External Imbalances and Financial Fragility in the Euro Area
Michele U. Fratianni
Indiana University Bloomington - Department of Business Economics & Public Policy; Universita' Politecnica delle Marche
Università Politecnica delle Marche - Faculty of Economics
Andrea Filippo Presbitero
Università Politecnica delle Marche - Department of Economics; Centre for Macroeconomics & Finance Research (CeMaFiR)
Andrew J. Hughes Hallett
George Mason University - School of Public Policy
May 8, 2012
This paper presents two views of the European sovereign debt crisis. The first is that the South in the euro zone has been fiscally irresponsible, and has failed to implement supply-side policies such as liberalizing labor markets and the market for services. The second view holds that the crisis reflects a deep divide between the external surpluses of the North and external deficits of the South. Basic stylized facts raise some doubt about the validity of the thesis that the debt crisis in the Euro-zone is driven primarily by fiscal fragility in the South. A relatively simple model shows how poor fundamentals can create a debt problem independently of fiscal responsibility. The empirical analysis of the determinants of government bond yield spreads relative to Germany suggests that both views in fact provide useful insights into the roots of the current sovereign crisis. Fiscal fragility and external imbalances explain a significant share of the widening spreads since the onset of the global financial crisis. However, differences in labor productivity growth between North and South assume a much relevant role since the Greek crisis erupted in 2010.
Number of Pages in PDF File: 45
Keywords: Sovereign yield spreads, external imbalances, adjustment burden, monetary union
JEL Classification: F32, F42, G12, H63working papers series
Date posted: May 10, 2012
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