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A Devaluation Option for Southern Europe

CAMBRIDGE – This year is likely to mark a make-or-break ordeal for the euro. The eurozone’s survival demands a credible solution to its long-running sovereign-debt crisis, which in turn requires addressing the two macroeconomic imbalances – external and fiscal – which are at the heart of that crisis.

The crisis has exposed the deep disparities in competitiveness that have developed within the eurozone. From 1996 to 2010, unit labor costs in Germany increased by just 8%, and by 13% in France. Compare that to 24% in Portugal, 35% in Spain, 37% in Italy, and a whopping 59% in Greece. The result has been large trade imbalances between eurozone countries, a problem compounded by large fiscal deficits and high levels of public debt in southern Europe (and France) – much of it owed to foreign creditors.