Debt Crisis in the Eurozone

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Nations such as Greece, Ireland and Portugal, who are currently way deep recession, meet the definition of a full-blown economic depression (Schuman, 2011). The depreciation of the euro relative to the home currency will make Euro-zone exports cheaper in global markets. this as a result would increase the competitive pressure in the home country. At the same time, it was observed in the last quarter of 2011, manufacturing industry weakened from China to Europe and euro region’s debt crisis is expected to darken the outlook of the global economy. Before going any further, it would be interesting to understand why it is necessary and helpful for countries to borrow and then to accumulate debt. Foreign borrowing is seen by governments as an addition to domestic saving, this borrowing helps in connecting to an investment saving gap and thus this leads to gain quicker growth, this is usually considered as final and vital economic goal for any country. The Mundell-Fleming model amalgamates the foreign finance and trade into a macro-economic theory. The theory came into evolution in the early 1960s and was introduced by the great Canadian Economist and the winner of 1999 Nobel Price Award, Robert Mundell. He was also heavily helped and facilitated by the British economist, J. Marcus Fleming. During the time period when this theory came into existence, both these economists were a part of the research team within the famous International Monetary Fund. While carrying out their research towards the Mundell-Fleming model, they enhanced the conventional Keynesian model in to such an open economy system whereby the capital and the goods market were internationally incorporated (Hailu et al, 2011). The Mundell-Fleming model is of the view that under a flexible exchange rate management system, the fiscal policy has almost none or little effect over the final yield or output whilst the monetary system is hugely valuable. This situation shows an entire mirror image when a fixed exchange rate is adopted i.e. the fiscal policy becomes effective rather than the monetary policy. The hypothesis that international money markets are completely amalgamated plays an important role in formulating these results. One of the major suppositions that the Mundell-Fleming model makes is that the economy under consideration is an open economy whereby the financial capital has an ideal mobility. The Mundell-Fleming model and the traditional IS-LM model are similar to each other when expressing the market for goods and services. One of the differences is that the Mundell-Fleming model includes a fresh terminology for net exports. this can be portrayed with the following equation: Y = C(Y -T) + I (r) + G + NX (E) Whereby. Y= The aggregate/cumulative income C= Consumption, I= Investment G= Government purchases (Y – T)= Disposable Income r = Interest rate NX = Net Exports E= Exchange Rate According to this equation, the total aggregate income of any country is the totting up of all these different factors. The consumption factor within the equation is positively dependent upon the disposable income whilst the investments and the net exports are negatively dependent upon the real interest and exchange rates respectively (Serrano et al, n.d.). The Mundell-Fleming model provides an understanding that clearly helps in analysing the consequences of adopting