio de Notcias and published in Portugal by Gradiva, demonstrated that in the period between the Carnation Revolution in 1974 and 2010, the democratic Portuguese Republic governments have encouraged over-expenditure and investment bubbles through unclear public-private partnerships and funding of numerous ineffective and unnecessary external consultancy and advisory of committees and firms. This allowed considerable slippage in state-managed public works and inflated top management and head officer bonuses and wages. Persistent and lasting recruitment policies boosted the number of redundant public servants. Risky credit, public debt creation, and European structural and cohesion funds were mismanaged across almost four decades. The Prime Minister Scrates's cabinet was not able to forecast or prevent this in 2005, and later it was incapable of doing anything to improve the situation when the country was on the verge of bankruptcy by 2011. On 16 May 2011 the Eurozone leaders officially approved a 78 billion bailout package for Portugal. The bailout loan will be equally split between the European Financial Stabilization Mechanism, the European Financial Stability Facility, and the International Monetary Fund. According to the Portuguese finance minister, the average interest rate on the bailout loan is

expected to be 5.1% As part of the bailout, Portugal agreed to eliminate its golden share in Portugal Telecom to pave the way for privatization. Portugal became the third Eurozone country, after Ireland and Greece, to receive a bailout package. On 6 July 2011 it was confirmed that the ratings agency Moody's had cut Portugal's credit rating to junk status, Moody's also launched speculation that Portugal may follow Greece in requesting a second bailout. Italy: Italy's deficit of 4.6 percent of GDP in 2010 was similar to Germanys at 4.3. However, its debt has increased to almost 120 percent of GDP (U.S. $2.4 trillion in 2010) and economic growth was lower than the EU average for over a decade. This has led investors to view Italian bonds more and more as a risky asset. On the other hand, the public debt of Italy has a longer maturity and a big share of it is held domestically. Overall this makes the country more resilient to financial shocks, ranking better than France and Belgium. Spain: Shortly after the announcement of the EU's new "emergency fund" for eurozone countries in early May 2010, Spain's government announced new austerity measures designed to further reduce the country's budget deficit. The Spanish government had hoped to avoid such deep cuts, but weak economic growth as well as domestic and international pressure forced the government to expand on cuts. As one of the largest eurozone economies the condition of Spain's economy is of particular concern to international observers, and faced pressure from the United States, the IMF, other European countries and the European Commission to cut its deficit more aggressively. Spain succeeded in trimming its deficit from 11.2% of GDP in 2009 to 9.2% in 2010 and around 6% in 2011.

Belgium: In 2010, Belgium's public debt was 100% of its GDP the third highest in the eurozone after Greece and Italy and there were doubts about the financial stability of the banks. After inconclusive elections in June 2010, by November 2011 the country still had only a caretaker government as parties from the two main language groups in the country (Flemish and Walloon) were unable to reach agreement on how to form a majority government. Financial analysts forecast that Belgium would be the next country to be hit by the financial crisis as Belgium's borrowing costs rose. However the government deficit of 5% was relatively modest and Belgian government 10-year bond yields in November 2010 of 3.7% were still below those of Ireland (9.2%), Portugal (7%) and Spain (5.2%). Furthermore, thanks to Belgium's high personal savings rate, the Belgian Government financed the deficit from mainly domestic savings, making it less prone to fluctuations of international credit markets. Nevertheless on 25 November 2011, Belgium's longterm sovereign credit rating was downgraded from AA+ to AA by Standard and Poor and 10year bond yields reached 5.66%. Shortly after Belgian negotiating parties reached an agreement to form a new government. The deal includes spending cuts and tax rises worth about 11 billion, which should bring the budget deficit down to 2.8% of GDP by 2012, and to balance the books in 2015. Following the announcement Belgium 10-year bond yields fell sharply to 4.6%. France: France's public debt in 2010 was approximately U.S. $2.1 trillion and 83% GDP, with a 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. Other European countries United Kingdom: According to the Financial Policy Committee "Any associated disruption to bank funding markets could spill over to UK banks." Bank of England governor Mervyn King declared that

