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Euro debt crisis 101: What can Merkel, Sarkozy plan accomplish?

German Chancellor Angela Merkel and French President Nicolas Sarkozy are pushing for a more economically disciplined and unified eurozone as a way to stem Europe's spiraling debt crises. But it remains to be seen just how much the two leaders can do to reverse the economic damage spreading quickly. Below, the Monitor answers key questions about the debt crisis and the trouble it spells for the eurozone.

A brokers reacts in a trading room of a Portuguese bank in Lisbon Wednesday, Aug. 17. Portugal has raised euro 1.16 billion ($1.67 billion) in a short-term debt auction amid continuing market jitters over the eurozone's sovereign debt crisis. Portugal needed a euro78 billion bailout earlier this year to help pay its heavy debts as it struggles to break out of an economic recession.
Francisco Seco/AP
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1. What is Europe's debt crisis and why is the eurozone economy in such trouble?

The eurozone is a monetary union, launched in 1999, and consisting of 17 EU members, which have adopted the euro as their common currency. These countries include nations differing widely in economic weight. The German gross domestic product (GDP) for instance was more than $3 trillion last year, while that of Greece was $310 billion.

As members of one currency, these nations waived two important fiscal instruments – individual interest and exchange rates. This was bound to create problems, says Michael Wohlgemuth, Managing Research Associate at the Walter Eucken Institute in Freiburg, Germany. "A country like Germany, which had rather bad growth figures in the early years of the eurozone, would have needed lower interest rates, while, let’s say, Ireland would have needed higher rates.”

Equally important: eurozone members signed up to the Stability and Growth Pact, obliging them to keep the annual budget deficit lower than 3 percent of GDP and the national debt under 60 percent of GDP. But hardly any member state has stuck to these limits.

“The lack of fiscal discipline and the temptations of low interest rates led to a typical over-consumption crisis, particularly at the periphery of the eurozone,” says Mr. Wohlgemuth. “Basically, countries like Greece, Portugal, and Spain threw a party with borrowed money.”

Sovereign debts spiraled out of control – Greece’s is now at about 140 percent. The rating agencies downgraded several EU economies in recent months, making it virtually impossible for them to raise money to pay off their debts. Consequently, Greece, Ireland, and Portugal all received financial aid from the other eurozone members and the International Monetary Fund (IMF) in return for promises of structural reforms, privatization of public assets, and spending cuts. Spain and Italy initiated austerity programs to avoid being drawn into the crisis, but markets remain nervous.

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