The Euro-Zone Challenge

Greece is facing a serious financial crisis – with a current national budget deficit of ~13% of GDP – Greece is running about 10% over the GDP deficit limit set by the Euro-Zone of 3%. Greece’s debt is growing so fast and spending exceeds revenue by so much that several ratings agencies have downgraded their sovereign debt to near junk levels.
Greece’s malaise is going to test the staying power of the EU’s rules and resolve. Technically Greece’s debt rating is below the minimum (A-) that the European Central Bank (ECB) is supposed to accept as collateral for loans. This will cut Greek banks off from an important source of funds. The ECB must decide whether to bend the rules and bail Greece out or accept the risks to the Euro of Greece’s ailing fiscal picture. The major catch here is that one of the initial concerns over the long-term success of the Euro-Zone was the large differences across the national economies and the ability of the ECB to set appropriate and sustainable monetary policy over such a diverse group. This will be the first major test of the ECB and the stakes couldn’t be higher because other nations are struggling under the current policies and if the ECB steps in to help Greece others will want their bailout too. In particular, Italy and Spain may be the most upset. For now all we can do is sit and wait, but I for one was skeptical of the Euro-Zone from the start.