the UK is very much at risk from a domino-fall of defaults and called on banks to build up more capital when financial conditions allowed. Iceland: Iceland suffered the failure of its banking system and a subsequent economic crisis. After a sharp increase in public debts due to the banking failures, the government has been able to reduce the size of deficits each year. The effort has been made more difficult by a more sluggish recovery than earlier expected. Before the crash of the three largest commercial banks in Iceland, Glitnir, Landsbanki and Kaupthing, they jointly owed over 10 times Iceland's GDP. In October 2008, the Icelandic parliament passed emergency legislation to minimize the impact of the financial crisis. The Financial Supervisory Authority of Iceland used permission granted by the emergency legislation to take over the domestic operations of the three largest banks. Switzerland: In September 2011, the Swiss National Bank weakened the Swiss franc to a floor of 1.20 francs per euro. The franc has been appreciating against the euro during the crisis, harming Swiss exporters. The SNB surprised currency traders by pledging that "it will no longer tolerate a eurofranc exchange rate below the minimum rate of 1.20 francs." This is the biggest Swiss intervention since 1978.

Germany is the reason for Euro crisis, economist says

Germany is the reason for the crisis that Europe faces today, rather than periphery countries of the European Union like Greece, Italy, Spain and Portugal as commonly believed, according to a prominent London-based economist. The problem in Europe is Germany, John Weeks, professor emeritus and senior researcher of economic development at the University of London, said at the sidelines of a seminar at Istanbuls Kadir Has University. Germanys current giant trade surplus is equivalent to the trade deficit of most European countries. The German government pursued policies of holding wages down, which have made the country more competitive and turned its $33 billion current account deficit in 2000 to a surplus of $200 billion, while all other European countries have a deficit, Weeks told the Hrriyet Daily News. All the allegations that Greeks are lazy people and retire earlier, or that Italians work less [than Germany], are not true, he said. Italians worked 38 hours and Greeks 38.5 hours per week in 2009, while the figure for Germans was 35.7 hours, he said. Germanys trade surplus cannot be the result of market forces, but rather mercantile government policies, Weeks said. That is why we have a crisis. Unless Germany reduces its trade surplus, other countries will either go into more debt to pay for their imports, encourage foreign investment flows or force down wages to reach inflation rates below that of Germany, he said. He said such a move by Germany was rather unlikely, so further proposed the country follow fiscal expansion policy, importing more and exporting less. Germany is not prepared to do any of these, Weeks said. Normally, a German businessman would not want the eurozone economy to collapse, he said. Germany has this nice big market in Europe, but does not want to see it. Weeks said things have been happening so late that Germanys reduction of exports alone was not enough to address the crisis in Europe. Issuing common eurobonds is a step to be taken

immediately and the European Central Bank has to agree to be the lender of last resort, he said. This would temporarily solve the problem of speculative pressure as well as allow countries to sell long-term bonds, he said. With such an aggressive speculative market, it is difficult to sell long-term bonds. European countries may be too late now to properly address the deep crisis the EU is about to enter, he said. The latest agreement made for Greece is clearly not sustainable, he said, adding that unless a new bailout package is approved, Greece will have to leave the eurozone.
Greece will leave the euro

I believe a year from now Greece will be out, Weeks told the Daily News. The possibility of Italy and Spain leaving the euro is less likely, he said. However, EU countries will enter a deep depression that may be more severe than the 2008 crisis, he said. Greeces leaving the euro should not necessarily result in the country leaving the EU, unless governments in Germany and other countries vindicate it, he said. Should Greece drop out of the eurozone, a political crisis might burst in Germany that will either drive to change Merkels policies or replace her, Weeks said. This will increase Germanys domestic support for the creation of a common European fiscal authority for eurozone countries, he said.
One year left for Turkey to act

Turkeys rapid economic growth is based on exports mainly toward the EU, Weeks said, adding that the Turkish government will have to reduce the countrys serious current account deficit certainly within the next year, before growth rates start reducing [due to the depression in Europe]. Otherwise, Turkey may become a target for speculators, he said. Apart from diversification of exports to countries less affected by the crisis, Turkish government could also apply temporary import controls, according to him. For instance, it could encourage domestic import substitution of intermediary products.

