85 Pages Posted: 1 Dec 2011 Last revised: 6 Dec 2011
Date Written: November 25, 2011
The eurozone, composed of 17 countries which have adopted the euro as their currency, has been struggling with an apparently-intractable crisis over the enormous debts faced by its weakest economies and by countries impacted by the bursting of the housing boom in the past global recession of 2007-09. “Fiscally-distressed” countries now include Italy and Spain, both too big to bail out, along with Greece, Ireland and Portugal. Major contributing factors are the sizes of net government debt, primary budget deficits and negative current account (trade) balances, each expressed as a percent of GDP.
With potential loss of access to bond markets, inability to devalue and failure of the European Central Bank (ECB) to intervene, stern demands by Germany for adoption of severe austerity programs and reform could lead to a deeper recession, bond restructurings, bailouts, and even defaults on sovereign debt.
The only resolution now apparently demanded by bond markets and deficit hawks is unequivocal confirmation of the ECB as lender-of-last-resort for Italy and Spain. However, Germany’s leaders are firmly opposed to expansion of ECB’s role due to concerns of inflation, devaluation of its assets, and moral hazard (rewarding risky behavior’s losses). Quickly-moving bond markets may provide a stern test of the slowly-unfolding, “just-in-time” crisis management led by Germany, which currently is proposing a “fiscal union” with enforceable deficit limits.
Underlying structural factors associated with peripheral eurozone countries – overspending, imports exceeding exports, higher real labor costs, lower productivity, real appreciation, tax avoidance and the reluctance to radically reform – reflect national traits and behavior which may be difficult to change quickly.
Over 40 charts support paper’s observations.
Keywords: sovereign debt, bond restructuring, defaults on debt, European Central Bank, primary budget deficit, current account balance, moral hazard, deficit hawks, PIIGS, recession, eurozone
JEL Classification: E44, E58, E62, E65, F32, H62, H87, I22, N20, P43
Suggested Citation: Suggested Citation