Notwithstanding the recently enacted EU fiscal pact, Europe is again facing a sovereign-debt crisis. Standard & Poor’s has downgraded a number of Spanish banks and Spain’s sovereign debt. For two years, Spain and other European countries, including those not facing an immediate crisis, such as France and Italy, have struggled to establish appropriate austerity policies to reduce fiscal deficits. Besides being unpopular, such measures produce an immediate negative result — a reduction in economic output. Will that effect continue to overshadow the expected positive result from improved market confidence among households and investors? It depends on how plans for reducing budget deficits are implemented.
The fortitude of Europe’s political leaders in the face of setbacks will be critical. Indications are that, although the thrust of budget consolidations that have been initiated by European governments is appropriate, policymakers lack the necessary conviction to stay the course.
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