CONCEQUENCES OF THE EURO CRISIS

IMPACT ON ACTUAL AND POTENTIAL GROWTH

A SYMMETRIC SHOCK WITH ASYMMETRIC IMPLICATIONS

The financial crisis has hit the various Member States to a different degree. Ireland, the Baltic countries, Hungary and Germany are likely to post contractions exceeding the EU average of 4% . By contrast, Bulgaria, Poland, Greece, Cyprus and Malta seem to be much less affected than the average. extent to which housing markets had been overvalued and construction industries oversized. Strong real house price increases have been observed in the past ten years or so in the United Kingdom, France, Ireland, Spain and the Baltic countries, and in some cases this has been associated with buoyant construction activity with the striking exception of the United Kingdom where strict zoning laws prevail. The greater the dependency of the economy on housing activity, including the dependency on wealth effects of house price increases on consumption, the greater the sensitivity of domestic demand to the financial market shock. Some Member States in Central and Eastern Europe have been particularly hard hit through this wealth channel, notably the Baltic countries. The export dependency of the economy and the current account position.

Countries where export demand has been strong and/or which have registered current account surpluses are more exposed to the sharp contraction of world trade (e.g. Germany, the Netherlands, and Austria). Countries which have been running large surpluses are also more likely to beexposed to adverse balance sheet effects of corrections in international financial asset markets. Conversely, countries which have been running large current account deficits may face a risk of reversals of capital flows. Some Member States in Central and Eastern Europe are in this category. In some of these cases, the sudden stops in foreign financing forced governments to make a call on balance of payment assistance from the EU, IMF and the World Bank. The size of the financial sector and/or its exposure to risky assets.

Countries which house large financial centers, such as the United Kingdom, Ireland and Luxembourg, are obviously exposed to financial turbulence. Conversely, countries which are the home base of cross-border banking activities in emerging economies in Central and Eastern

Europe are also likely to be more strongly affected. The exposure for European banks to emerging market risk is fairly concentrated in a few countries (notably Austria, Belgium and Sweden). THE IMPACT OF THE CRISIS ON POTENTIAL GROWTH Gauging the impact of the crisis on potential growth is important because this is a main determinant of the development of the standards of living in the medium and longer run. It is also an important determinant of the gauge of economic slack i.e. the output gap in the short run, which in turn defines the room for short-term policy stimulus beyond which inflation pressures are likely to emerge. Conversely, if the level of potential output is underestimated, the risk of deflation and the associated case for policy stimulus will be understated. Potential output is, finally, an important determinant of the 'structural' or cyclically-adjusted fiscal position: the lower potential output, the smaller will be the (negative) output gap and hence the larger will be the structural (or lasting) component of the budget deficit.

IMPACT ON LABOUR MARKET AND EMPLOYMENT

Labour markets in the EU started to weaken considerably in the second half of 2008, deteriorating further in the course of 2009. Increased internal flexibility (flexible working time arrangements, temporary closures etc.), coupled with nominal wage concessions in return for employment stability in some firms and industries appears to have prevented, though perhaps only delayed, more significant labour shedding so far. The EU unemployment rate has soared by more than 2 percentage points.

The present chapter takes stock of labour market developments since the onset of the and examines the evidence on further job losses possibly being in the pipeline. Until the financial crisis broke in the summer of 2007 the EU labour markets had performed relatively well. The employment rate, at about 68% of the workforce, was approaching the Lisbon target of 70%, owing largely to significant increases in the employment rates of women and older workers. Unemployment had declined to a rate of about 7%, despite a very substantial increase in the labour force, especially of non-EU nationals and women. Importantly, the decline in the unemployment rate had not led to a notable acceleration in inflation, implying that the level of unemployment at which labour shortages start to produce wage pressures (i.e. structural unemployment) had declined.

These improvements had been spurred by reforms to enhance the flexibility of the labour market and raise the potential labour supply. The reforms usually included a combination of cuts in income taxes targeted at low-incomes and a redirection of active labour market policies towards more effective job search and early activation. Measures to stimulate the supply side of the labour market and improve the matching of job seekers with vacancies were at the centre of policies in a majority of countries. Importantly, however, in many countries the increase in flexibility of the labour market was achieved by easing the access to non-standard forms of work.

