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Euro Rescue Raises Hopes and Questions

Author: Roya Wolverson
May 10, 2010

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The European Union's massive $955 billion rescue plan (Reuters) to buoy the balance sheets of fiscally risky eurozone countries aims to stave off a sovereign debt crisis (WSJ) that threatens global financial stability. The euro and global markets soared after agreement was reached on the plan, signaling investors' awe at the scale of the deal and EU leaders' ability to unify. Markets were also comforted by the European Central Bank's decision to buy eurozone government bonds in the open market, which creates an added safety net for the euro area to prevent Greece's debt problems from spreading to Portugal, Spain, and other EU member states.

But questions remain over how the plan will be executed and its long-term implications, since the guarantees may involve approval by parliaments of individual countries. Broader structural reforms have also yet to be addressed. Of great concern is the role of Germany, which may need to shoulder up to 123 billion euros of the debt from the package, or more if a larger country like Spain requires a rescue. German Chancellor Angela Merkel said she would present the package of guarantees to the German cabinet on May 11, but her coalition government's crippling defeat in North Rhine-Westphalia on May 9 could (Spiegel) make pushing reforms through Germany's upper house of parliament, the Bundesrat, more challenging. Following the electoral defeat, Merkel announced (WSJ) that her government will not pursue tax cuts for at least another two years, a move EU countries were hoping would boost eurozone growth.

Germany's eurosceptics are already beginning to bristle (Reuters). The group of German academics who challenged the aid package for Greece in the country's top court said they may file a similar lawsuit against the euro stabilization package, because of "fears that parliamentary rights are being undermined."

The weekend deal requires Portugal to postpone its public work projects and Spain to make further budget cuts. But tougher measures could cause more social unrest, suppress growth, and tip the EU "into a 1930s Fisherite death spiral," said the Daily Telegraph's Ambrose Evans-Pritchard. The ECB's decision to buy euro area bonds, meanwhile, has called into question (Bloomberg) the central bank's credibility in setting monetary policy.

Structural differences across the sixteen-member eurozone countries and the broader European Union also await reform. Agreements on fiscal policy, taxation, labor markets, and pension systems are all complex challenges the monetary union will face in years to come, analysts say. And Germany will not be exempt from the reform calls. Germany's balance sheet looks healthier than some southern European countries, but it still has to contend with the effects of its large trade surplus and low domestic demand on eurozone imbalances, notes (Reuters) Charles Grant, director of London's Center for European Reform.

Still, persisting with the eurozone project is in Europe's best interests in the long term, says CFR's Marc Levinson. Countries that have aspired to join the union "have transformed their economies, reformed their judicial systems, democratized their political systems, put once-powerful military establishments under civilian control, and embraced a vast number of social changes," he notes. Without the EU's insistence on reform for member states, "Europe could become a less democratic and arguably less stable place."

Additional Reading:

Newsweek's Robert Samuelson says the eurozone debt crisis is a "death spiral" for the welfare state overall, since budget cuts threaten to slow economic growth, while ballooning deficits risk more financial crises.

In City Journal, University of Chicago professor Luigi Zingales says a bailout may be preferable for French and German banks, but restructuring is still better for Greek and European taxpayers.

This Center for Geoeconomic Studies Geographic chart shows that European default risk has replaced inflation risk over time.

Background:

This CFR Backgrounder profiles five eurozone member countries with shaky fiscal outlooks.

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