July 10, 2014
WASHINGTON—A new book published by the Peterson Institute for International Economics freshly analyzes the sovereign debt crisis in Europe of the last five years, and concludes that the economies in the southern periphery are solvent and for the most part not in need of further debt restructurings. The book, Managing the Euro Area Debt Crisis, by William R. Cline, a renowned expert on international debt and current account balances, notes that Greece is an exception, and its need for debt relief remains open.
For this study, Cline developed a new method to assess the probability distribution of future paths for the sovereign debt burden. This method goes beyond the usual enumeration of scenarios by taking account of likely correlations between good and bad scenarios for each of five key macroeconomic variables (GDP growth, primary or noninterest fiscal balance, sovereign risk spread in the interest rate, bank recapitalization costs, and privatization earnings).
Managing the Euro Area Debt Crisis argues that the policy breakthrough that stabilized the region was the July 2012 decision by the European Central Bank to do "whatever it takes" to preserve the euro, through its program of Outright Monetary Transactions (OMT) to conditionally purchase government bonds. By early 2014, sovereign spreads within the euro area had fallen to around 200 basis points or less, and both Ireland and Portugal had completed their official support programs successfully.
In contrast, at the height of the crisis in 2011–12, sovereign borrowing risk spreads versus German bonds rose to 500–600 basis points in Italy and Spain and far higher in Ireland and Portugal, risking self-fulfilling prophecies of insolvency. Thus Cline argues that European leaders took the appropriate steps at the height of the euro crisis to enable the euro area's southern periphery economies to stabilize, and avoid further cases of debt restructuring or haircuts as required by Greece.
Cline's innovative approach to assessing the sustainability of government debt does indicate, however, that Ireland, Portugal, Italy, and Spain must sustain the sizable primary surpluses—the only path to solvency.
|Outlook for public debt by 2020 assuming average economic performance, 2014–20|
|Debt as percent of GDP||Growth
(percent of GDP)
Despite Greece's 2012 haircut of about 50 percent on private holders, Cline projects that public debt will remain high (at 175 percent of GDP at end-2013, declining to 127 percent by 2020). But low interest rates on the predominantly officially-held debt make the real burden less than implied by the debt ratio. Moreover, little Greek debt comes due over the next decade, due to the restructuring, and the government was able to return to the market for 5-year debt in early 2014. Whether further official-sector relief for Greece will be necessary is thus unclear.
Cline warns that it will be crucial to ensure that the bond purchasing program known as OMT remains in place and not be undermined by court decisions that make debt purchased by the ECB senior to the debt held by private investors. Without equal treatment as creditors, private investors would fear larger costs imposed on them in the case of restructuring, undermining confidence. Cline similarly labels as misguided recent proposals for a formal euro area debt restructuring mechanism, because such a mechanism would send a counterproductive signal that could erode the improvement in confidence achieved though the OMT.
Managing the Euro Area Debt Crisis
William R. Cline
ISBN paper 978-0-88132-687-1
June 2014 | 218pp. | $25.95
About the Author
William R. Cline, senior fellow, has been associated with the Peterson Institute since its inception in 1981. During 1996–2001, while on leave from the Institute, he was deputy managing director and chief economist of the Institute of International Finance. Before joining the Peterson Institute, he was senior fellow, the Brookings Institution (1973–81); deputy director of development and trade research, office of the assistant secretary for international affairs, US Treasury Department (1971–73); Ford Foundation visiting professor in Brazil (1970–71); and lecturer and assistant professor of economics at Princeton University. His numerous publications include Resolving the European Debt Crisis (coeditor, 2012), Financial Globalization, Economic Growth, and the Crisis of 2007–09 (2010), and The United States as a Debtor Nation (2005).
About the Peterson Institute
The Peterson Institute for International Economics is a private, nonprofit institution for the rigorous, open, and intellectually honest study and discussion of international economic policy. Its purpose is to identify and analyze important issues to making globalization beneficial and sustainable for the people of the United States and the world and then to develop and communicate practical new approaches for dealing with them. The Institute is widely recognized as nonpartisan. It receives its funding from a wide range of corporations, foundations, and private individuals from the United States and around the world, as well as from income on its endowment.