The second half of 2008 and deteriorated further in the course of 2009. In the second quarter of 2009 the unemployment rate had increased by 2.2 percentage points from its 6.7% low a year

earlier. The sharpest increases in unemployment have been registered in countries facing the largest downturns in activity, notably the Baltic countries, Ireland and Spain. Almost three years of progress since mid-2005 in bringing the unemployment rate down from 9 had been all but wiped out in about a year. According to the 2009 Commission's spring forecast the unemployment rate is expected to increase to close to 11% in the EU by 2010.

In the early phases of the crisis, the bulk of job losses were concentrated in just a handful of Member States, largely as a result of pre-existing weaknesses as well as a larger exposure to the direct consequences of the shocks (e.g. adjustments in the financial sector and housing markets, relative exposure to international trade). However, as the crisis subsequently put a widespread brake on domestic demand across the whole of the EU, at a time when external demand was already fading, employment has been falling in all Member States since the first quarter of 2008.

A considerable increase in unemployment is registered among craft workers and those previously employed in elementary occupations, largely working in services. Women are less affected than men, given that the crisis hit first and foremost sectors where male employment is relatively high (car industry, construction). Even so, in the first quarter of 2009 a decline in female employment was registered for the first time since the fourth quarter of 2005.

A major challenge stems from the risk that unemployment may not easily revert to pre-crisis levels once the recovery sets in, since the exit probabilities from unemployment are bound to fall and the average duration of unemployment spells are set to go up at this juncture. In this respect, there is a concern that, if not adequately addressed by policy measures, skills erosion of the unemployed may contribute to unemployment persistency (hysteresis). Together with longlasting effects on potential growth, this could threaten the European model(s) of social welfare, which are already strained by ageing populations.

IMPACT ON BUDGETARY POSITIONS

The fiscal costs of the financial crisis will be enormous. A sharp deterioration in public finances is now taking place. The decline in potential growth due to the crisis may add further pressure on public finances, and contingent liabilities related to financial rescues and interventions in other areas add further sustainability risk. Part of the improvement of fiscal positions in recent years was associated inter alia with growth of tax rich activity in housing and construction markets. The unwinding of these windfalls in the wake of the crisis, along with the fiscal stimulus adopted by EU governments as part of the EU strategy for coordinated action, is likely to weigh heavily on the fiscal challenges even before the budgetary cost of ageing kicks in (which will act as a source of fiscal stress in its own right).

The distribution of the increases in fiscal deficits, however, is uneven, even though fiscal positions have deteriorated virtually everywhere in the EU. Generally speaking, countries that had comparatively solid fiscal positions at the onset of the crisis are likely to remain below or close to the 3% of GDP mark. By far the sharpest (projected) deficit increases rising to twodigit levels as a percent of GDP will occur in Latvia, the United Kingdom, Ireland and Spain.

It is no coincidence that these countries' fiscal positions are being disproportionally hit, given that some of the mechanisms that shaped the crisis were particularly prevalent there. The United Kingdom and Ireland are important financial centers and all four countries have also seen major housing booms. Credit growth and soaring asset prices, in particular housing prices, tend to buoy government revenues during the boom and to result in large shortfalls in the subsequent slump.

The main determinants of the revenue windfalls (or shortfalls) reside in growth surprises (i.e. errors in growth projections). But after controlling for these growth surprises, house price developments explain a significant share of the windfalls in Ireland, Spain and the United Kingdom. Deteriorating trade balances associated with rapid growth in imports and weak exports in the run up to the crisis also yielded windfalls in several countries, reflecting that imports are part of the VAT tax base whereas exports are not. Both internal and external imbalances thus exacerbate the cyclical swings in the fiscal balance.

FISCAL STRESS AND SOVEREIGN RISK SPREADS

One of the striking features of this financial crisis episode has been the substantial widening in sovereign risk spreads and the downgrading of the credit ratings of some Member States. This may mirror concerns about the fiscal solvency in the face of the financial crisis, as EU governments have committed large resources to guarantee, recapitalize and resolve financial institutions and to offer also far-reaching deposit guarantees than in the past. Widening risk spreads can be regarded as indicative of the insurance premium financial market participants demand to the sovereign borrowers that are providing these guarantees. Discrimination among sovereign issuers may also reflect a flight to safety and liquidity, resulting in a decline in the yields of the most liquid sovereign bond markets (such as benchmark Bunds). Either way, spreads are widening and may expose the worst affected Member States to a vicious circle of higher debt and higher interest rates.

