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Policy Response the Greek Crisis

What is Actually Going On?The w orlds largest economy is suffering a crisis of confidence brought on by the fiscal distress and

increased default risk of one of the EUs smaller economies. Seen in the context of the fact that thisEurozone Crisis provoked by the financial distress of Greece occurs at the same time that a US

Dollarzone Crisis does not occur as a result of the severe financial distress of the state of California, amuch bigger and more economic central economic entity within the US casts some serious doubt as tohow structural of fundamental this crisis might be. Doesn t it seem a bit odd that the Eurozone has

become much more volatile as a result of its crisis?

What Choices We Face in the SituationWhen faced with a sovereign debt crisis, there are a limited number of ways in which such a crisis mightultimately be resolved. Of course, we should all hope for some combination of the four.

1. Austerity: Drastic cuts in spending while increasing tax revenues in order to generate sufficientsurplus to address the sovereign debt situation. This would not only threaten economic growth

in Greece, but could also lead to UK-style social and political strife further down the line.2. Default: Either total or partial. This would cause the immediate downgrade of all Greek debt,

thereby causing a general sell- off of Greek assets. This would also lead to a chain-reaction

which might include bankruptcies of European banks and financial houses across the Eurozone.3. Monetary Expansion: This carries a certain risk of inflation, since this avenue has already been

heavily employed by the ECB and the rest of Europe s central banks. Nevertheless, this threatcan be mitigated by perfection of use of proper monetary distribution channels.

4. External Bailout: Quite straightforward really. Under this option, Greece s sovereign debt crisisis addressed (at least partially) by external parties. There are two problems with this situation.

First, this may create some concern about moral hazard. Second, comes the question of whoshould bail Greece out and under which conditions. To be sure, the terms would have to besustainable, and fair to both parties.

What Should Be Done?

In general, the crisis response measures for the Greek sovereign debt crisis should strive to solve thecrisis is such a way that the EU s credibility is re-enforced, while Greece s recovery should be broughtabout as quickly and with as little contraction as possible.

Furthermore, the crisis response should be multi-faceted. It should involve elements of multilateralfinancial assistance, technical assistance vis--vis rule of law and tax-enforcement measures, and as

much private sector cooperation as can be safely secured.

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What Should be Avoided?We should avoid causing economic destruction. We should therefore do what we can to limit relianceon austerity measures. This is because austerity has negative consequences for long-term growth andfor socio-political stability within a country. Accordingly, the recent history of austerity packages across

the all of the other continents of the world has been met with protest, rebellion, and social strife.

With this in mind, sovereign debt defaults should also be avoided. A sovereign default even a partialone would most likely lead to an economic chain reaction. Not only would Greek banks go bankrupt,but so to might neighboring Eurozone countries, as well as European banks who are holding

Mediterranean assets. Ultimately, nobody knows where the last dominos will fall.

Effects on Mediterranean Rim and European PeripheryThe effect mitigation of Greek sovereign debt crisis would have unambiguously positive effects on thesovereign debt situation across the peripheral regions of the EU and the Eurozone. This would primarily

be because of increased confidence in the European institutions as well as a general reduction of risk-premia across the European Periphery. Since the risk premia are also the most volatile component of sovereign debt prices, doing this would also reduce volatility.

Because the case of Portugal is specifically connected to wider financial market volatilities and wasactually not in unmanageable financial trouble as a result of its own sovereign debt situation, yet has

run into trouble because of a rapid decrease in liquidity and a radical increase in global risk-aversion, asolid and well organized European crisis-response to the Greek situation would do a lot to alleviatePortugal s problems.