The Systemic Character of the Sovereign Debt Crisis: Policy Implications and Governance Issues

1
The Systemic Character of the Sovereign Debt
Crisis Policy Implications and Governance Issues

• Argentino Pessoa
• CEF.UP, Faculdade de Economia do Porto, Portugal
• Email apessoa_at_fep.up.pt

2
The Euro Area Debt Crisis structural mechanisms
Saving rate
Exchange risk
Interest rate
Single currency
Foreign borrowing
2008 crisis
Sovereign debt
Automatic stabilizers
3
The Euro Area Debt Crisis the beginning
Current account deficits
Budget deficit
Trust
Debt yields
Political factors
Concerns over fiscal sustainability
Heavy borrowing
4
How do increase competitiveness?
Currency devaluation
Competitiveness
Internal devaluation
Interest rate
Financial markets
deflationary policies
Economic growth
Budget deficit
Automatic stabilizers
5
The need for fiscal discipline and the
coordination failure
Single currency
Single fiscal structure
EDP
Debt ?
SGP
Coordination
Current account ???
National fiscal rules
6
The Euro zones vulnerability
Fear of default
Recession
Liquidity stops
Solvency crisis
Budget deficit
Interest rates on gov. bonds
Other member countries
Economic growth
Banking crisis
Credit reduction
7
Systemic nature of the crisis

• Implications
• Financial markets can force member states into
  default
• The fear of default in a member makes more
  fragile the banking system of the other members.
• Two problems
• Coordination failure
• Negative externalities (contagion)

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Optimal solution
Coordination failure
Collective action
Central bank ECB (limitless intervention in the
market)
Gov. budget budgetary union (issue debt)
Externalities (contagion)
Internalisation
9
Second best
New institutions
EFSF
ESM
EMF
Drawbacks
Amount of funds/leverage
Collective action clauses
Level of interest rates
10
Economic growth
Growth rate of GDP per person employed (constant
1990 PPP )
63

Italy

1
.
62

0
.
17

Spain

1
.
08

-
0
.
41

Source WDI (2011)

Note only 1991
-
2000.

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Disequilibria inside Euro zone
Surplus countries
supply of funds
Lower interest rates
Export-led growth
consumption
?
?
Peripheral countries
Higher risk premia
Demand for funds
Austerity
Spending
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The solvency condition
With the current level of interest rates and
without growth prospects all the austerity will
be vain
13
Thank you very much

• Argentino Pessoa
• CEF.UP, Faculdade de Economia do Porto, Portugal
• Email apessoa_at_fep.up.pt