IMPACT ON GLOBAL IMBALANCES

THE EURO CRISIS IS BIGGER THAN YOU THINK The eight newest European Union (EU) members (Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, and Romania) are committed to eventually adopting the euro. But, all already suffer from the problems that dragged the GIIPSGreece, Ireland, Italy, Portugal, and Spaininto crisis: lost competitiveness, widening external deficits, and deteriorating public finances. However, the peggersEstonia, Latvia, Lithuania, and Bulgaria, who have fixed exchange ratesare in much worse shape than the floatersthe Czech Republic, Hungary, Poland, and Romania. The structural distortions, including external imbalances, in all of the newcomers suggest that none of them will be ready to join the euro soon, as joining would likely only accentuate the distortions. When, or if, they adopt the euro, they should apply valuable lessons from the GIIPS experience so as to avoid painful adjustments later on. Three other important lessons have emerged for the newcomers: First, competitiveness needs to be closely monitored and, since currency devaluation is not an option under the euro, reforms must be made early on. For example, a tax structure that weighs more on construction and services could help moderate the demand for and supply of nontradables. Second, special attention needs to be placed on wage-setting and labor market flexibility, as well as on how to bolster the tradable sector. Third, there is a strong case for moderating the inflow of foreign capital, especially debt creating capital, during the early years of euro adoption via tighter bank regulations on borrowing abroad and general capital controls.

A THREAT TO THE U.S. ECONOMY

The United States has a vital interest in assuring that the crisis across the Atlantic is contained. The country is tightly linked to Europe via trade, investment, and financial markets, and the Euro crisis is already affecting the U.S. economy. If the crisis were to spread further across Europe, the sound conduct of U.S. monetary and fiscal policy could also come under threat. The United States has taken action to help ease the crisis, restarting the Federal Reserves dollar-swap line in early May and supporting the IMFs participation in the European rescue plan. The United States should also accept a weaker euro for some time. In exchange, it can exercise moral suasion to encourage fiscal consolidation and structural adjustment in the vulnerable Euro area countries and more expansive policies in the surplus ones. STOPPING THE SPREAD These worries come against a background where the crisis has been largely confined to Greece, a country that accounts for 2.6 percent of the Euro areas total GDP. One can only imagine what would happen if the crisis spread to Spain or Italycountries 5 to 6 times larger. The trade, investment, and financial problems would clearly balloon, but a spreading Euro crisis would also hurt U.S. interests in three other fundamental ways: 1. Although a spreading Euro crisis could initially lead U.S. government debt to fall in price due to a safe haven effect, it will place the spotlight on the high and rapidly rising debt levels of the United States. This could force a large rise in the yield that investors demand to hold U.S. debt, aggravating the countrys unstable debt dynamics. At the same time, the United States does enjoy obvious advantages compared to individual European countries, given that the dollar floats freely. 2. If the crisis were to spread, it would prolong the timeframe during which the European Central Bank maintains low policy rates, making the United States less likely to raise its own rates. This could aggravate the liquidity overhang with difficult-to-predict consequences as well as accentuate imbalances in the economy. 3. Were a spreading Euro crisis to trigger defaults and lead a number of European countries to leave the Euro area, it could undermine the viability of the wider European project, including the accession of several countries in the East. This could create a new frontier of geopolitical instability all around the European periphery and further the decline in confidence.

Thus, for the United States, the dangers involved in a spreading Euro crisis clearly outweigh the costs of supporting the European adjustment by accepting a lower euro, expanding the resources available to the IMF, and expanding the Feds currency swap operations. In return, the United States can add its weight to the push for necessary adjustments within Europe.

