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Degrauwe - Essay Example

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The fund later became a permanent European Stabilization Mechanism. It was designed to be funded by member countries to sustain…
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Download file to see previous pages... The EMF must, therefore, employ a more intelligent approach than that previously employed by its predecessor. During the period the EFSF was in existence, the interest rates charged were extremely high. For instance, in the case of Ireland, the interest rate charged by the EFSF on the Irish rescue program was up to six percent. The effect of this was very unfortunate: first of all, it made the Irish government experience hardship when trying to reduce its budget deficits that would consequently reduce the debt accumulated. Secondly, the EFSF charged Ireland an interest rate that was three percent above what had been charged on Germans, Dutch, and the Austrian government, which is a risk free rate. Simply put, what the EFSF did sent the signal that with such rates there was a risk of default. Meaning, the government of Ireland was not in a position to recover and put its budgetary situation in order. This should explain why the financial market developed mistrust that led to them also charging high risk premiums that consequently led to a high risk of default (Degrauwe p12).
It is not easy for governments to borrow money from the Eurozone in their own currencies. This is because there are quite a number of challenges that countries face by going this direction. One major challenge is that the European debt crisis is treated as a series of a country’s individual problem and not as a collective responsibility that has occurred as an outcome of systematic problems in the Eurozone. This makes the economic sovereignty of a member state become vulnerable whenever they are in debt. This is because unfavourable market sentiments can force them to default. This may lead a country to a situation of being in unstable as a consequence of high interest rate. The high interest rate on a country means that domestic lenders will also have to demand high interests on borrowers and this is what leads to economic crisis (Degrauwe p12).
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