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Eurozone Fears Permeate Davos

Author: Christopher Alessi
January 27, 2012

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The ongoing eurozone sovereign debt crisis has dominated the start of the World Economic Forum in Davos, Switzerland, with many private sector business leaders urging Germany to do more to alleviate Europe's fiscal woes. German Chancellor Angela Merkel formally opened the summit on Wednesday, calling on Europe to become "more European" (DeutscheWelle) and implement the fiscal compact agreed upon late last year by EU leaders. However, she resisted calls for Germany to provide more financing to weaker eurozone states and defended her approach of encouraging greater austerity (Bloomberg) and debt reduction in order to resolve the crisis.

What's at Stake

Eurozone market fears have been at least temporarily eased by policy responses in debt-laden Italy and Spain, sending borrowing costs down and stock markets up. Moreover, market actors have been relatively unfazed by Greece's inability to establish a bond swap agreement with private creditors, which was part of a second EU bailout agreement from last year.

But the newfound, if fragile, confidence in the eurozone is being undermined by what many see as the lack of a long-term European growth strategy (Reuters)--a view reinforced by the International Monetary Fund's World Economic Outlook, which predicted a eurozone GDP contraction of 0.5 percent for 2012. Citing eurozone uncertainty as a driving factor, the IMF downgraded its 2012 growth projection for the global economy to 3.3 percent from 4.1 percent.

The Debate

Austerity measures being proposed by Germany--including budget cuts, tax increases, and pension reform--have prompted much debate among economists, many of whom caution that excessive austerity without a plan to stimulate growth could damage the already slow global economic recovery.

Some EU policymakers, particularly Italian Prime Minister Mario Monti, are also indirectly challenging Merkel's approach (NYT). Monti has called for greater financial support from Europe's wealthier countries through the doubling of the eurozone's permanent bailout fund, the European Stability Mechanism, which is set to come into effect in July.

However, Merkel has shied away from Monti's prescriptions; during her Davos speech, she warned, "What we don't want is that we promise something that we can't deliver." At the same time, she has supported reforming EU labor laws as a means of generating new employment and triggering growth.

Policy Options

Speaking at Davos, investor George Soros also warned that the austerity measures being mandated by Germany for weak eurozone states could accelerate deflationary pressures and unravel the EU (SpiegelOnline). "The economy will contract and tax revenues will fall," Soros said. "So the debt burden will actually rise, requiring further budget cuts and setting in motion a vicious cycle." Soros recommended that in addition to fiscal discipline, the EU--namely, Germany--should provide more stimulus and share the eurozone debt burden in the form of euro bonds (WSJ).

World Bank President Robert Zoellick says Germany's plan for a fiscal compact should be expanded to offer "incentives and support" to eurozone states that implement the necessary budgetary cuts. "The European Commission, backed by the European Investment Bank, should deploy underutilized funds to match investments to countries' structural reforms," Zoellick writes in the Financial Times.

Background Materials

The eurozone is a buffeted by a sovereign debt crisis of nations whose membership in the currency union has been poorly policed, explains this CFR Backgrounder.

Whether the euro survives depends on Frankfurt finally assuming its role as leader, write Matthias Matthijs and Mark Blyth in Foreign Affairs.

Policymakers and market actors are increasingly concerned about a disorderly Greek default, while many analysts question the wisdom of Germany's strict austerity approach to the escalating eurozone sovereign debt crisis, says this CFR Analysis Brief.

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