THE EURO CRISIS AND THE DEVELOPING COUNTRIES The Euro crisis threatens the economic stability of much more than the Euro area alone. A weakened Europe implies slower export growth in developing countries as well as increased financial volatility. The Euro crisis may also be only the first episode in which post-financialcrisis vulnerabilities converge to such devastating effect, implying that similar dangers for developing countries could emerge from sovereign debt crises in other regions or another global credit crunch. IMPACT OF CRISIS ON DEVELOPING COUNYRIES Exports: The Euro crisis is likely to deduct at least 1 percent of growth, and potentially much more, 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 dollar since November 2009 and the two could reach parity before the crisis is over. A lower euro will sharply reduce the profitability of exporting to the European market and will also increase competition from Europe in sectors ranging from agriculture to garments and low-end automobiles. Tourism and Remittances: A lower euro will reduce the purchasing power of European tourists traveling to developing countries, and the value of remittances originating from Europe. Domestic Competition: At the same time, a lower euro may provide opportunities for consumers and firms to import from Europe at a lower cost. Capital Flows: The Euro crisis will force the European Central Bank to maintain a very low policy interest 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, as well as increase the risk of asset bubbles and, eventually, of sudden capital stops in emerging markets. Market Volatility: The Euro crisis will add greatly to the volatility of financial markets and will lead to sharp bouts of risk-aversion. The VIX index, which measures the cost of hedging against the volatility of stocks, has more than doubled in the last two months. This, in turn, has increased the level and volatility of spreads on emerging market bondswhich have risen by more than 130 basis points since Apriland will make currencies more volatile across the globe.

Credit Availability: The Euro crisis may constrain trade and other bank credit available to developing countries as it raises questions about the viability of European banksespecially those based in vulnerable countries whose assets likely include large amounts of their own governments bonds. But all international banks will be viewed as having either direct or indirect (through other banks) exposure to the vulnerable countries. The confidence that banks have in lending to each other has already fallen; the TED spread (the difference between the three-month inter-bank lending rate and the yield on three-month Treasury bills) reached a nine-month high of 35 basis points in May, up from this years low of 10.6 basis points in March. Contagious Crises: A failure to contain the crisis in Greece and its spread to Spain or other vulnerable countries will raise the alarm on sovereign debt in other industrial countriesfor example, Japan, whose debt-to-GDP ratio is projected to be nearly twice that of Greece in 2015and inevitably in any exposed emerging market. If more countries are hit, the pressures on trade, global credit, and capital flows to emerging markets will only increase.

POLICY IMPLICATIONS Though there are no one-size-fits-all prescriptions for developing countries given their very different starting points, some general policy conclusions emerge: Developing countries will need to rely less on exports to the industrial countries and more on their own domestic demand and South-South trade. In some cases, greater caution may be called for in reversing stimulus policies. In other cases, even greater prudence may be called for in containing fiscal deficits and moderating the accumulation of public debt. Given the sharp rise in exchange rate uncertainty, matching the currencies of foreign liabilities with those of export proceeds and reserve holdings will become even more important. The Euro crisis also calls for great caution in the way surging capital inflow is managed. In some countries, regulations to moderate the inflow of portfolio capital and to instead encourage the more stable form of foreign direct investment may be warranted.

 Countries with large external surpluses and that receive large capital inflows may allow their currencies to appreciate, as this may help both stimulate domestic demand and moderate inflationary pressures. Close monitoring and tight regulation of the operation of foreign banks and of their links with domestic banks may be prudent in the current circumstances.

IS A SOVEREIGN DEBT CRISIS LOOMING?

As the dust settles from the great financial crisis, skyrocketing government debt in advanced countries presents a new risk and is prompting calls for stimulus withdrawal. However, falling output, not stimulus spending, is by far the main cause of wider fiscal deficits. Accordingly, sustaining growthnot withdrawing stimulusshould remain most countries top priority if they are to break the debt spiral. Crucially, markets must remain confident in the major economies capacity to handle their fiscal affairs, hence the need for persuasive long-term fiscal consolidation plans. Though markets are nervous about holding the sovereign debt of the smaller Euro area members, these countries problems should prove manageableassuming the European economy continues to recover and neighbors help. Among the major economies, Japan offers the greatest source for worry in the medium term. MOUNTING PUBLIC DEBT Debt levels increased sharply during the crisis. It is estimated that sovereign debt jumped from 62 percent of world GDP in 2007 to 85 percent in 2009. Over the same period, the average fiscal deficit in the G20 rose from 1 percent of GDP to 7.9 percent. These trends were much more pronounced in advanced countries due to sharper output declines, a more severe banking crisis, and highly developed social safety nets. Since 2007, debt in seven out of the nine advanced G20 countries increased by more than 10 percent of GDP. By contrast, debt-to-GDP ratios declined or are little changed in eight of the ten emerging economies in the G20.

