Reference no: EM13829019

Debt Crisis

With the creation of the European Monetary System and the birth of the euro in 1999, the U.S dollar is facing challenges to its position as the key reserve currency in international financial transactions. However, for the euro to keep its international position as a reserve currency, the European Union must function as a cohesive political entity that can exert its influence on the world stage. There are numerous challenges facing euro-zone countries now, with debt crisis in several countries.

The euro, common currency among seventeen euro-zone countries is facing numerous challenges. Germany's finance minister said “his country is prepared to pursue bold action to preserve Europe's common currency, including deeper economic integration with its neighbours, and issued a warning to markets not to underestimate Berlin's resolve to protect the euro (Wall Street Journal, Dec. 11, 2010). Germany could accept steps toward fiscal union if current attempts to improve the euro zone's governance proved insufficient to end the year-old debt crisis. All European countries are determined to keep this European currency stable, so Europe will find steps toward further unification.

Many Germans, including leading members of the government, oppose further economic integration within the 17-nation euro zone over fears that Germany would be forced to pay the debt of others. Proponents of such steps warn that not only the euro but the EU itself could fall apart if governments fail to act. So far, Germany, the euro zone's economic motor, has vociferously opposed such proposals, sparking accusations from some of its neighbors that Berlin isn't acting in Europe's best interest. This is addressing fears that the debt crisis could spread from small countries such as Greece, Ireland, and Portugal to major economies such as Spain and Italy. It is argued that there will be no domino effect, as long as big economies like Germany defend the common currency.

Europe should concentrate on explaining to markets the decisions it has made so far, including the move to set up a European Stability Mechanism in 2013 that could impose losses on bond investors if euro members run up excessive debts.

Under the present structure, with unified monetary policy but not fiscal policy, different interest rates [on government bonds] are the mechanism that makes member states adhere to solid public finances. There is a need to improve the existing structure, and if this structure doesn't work, then they must indeed talk about alternatives.

1. Which countries are currently in the Euro zone? Of these countries, which are currently experiencing government debt problems?

2. How would, for example, Portugal defaulting on its bond payments impact the other countries in the Euro-zone? What would happen to interest rates? What would be the possibility of debt crises in other Euro-zone countries? How would this impact economic growth in the Euro-zone?

3. Will increasing the size of the bailout fund (from which troubled countries can draw in times of crisis) help to prevent future crises? Why or why not? What is the downside of increasing this fund?

4. Germany seems to be the Euro-zone country that is leading the push toward greater fiscal integration as a means to greater financial stability. Why? What does Germany stand to gain by a fiscal union?