Question

1.Explain why two (2) countries with similar budget deficits as percentage of their GDP but with very different debt servicing records may face (a) different, or (b) the same consequences/ outcomes with regard to illiquidity or even solvency when they are facing capital markets.

2.Explain why countries find it more costly to maintain a fixed exchange when a devaluation is expected compared to a situation when a devaluation is not expected.

3.Explain why it was felt important to make the ‘no bail-out’ clause part the ‘Maastricht Treaty’.

4.In a fixed exchange rate system, a devaluation (a) has a cost, or (b) does not have costs for a country. Explain why you think that (a) or (b) is the correct answer.

5.Explain (a) why and (b) how financial markets exerted different degrees of pressure on countries to engage in austerity programs.

6.Explain why you believe that the departure of a current EMU member country (Greece, for example) would (a) strengthen, or (b) weaken the survivability of the EMU.
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Answer 1

Answer (1): Debt servicing record of a country means its past debt clearing record, as to how has the country dealt with clearing the debts which it had taken in the past from any other country or any organization. If the previous record of debt maintenance is good, a country is most likely to get a good and handsome from the lenders when the need be, however, a country with poor debt clearance in the past is most likely to face the deterrence of the lenders.

                       If two countries have similar budget deficits as the percentage of their GDP, but have different debt servicing records, this will result in to very much different consequences for both the countries, as the country with a good debt servicing record will get the required fund to manage its budget deficit easily from the lenders, whereas the country with the poor debt servicing record will not get the required fund to manage its budget deficit easily from the lenders and may need to convince the lenders to trust on it.

Answer (2): When a devaluation is expected, the investments in the country receives a huge setback and huge amount of funding are withdrawn, in the fear of losing the value of the fund. This results in to an investment withdrawal crunch before a devaluation is expected and it further worsens the scenario. A huge cashless scenario appears up in the country, and more and more fund investment is required which becomes scarce. The country therefore finds it very costly to maintain a fixed exchange when a evaluation is expected.

Answer (3): The No Bail-out clause had to be included in the Maastricht Treaty because the European Union felt the need to restrict its union members from engaging in unaccounted for and huge financial bail out monetary policies. This is felt because such a monetary policy would not only affect that particular country, but all the European Union countries negatively.

Answer (4): In a fixed exchange system, a devaluation means a huge cost for the country. This is because, fixed exchange rate means that the monetary transaction between the country with any foreign country has a fixed rate and will be needed to be done at that fixed rate itself. However, during a devaluation, the value of the currency of the country falls drastically thereby making it very difficulty for the country to match up to the fixed exchange rate with the foreign country, and results in a huge loss. Hence, devaluation means a huge cost in a fixed exchange system.

Answer (5): When a country is reeling with devaluation or a serious monetary crunch in the country, and many other organizations or countries have a lot of invested money which is stuck, it is then, that the lenders force the country to engage in austerity programs which involves all types of cuts on government spending and increasing all measures to raise government income by increasing taxes on the citizens or by increasing the interest rates prevailing in the country. All these types of steps increases the burden on the people by a huge margin.

Answer (6): The European Union members have in all the years of their Union have made the European Union very strong in every way. There have been some shortcomings for some of the member countries, but as a union they have been largely very successful. They together constitute a huge power in the world. Therefore, the departure of any of the member countries be detrimental to the unified growth and development of all the European Union members. The economic setback would be a huge blow to the whole Union as there is a big fear that any exit will devaluate their currency. Further, many Geo-political affects would possibly palpate with any exit Therefore, we can conclude that the departure any country would weaken the survival of the EMU in the long-run.