The Greek economy, which just went through a debt crisis, might be in trouble yet again and so may be the Portuguese economy. Leading economist and Nobel laureate Joseph Stiglitzhad recently suggested that Germany leave the Euro. The Greek economy is expected to contract by 4% this year and 2% to 3% in the next year. In contrast the French economy grew by 0.7% in the second quarter of this year, while the German economy expanded by 2.2%. The Euro zone seems to be made up of a motley crew, each going its own way. The key issue here is that in times of economic recession, management of such diverse economies becomes all the more difficult as each requires a different level of stimulus. However, the Euro zone has one single central bank, which manages the interest rate for the entire Euro economy. Thus, using the monetary policy lever of interest rates to stimulate one or a few nations in the Euro zone becomes an extremely difficult proposition.
Lowering interest rates to stimulate one area of the economy could lead to inflation in another area of the Euro zone, which is on a high growth path. This renders the tool of monetary policy quite useless in the Euro zone. The fiscal policy tools could be used by different nations to shore up their economies. But in the case of Greece, there is little room left to reduce taxes as its deficit nearly led to a sovereign debt crisis in the recent past. Politics also plays up when it comes to fiscal policy. For example, in Portugal, the ruling party wants to hike taxes, whereas the social democrats want taxes to be cut. Thus, what may be exigent for the economy is caught in a political tangle or a democratic process.
Early this week, Euro leaders worked on a deal to punish spendthrift nations in the zone, which were putting the Euro at risk. While this idea was not welcomed, the idea of a safety net proposed by Germany in the case of another debt crisis was welcomed. The debt crisis that has affected Greece and Ireland and Portugal and Spain to a lesser degree has sent the Europeans scrambling to find a solution that can rein in profligate nations. Unfortunately, any major change in the EU policy requires 27 nations of the zone to vote and it is anybody's guess how difficult can that make for any resolution to be passed.
The genesis of the crisis lies in the leniency displayed by the members earlier when some nations breached the 3% deficit limit and the 60% public debt limit of their GDPs. Lack of political will led the culprits to go scot free and the existing penalties were never levied on these nations. The onset of the recession led some such defaulting nations to get into dire trouble with their debt levels. As a result, today, there is a substantial difference in the macro economic conditions of various nations of the Euro zone and this is putting pressure on the unity of the Euro.
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