The on-going financial crisis which has resulted in the collapse of financial institutions, downturns in stock markets and bank bailouts around the world since 2008 has led to the European sovereign debt crisis. The purpose of this essay is to analyse the effectiveness of several economic policies which can be used to solve this crisis. The essay looks at the effectiveness of fiscal austerity which has already been implemented by some European countries, then look at whether there is room for monetary policy, lastly looks at whether there is room for further policy recommendations.
The European sovereign debt crisis refers to the collapse of several financial institutions in certain European countries which form part of the European Union, high government debt in these European countries as well as rapidly increasing bond yield spreads in government securities has caused a sovereign debt crisis. This on-going financial crisis, which began in 2008, has made it very difficult or even impossible for some country’s governments in Europe to pay back their debt without the assistance of third parties which then further increases their debt (Times, 2012).
Economists have thought long and hard about ways in which they can improve and in essence solve the European debt crisis. One way of doing so is through fiscal policy, which refers to government spending and taxation. A fiscal consolidation, which is a term typically used to discuss government economic policy, refers to a policy which is implemented with the intention of decreasing government deficits and decreasing the accumulation of government debt (W.Lee, 2012). According to the economist, rich-world countries need to stabilise their debt to GDP ratio which requires a tightening of government primary balance, this is done by reining in government spending through spending cuts which is much easier than the process of increasing taxes. However, a problem arises in the fact that by cutting spending, the government will also be cutting GDP growth (Economist, 2012). This conflicting idea about the relationship between spending cuts and GDP growth as well as the relationship between increased spending and government debt will be analysed later in this essay.
One policy recommendation which some economists believe can be used to combat the European sovereign debt crisis, which is currently at the forefront, is an austerity fiscal policy. An austerity fiscal policy involves government deficit cutting, decreases in government spending and thus a decrease in the amount of benefits and public services provided to consumers. The main goal of this policy is to decrease deficit spending and thus decrease future increases in government debt. It is sometimes coupled with an increase in