The European sovereign debt crisis, started from Greece, Ireland, Portugal, Spain and Italy lately, where the rating of their sovereign debts have been downgraded, has indicated an impending threat to the recovery of world economy and potential renewal of global financial crisis in the future (Anand, Gupta and Dash, 2012). A sovereign debt crisis is an economic and financial problem resulted from the perceived incapability of a nation to pay its public debt. In this case, the crisis affected not only the peripheral countries of euro zone, but also the main economies of Europe because international investors no longer believe the tax income of these countries can support their debt repayment.
The author identified three main causes for the sovereign debt crisis in Europe. Firstly, the contradictory and incomplete structure of the Euro system made the crisis inevitable. Members of European Monetary Union (EMU) share a common currency while they have diverse taxation, pension and treasury systems (Anand, Gupta and Dash, 2012). The spending authorities remained domestic and subjected to their own political forces. Such arrangement reveals the possibility of fiscal free-riding and other members automatically become victims of it. For example, as a member of euro zone, the government of Greece would not worry about the adverse consequences for its fiscal profligacy as much as a stand-alone government. The currency risk exists only corresponding to currencies outside euro zone, such as dollar and yen; no one member would weaken against the other, and therefore result in neither overstretch of capital market nor depreciation of the currency. Unfortunately, the unfavourable outcomes of indiscipline in one country would spread over the whole union while exert only a small portion on the irresponsible country itself.
Additionally, a requirement of unanimous agreement in the Union also generated problems. The euro zone, with seventeen countries as its member, always finds it hard to make decisions quickly. This structural problem led to the inefficiency of the members to response to the simmering crisis. As a result, the financial contagion of the catastrophe was not successfully avoided and those negative effects eventually spread from peripheral countries to the major European economy.
Secondly, the fiscal indiscipline in peripheral countries led to their unsustainably high debt levels. Although MEU members have signed the Maastricht Treaty in 1992, which restricted them from adopting government deficit and raising debt levels, countries including Greece and Italy unfaithfully bypassed the regulations stated in the convention and continued to mask their financial and economic situations through inconsistent accounting as well as the help from U.S. investment banks (Simkovic, 2009).
When it comes to the application of euro, countries such as Ireland, Greece and Spain received similar and very low level of interest rate despite their divergent credit...