Adjustment Difficulties and Debt Overhangs in the Eurozone Periphery

CEPS Working Documents

27 Pages Posted: 29 Jul 2011

See all articles by Daniel Gros

Daniel Gros

Centre for European Policy Studies, Brussels; CESifo (Center for Economic Studies and Ifo Institute)

Cinzia Alcidi

CEPS; Graduate Institute of International and Development Studies (IHEID)

Date Written: May 4, 2011

Abstract

This paper describes four key drivers behind the adjustment difficulties in the periphery of the eurozone: • The adjustment will be particularly difficult for Greece and Portugal, as two relatively closed economies with low savings rates. Both of these countries combine high external debt levels with low growth rates, which suggest they are facing a solvency problem. In both countries fiscal adjustment is a necessary condition for overall sustainability, but it not sufficient by itself. A sharp cut in domestic consumption (or an unrealistically large jump in exports) is required to quickly establish external sustainability. An internal devaluation (a cut in nominal wages in the private sector) is unavoidable in the longer run. Without such this adjustment in the private sector, even continuing large-scale provision of official funding will not stave off default. • Ireland’s problems are different. They stem from the exceptionally large losses in the Irish banks, which were taken on by the national government, leading to an explosion of government debt. However, the Irish sovereign should be solvent because the country has little net foreign debt. • Spain faces a similar problem as Ireland, although its foreign debt is somewhat higher but its construction bubble has been less extreme. The government should thus also be solvent, although further losses in the banking system seem unavoidable. • Italy seems to have a better starting position on almost on all accounts. But its domestic savings rate has deteriorated substantially over the last decade.

Keywords: eurozone, economy, savings, debt, bank, Greece, Portugal

Suggested Citation

Gros, Daniel and Alcidi, Cinzia, Adjustment Difficulties and Debt Overhangs in the Eurozone Periphery (May 4, 2011). CEPS Working Documents, Available at SSRN: https://ssrn.com/abstract=1898598 or http://dx.doi.org/10.2139/ssrn.1898598

Daniel Gros (Contact Author)

Centre for European Policy Studies, Brussels ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Cinzia Alcidi

CEPS ( email )

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Brussels, 1000
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Graduate Institute of International and Development Studies (IHEID) ( email )

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Switzerland

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