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

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@fep.up.pt. The Euro Area Debt Crisis: structural mechanisms. Saving rate. Exchange risk. Interest rate.

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

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  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@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 zone’s 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)

  8. Optimal solution Coordination failure Collective action Central bank: ECB (limitless intervention in the market) Gov. budget: budgetary union (issue debt) Internalisation Externalities (contagion)

  9. “Second best” New institutions: EFSF ESM EMF Drawbacks: Amount of funds/leverage Collective action clauses Level of interest rates

  10. 1990 - 2000 2001 - 2008 Euro zone 1 . 56* 0 . 82 EU 2 . 0* 1 . 36 World 1 . 73* 3 . 12 China 5 . 97 10 . 14 India 4 . 1 5 . 44 US 1 . 9 1 . 57 Germany 1 . 54* 0 . 92 Portugal 2 . 13 0 . 89 Ireland 3 . 3 1 . 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.

  11. 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

  12. 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@fep.up.pt

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