currency union. is is the only scenario in which euro zone members address the structural flaws in the euro zone. It requires euro zone members to adopt a US-style system where countries pass constitutional amendments prohibiting borrowing for operating purposes similar to US states, which can issue debt to finance infrastructure but not salaries, services, transfer payments or other operating expenses.
is scenario would give an immediate boost to
investor confidence, driving down borrowing costs across the euro zone. Although growth would still weaken in 2010, the euro zone economic recovery would be much stronger in 2011. is could also be accompanied by a significant strengthening of the euro.
In our pessimistic scenario, the currency union breaks apart and there is a deeper and broader-based recession in Europe than in our base case scenario. We also put the probability of such an outcome at 10%. Reintroducing local currencies would result in severe dislocations across the euro zone leading to a flight to safety to the US dollar and other global currencies. ere would also be the risk of a “beggar thy neighbor” mentality developing in which euro zone members employ protective tariffs and resort to competitive devaluations. Under such a scenario, a liquidity crisis could develop similar to the one in the fall of 2008 when LIBOR spreads blew out.
e European banking system would come under tremendous strain and the likelihood of a euro zone depression would increase.
The Good, the Bad and the Ugly of Europe The Three Strike Rule: Debt, Budget Deficit and Current Account Balance
D e b t t o
e above list does not include all 16 members of the common currency. Cyprus, Malta, Slovenia and Slovakia are excluded for this analysis.
Budget Deficit to
Balance to GDP
Debt to GDP of 60% or less; Budget and Current Account Balance above -3% of GDP
Debt to GDP above 60% but less than 90%; Budget and Current Account Balance below -3% of GDP but above -5% of GDP
Debt to GDP above 90% Budget and Current Account Balance below -5% of GDP