Memo On European Sovereign Debt ± 11/29/10
Justin Ciambella, Gardner Davis, Sean Donovan, Kunal Malkani, and Nicholas Paine
To mitigate the increases in debt, spending cuts and tax increases were implemented, but thisfiscal tightening sunk the economy further into recession, leading to a 7.1% drop in GDP in 2009and 13% unemployment
. The negative shocks of the housing bubble burst and the subsequentfiscal tightening sent Ireland into a downward spiral of recession and increased government debt.This trend scared investors, resulting in the government¶s debt being downgraded in quality bythe S&P.
esponse: Bailout and Austerity
To combat this growing pessimism among investors, the EU and the IMF responded similarly asthey did in Greece, providing Ireland with an ¼85bn bailout. ¼50bn is aimed at helping Ireland¶s public finances, while the government implements a ¼15bn austerity package over the next four years. The remaining ¼35bn will go towards recapitalizing Ireland¶s banks, with ¼10bn to be usedin the short term recapitalization, and the rest set up as a contingency fund that can be drawnupon if needed.
There is a lack of a consensus as to whether the bailout and austerity measures taken will beenough to restore market confidence and prevent default. Ireland has taken a very tough stance onkeeping the Euro and not defaulting, implementing costly austerity measures to do so, which intheory should help fend off some speculative attacks. However, some call for a more completerestructuring of the Irish banks and their loans.
3) Crisis¶s Affects to the Euro Zone
Implications for the Euro Zone:
The debt crises in Greece and Ireland have tested the sixteen-member euro zone¶s commitment toa common currency. Since the euro zone shares a common currency, their economies arenaturally very interdependent, despite asymmetric shocks to some periphery countries. Banks incountries throughout the euro zone, especially in France, and Germany to a lesser extent, werelarge holders of sovereign Greek debt.
A default by either Greece or Ireland would have sentnegative shockwaves throughout the financial system and the broader economy of the euro zone;consequently, as an attempt to prevent this fear from materializing, the EU agreed to the bailouts.Although Germany was initially, and still is, reluctant to partake in bailouts, it has helped their economy, with the EU projecting robust 3.7% growth for Germany in 2010, lifting EU growth to1.8%.