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Response to the greek crisis

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  • 1. Policy Response the Greek CrisisWhat is Actually Going On?The world’s largest economy is suffering a crisis of confidence brought on by the fiscal distress andincreased default risk of one of the EU’s smaller economies. Seen in the context of the fact that this“Eurozone Crisis” provoked by the financial distress of Greece occurs at the same time that a “USDollarzone Crisis” does not occur as a result of the severe financial distress of the state of California, amuch bigger and more economic central economic entity within the US casts some serious doubt as tohow “structural” of “fundamental” this crisis might be. Doesn’t it seem a bit odd that the Eurozone hasbecome much more volatile as a result of its crisis?What Choices We Face in the SituationWhen faced with a sovereign debt crisis, there are a limited number of ways in which such a crisis mightultimately be resolved. Of course, we should all hope for some combination of the four. 1. Austerity: Drastic cuts in spending while increasing tax revenues in order to generate sufficient surplus to address the sovereign debt situation. This would not only threaten economic growth in Greece, but could also lead to UK-style social and political strife further down the line. 2. Default: Either total or partial. This would cause the immediate downgrade of all Greek debt, thereby causing a general sell- off of Greek assets. This would also lead to a chain-reaction which might include bankruptcies of European banks and financial houses across the Eurozone. 3. Monetary Expansion: This carries a certain risk of inflation, since this avenue has already been heavily employed by the ECB and the rest of Europe’s central banks. Nevertheless, this threat can be mitigated by perfection of use of proper monetary distribution channels. 4. External Bailout: Quite straightforward really. Under this option, Greece’s sovereign debt crisis is addressed (at least partially) by external parties. There are two problems with this situation. First, this may create some concern about moral hazard. Second, comes the question of who should bail Greece out and under which conditions. To be sure, the terms would have to be sustainable, and fair to both parties.What Should Be Done?In general, the crisis response measures for the Greek sovereign debt crisis should strive to solve thecrisis is such a way that the EU’s credibility is re-enforced, while Greece’s recovery should be broughtabout as quickly and with as little contraction as possible.Furthermore, the crisis response should be multi-faceted. It should involve elements of multilateralfinancial assistance, technical assistance vis-à-vis rule of law and tax-enforcement measures, and asmuch private sector cooperation as can be safely secured. 1 Maxens Berre
  • 2. Basically, any response should include the following measures:  A private-sector financial and banking-sector agreement which resemble the Vienna Initiative, whereby a voluntary agreement can be reached with the banks in order to minimize the economic contraction caused by bank sell-offs of Greek assets. As far-fetched as it sounds, this strategy worked in Eastern Europe in 2009.  In order to bolster revenues, the Greek tax code should be enforced with the institutional support of the EU. This is the sort of institutional support which would both help resolve the sovereign debt problems and bolster Brussels’ credibility. This in turn, would reduce the risk- premium involved.  The targeted expansion of the money supply. This means that the money supply should not just be increased, but that the new money should be sent to specific trouble areas in the Mediterranean economy. This would serve to reduce how much the money supply actually needs to be expanded by, (thus reducing the threat of inflation), while cutting down on how much of the new money supply is waster (also reducing the threat of inflation). This plan can be said to be based on the British WWI-financial crisis during which they targeted specifically the import-export financial sector for monetization. It worked. The UK economy recovered from being put under embargo by German – then the world’s 2nd economy. With this experience in mind, a good way to directly monetize the problem areas would be for a stabilizing proportion of Greek bonds to be bought off of the market.  The implementation of European microprudential financial and banking regulation should ensure that any new money actually makes it from the financial sector to the real economy, in order to re-establish and bolster production.How Should it all be Paid For?This is one of the main issues when it comes to questions of credibility. Since this is really a story about alack of confidence in – as well as credibility of– the EU’s financial crisis-response capabilities, it shouldfundamentally be the party to either finance, or coordinate the financing of Greek sovereign debt crisisresponse.Therefore the EFSF and the EFSM should be employed to their maximum extents. The EFSF is a crisis-response tool which acts a sovereign-default risk pool. Therefore the bailout cost is fairly-distributedacross the EU nations. In fact it is done along ECB lines. The EFSM meanwhile is a crisis-response toolwhich relies on financial guarantee of the European Commission.In addition, the monetary tool should be employed. This is because anti-growth monetary policy is amajor underlying factor to this crisis. 2 Maxens Berre
  • 3. What Should be Avoided?We should avoid causing economic destruction. We should therefore do what we can to limit relianceon austerity measures. This is because austerity has negative consequences for long-term growth andfor socio-political stability within a country. Accordingly, the recent history of austerity packages acrossthe all of the other continents of the world has been met with protest, rebellion, and social strife.With this in mind, sovereign debt defaults should also be avoided. A sovereign default – even a partialone – would most likely lead to an economic chain reaction. Not only would Greek banks go bankrupt,but so to might neighboring Eurozone countries, as well as European banks who are holdingMediterranean assets. Ultimately, nobody knows where the last dominos will fall.Effects on Mediterranean Rim and European PeripheryThe effect mitigation of Greek sovereign debt crisis would have unambiguously positive effects on thesovereign debt situation across the peripheral regions of the EU and the Eurozone. This would primarilybe because of increased confidence in the European institutions as well as a general reduction of risk-premia across the European Periphery. Since the risk premia are also the most volatile component ofsovereign debt prices, doing this would also reduce volatility.Because the case of Portugal is specifically connected to wider financial market volatilities and wasactually not in unmanageable financial trouble as a result of its own sovereign debt situation, yet hasrun into trouble because of a rapid decrease in liquidity and a radical increase in global risk-aversion, asolid and well organized European crisis-response to the Greek situation would do a lot to alleviatePortugal’s problems. 3 Maxens Berre