EUROPIAN CRISIS AND INDIA A crisis in an economy impacts other economies via three channels: Trade Channel: When an economy falls into a recession, it impacts the affected countrys trading partners too. Falling household and business demand in the slump-hit economy hits the exports/imports of its trading partners. The share of exports to EU (excluding UK) and imports from EU has fallen over the years. In 1987-88, exports to EU constituted about 18.6% of total exports. This has declined to 17.5% by 2008-09. The decline of imports is higher from 25% in 1987-88 to 12% in 2008-09. Hence, total trade between India and EMU is about 29.5% and could be impacted due to the crisis. However, trade channel can impact Indian external sector indirectly as well. When the recent crisis gripped the world 2008, most policymakers, economists and experts put forth the view that India would be only marginally affected. Two reasons were cited forth:

First, India was a virtual non-entity in global trade as its share was less than 0.5%-0.7% of the total global trade volumes. Hence, it was assumed that its economy was largely insulated from the turmoil.

Second, share of developed economies in trade had declined. In 1987-88 developed economies contributed 59% of exports and in 2008-09 their share has declined to 37%. The share of developing economies has increased from 14% in 1987-88 to 37% in 200809. In case of imports developed economies share has again fallen from 60% in 1987-88 to 32% in 2008-09 while developing economies has risen from17% to 32%.

Because of this shift it was felt that impact of global crisis on Indian economy would be limited. As crisis originated in US and developed economies with developing economies still growing, it was felt Indian trade will continue to grow. However once the crisis struck in September 2008, Indian trade sector declined sharply and growth was negative for 13 straight months from Oct-08 to Oct-09.

Moreover, World Trade volumes declined for the first time in 60 years. IMF says the decline in world trade in 2009 was around 12.3%. The Indian government had to intervene and provide stimulus to exporters. Trade volumes declined as world economy is far more integrated than we assume it to be. Demand in developing economies also declined leading to overall slump in world trade. So, the overall impact of European crisis on Indian trade could be much more than direct linkage indicates. Financial Channel: The current crisis has shown the power of finance channel (though trade channel was also very strong as above analysis points). The impact of turmoil in one economys financial markets is not merely transmitted to other markets, the quantum and direction of the movement is also more or less similar (decline in equity markets, rise in corporate bond spreads and depreciation in currency). This is because cross border financial linkages have increased substantially over the years. Besides, the correlation between assets too has been rising across the world. If you plot the BSE Sensex with other advanced economy stock indices, you more or less see the same trend. So much so, one can determine the trend in the Indian equity market by just looking at movements in other global indices. Apart from movement in financial markets, three kinds of financial flows could impact Indian financial markets:

Foreign Direct Investment: There are many European companies which have investments in India. So, there could be a possibility of slowdown in FDI in India. We looked at top 15 FDI investors in India which constitute about 92% of total FDI. EU economies have contributed about 12.8% of total FDI since April 2000. But again FDI remained robust throughout this crisis. Given the severity of the crisis it was felt there will be little FDI investment. However, in case of India, FDI inflows remained positive throughout the crisis. The FDI inflows actually helped keep maintain capital account when all other categories showed sharp decline.

Jan Mar 2008 Apr Jun 2008 Jul Sep 2008 Oct-Dec 2008 Jan - Mar 2009 April-June 2009 Jul-Sep 2009 Oct-Dec 2009

Gross FDI Gross FDI Net FDI (in inflows(in Outflows(in USD bn) USD bn) USD bn) 13.7 -7.4 6.4 11.9 -2.9 9.0 8.8 -3.9 4.9 6.3 -5.9 0.4 8.0 -4.8 3.2 8.7 -2.6 6.1 10.7 -4.2 6.5 7.1 -3.2 3.9 Source: RBI

Foreign Institutional Investment: Unlike FDI, it is difficult to pinpoint the origin of FII investment. However, the linkage here is pretty direct. With a turmoil in global financial markets, FII inflows will decline. We have a large number of global financial firms which operate across the world and in case of a decline in one major market, there is a pull out from other markets as well. FII(in USD bn) -3.7 -4.2 -1.3 -5.8 -2.7 8.3 9.7 5.7

Jan Mar 2008 Apr Jun 2008 Jul Sep 2008 Oct-Dec 2008 Jan - Mar 2009 April-June 2009 Jul-Sep 2009 Oct-Dec 2009

External Commercial Borrowings: External commercial borrowings could also decline if the European crisis spreads to other economies. ECBs declined in the first stage of the crisis as well.

