The euro zone should be reduced from its current size with those countries currently experiencing difficulties seeking external solutions, Hans Werner-Sinn, president of the IFO Institute, told CNBC Thursday.
"In the end, we need a reduced euro zone. Some countries which are now in, and for whom the way towards an equilibrium is too long, they would be better to do it outside and depreciate their currencies. For others they can do it within the euro zone," Werner-Sinn said.
He warned that this would be only an “intermediate” solution and added that the current debt crisis could not be solved politically because of its complexity.
"Europe's politicians cannot do very much, as this is beyond the political sphere. The problem is Europe needs a re-alignment. Some countries (had) become way too expensive in the first years of the euro when the interest rates were artificially converging and overheated. So these countries have to depreciate in real terms," he said.
Labor costs and competitiveness have been issues for some of the peripheral countries compared to the 'core' of the euro zone.
So far European leaders, including German Chancellor Angela Merkel and French President Nicolas Sarkozy, have dismissed any notion that the euro zone should be restructured into a smaller unit with some countries leaving.
Werner-Sinn admitted realignment would be 'very difficult' to achieve and it would have to be indirect as it could not be done via the currency because of the euro zone.
"They have to reduce their prices or Germany has to become more expensive. But they don't want tor educe their prices because all sorts of internal imbalances result. Germany doesn't want to inflate because of its historical experiences,” he said.
Germany suffered from hyperinflation after the first world war and is a period in history modern day Germany is keen to avoid.
Werner-Sinn staunchly disagreed with the notion of a euro bond– which would converge all the debt between individual states in the euro zone – claiming it might calm the markets but would not be the long term solution. "This socializes the debt in Europe and would calm the markets but it would perpetuate the disequilibrium among the European countries," he added.
Last week's EU summit, which proposed treaty changes in principle, was agreed by 26 out of the 27 EU countries, with Britain declining to agree, but has been viewed by many investors as a disappointment that fails to deal decisively with the problem.
Charles Diebel told CNBC that markets were being naïve in expecting each summit to be the one which finally resolves the debt crisis.
"The expectation that a single summit is the solution is wrong. There are going to be lots of summits in 2012. They are working on it bit by bit. These embedded expectations that you are going to get a solution at this meeting or the next one is not the way it is going to work," he said.
David Bloom said a dangerous game was being played between European leaders and the ECB.
"Things have to get worse before they get better. Europe has to save itself and the way it is going to do that is through structural reform and eventually I think the ECB will print but it is a very dangerous game that is being played out," Bloom said.