The paper "The European Sovereign Debt Crisis " is a perfect example of a macro & microeconomics case study. This paper intends to discuss the European Sovereign Debt Crisis. The first section is a detailed assessment of the sovereign debt crisis covering the impact of a default on a state. The second section offers an overview of how the global financial crisis paved the way for the European Sovereign Debt crisis. Factors leading to the European Sovereign Debt will be given the necessary attention. As for indicators of the possibility of default, CDS spread and sovereign bond rating will surface in the essay.
Finally, a number of recommendations will be drawn at the end. Sovereign Debt Crisis Before exploring the European sovereign debt crisis, it is important to understand the terms sovereign default. Duthel (2012) found that sovereign debt arises when a sovereign state fails to repay fully its debt. Under such a situation, an environment of skepticism among potential lenders or those who have purchased government bonds is created. In reaction to the suspicion that the government might not be able to settle its debt, lenders, and bondholders raise interest rates consequently giving rise to a sovereign debt crisis.
Duthel goes ahead to state that the government is exposed to a sovereign debt crisis when it depends on short-term bonds as a means of financing its activities. Blanchard and Fischer (1989) reiterate that short-term bonds lead to a mismatch in maturity between the bonds and the value of the long-term assets. Besides, a sovereign debt crisis occurs due to a mismatch in currencies under a situation where a government is unable to issue bonds in its own currency following a deterioration in the value of the domestic currency.
In effect, a government is obliged to pay back in foreign currency, which is expensive. Bearing in mind that a sovereign state may not be forced to settle its debt, they may not qualify for any other credit. Additionally, the defaulting state risks the possibility of its overseas assets being seized. Domestically, the government will experience pressure from internal bondholders who will require the government to pay the outstanding debt.
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