ECB(in USD bn) Jan Mar 2008 4.8 Apr Jun 2008 1.5 Jul Sep 2008 1.7 Oct-Dec 2008 3.8 Jan - Mar 2009 1.1 April-June 2009 -0.5 Jul-Sep 2009 1.2 Oct-Dec 2009 1.5

Remittances and NRI deposits: Another important flow is NRI deposits and Remittances. Former shows whether NRI depositors withdrew funds in wake of crisis and latter shows whether Indians living abroad stopped sending funds to their homes again because of the crisis. An interesting trend in the case of NRI deposits was seen. The deposits increase in the crisis periods Oct-Dec 2008 and Jan- Mar 2009 and decline thereafter. It could be that NRI preferred to invest higher proceeds in India seeing crisis in their own economies !In case of remittances, there was a decline in crisis period Oct 08 Mar 09 but then improvements as crisis eases. There were huge concerns of remittances collapsing because of the crisis. In some countries they did collapse worsening poverty status. In India, despite the decline it manages to remain in positive.

NRI Remittances Deposits (in USD bn) (in USD bn) Jan Mar 2008 1.1 13.4 Apr Jun 2008 0.8 11.6 Jul Sep 2008 0.3 13.0 Oct-Dec 2008 1.0 10.0 Jan - Mar 2009 2.2 9.5 April-June 2009 1.8 12.9 Jul-Sep 2009 1.0 13.8 Oct-Dec 2009 0.6 12.8

Confidence Channel: This channel shows confidence declines in business and households seeing the global uncertainty. So even if an economys macroeconomic conditions and outlook look favorable, the decline in confidence can disrupt the economic conditions. Decline in confidence is also one of the reasons for decline in business investments which led to decline in overall Indian GDP growth. Credit growth also declined because of decline in business investments. RBI Governor Mr Subbarao has stressed on this channel on numerous occasions.

POLICY RECOMMENDATIONS
Greece, Ireland, Italy, Portugal, and Spain:
Implement fiscal consolidation to stabilize the debt-to-GDP ratio within three years. Structural reforms designed to rebalance the economy toward the tradable sectors and increase competitiveness are essential. To facilitate this, reduce unit labor costs by at least 6 percent over three yearseither immediately with a 6 percent across-the-board wage cut, or more graduallyand institute structural reforms to raise productivity. Begin with public sector wages.

Explain the severity of the situation to citizens in order to build the public will necessary for these adjustments. Distribute the adjustments in a transparent and fair way to ensure that specific groups do not feel unjustly hit, and that the most vulnerable are protected.

Euro Area:
Maintain an expansionary monetary policy that errs on the side of growth for an extended period. Explicitly promote a weak euro. Require countries to cede some fiscal autonomy. Give member states the right to review other members annual budgets and main economic indicators, such as GDP growth, productivity growth, and 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 on appropriate sanctions. Tighten the criteria for admission to the Euro area. Require newcomers to run large fiscal surpluses to offset the demand boom that typically accompanies euro adoption. Do not require one size to fit all, however; consider cyclical as well as structural indicators.

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

Germany and Other Surplus Countries:

Expand domestic demand by about 1 percent of the Euro areas GDP over three years 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 2 percent range.

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 significant resources, broader expertise, and distance from regional politics are needed. If support packages are needed, ensure that they are of sufficient size to reassure markets.

Developed Countries: Maintain stimulus efforts in the short term. Strong economic growth is the best long term debt reduction strategy and the global recovery is still dependent on government support. Restrain spending and/or increase taxes as soon as a robust recovery is established.

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.

Developing Countries:
Rely less on exports to the industrial countries and more on South-South trade. Match the currencies of foreign liabilities with those of export proceeds and reserve holdings. Moderate the inflow of portfolio capital and encourage the more stable form of foreign 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 the exchange rate is pegged.