ABSTRACT
In this white paper, we explain the key forces behind the euro crisis and analyse its impact on government and investor decision-making. We argue that as long as existing macro dynamics, especially current account imbalances and high levels of debt, are not reversed, the euro area will remain in crisis mode. Furthermore, contagion has the potential to create an immediate crisis of confidence and amplify existing challenges. We find that, with a few exceptions, euro area government debt is similar in size and composition to public debt of countries outside the euro. However, the market reaction has been exaggerated in Europe due to the continent’s unique institutional framework. The United States, United Kingdom, and Japan are by no means in a better position in the long run. We confirm the hypothesis that Greece is an exceptional case. In addition, we argue that it is almost unmanageable for Greece to regain competitiveness by more than 20% within the straitjacket of the European Monetary Union. Our empirical analysis of debt crises demonstrates a long-lasting negative impact on economic output and loan policies. Thus, the economic outlook for the indebted countries is gloomy. Tackling the roots of the euro crisis should therefore be the top priority on the policy agenda. We provide a novel toolbox for investors’ assessment of sustainable public finances that will enhance their decision-making in sovereign bond markets.
Key words: EMU, Sovereign Debt, Sustainability, Macroeconomic Implications

The Euro Crisis and Its Implications
Prof. Bodo Herzog 1
July 2012
White Paper in Cooperation with DWS Investments