Transcript THE EURO AREA ENLARGMENT

Dr Katarzyna Sum
Chair of International Finance
Warsaw School of Economics
THE PUBLIC DEBT AS A
GLOBAL PROBLEM
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Lecture outline
 Increasing debt levels in the world
 Debt crisis- definition and mechanism
The case of the euro area sovereign debt
crisis
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Government debt to GDP in the
world
Source: Wikipedia.
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The Polish public debt clock
Source:www.for.org.pl
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Government bonds
 National government bonds- issued in
domestic currency
 Sovereign bonds- issued in foreign
currency
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Government bonds
 Low risk premium of government
bonds:



Governments are able to undertake policy
measures to pay off their debt (taxes,
expenses)
The risk premium depends on the credibility
of the government
Sovereign bonds – additional risk related to
exchange rate movements and availability of
foreign currency
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Problems related to public debt
accummulation
 Decreasing credibility  Increasing risk premia
 Investors start demanding a much higher compensation
for the risk of holding the increasingly large amounts of
public debt that authorities are going to issue
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Accummulation of public debt
globally
 Individual country factors
Global factors the financial crisis from 2007-2009,
 Global unequilibrium
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Accummulation of public debt
globally
The need to recapitalize banks after the
crisis
Governments had to take over a large part
of the debts of failing financial institutions
The introduction of large stimulus
programmes to revive demand
Prospects of further debt increase due to
demographic tendencies
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Accummulation of public debt
globally
Total industrialised country public sector
debt is exceeded 100% of GDP in 2011!!!
(OECD)
Strong deterioration in countries which
had a balanced situation before the crisis
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Further development will depend on:
The ultimate costs of the financial crisis
The rate of real growth
The level of interest rates,
Political decisions about spending and taxes
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Short term and long term
spending
 Short term- to mitigate the effects of the
financial crisis
Long term- to deal with the ageing of societies
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Unfunded liabilities arising from
ageing
The pension system is based on the pay-as you
go method
This means that current pensions has to be
financed by current contributions
Ageing of the population creates the need of
additional borrowing
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Age related government
expenditure
Source: Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, The future of public debt:
prospects and implications, BIS Working Paper 2010.
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Prospects
Source: Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, The future of public debt:
prospects and implications, BIS Working Paper 2010
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Debt crisis
A situation of excessive government debt
accummulation which renders an economy
incapable of paying off its debt without the help
of third parties
A type of financial crisis
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Debt crisis
Initially high level of public debt creates the risk
of unstable debt dynamics
Increasing risk premia
Lower long term growth due the higher cost of
servicing the debt
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What happens to bond yields
during the debt crisis?
Source: Nicholas Vause, Goetz von Peter, Euro area sovereign crisis drives global financial markets,
BIS Quarterly Review, December 2011
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What triggered the sovereign debt
crisis in the Eurozone?
The performance of respective Eurozone
countries
 Excessive lending, asset price bubbles
and a loss of competitiveness 
Overheating combined with structural
problems
 PIIGS
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Did the euro zone try to prevnet
the debt crisis?
 The Stability and Growth Pact Aimed at
preventing excessive deficits and public debt
The no-bail out principle- the respective euro
area member states are not liable for the debt of
other member states
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•
Source: Nicholas Vause, Goetz von Peter, Euro area sovereign crisis drives global financial
markets, BIS Quarterly Review, December 2011
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The preventive measures
undertaken were not sufficient!
Even before the financial crisis countries did not
comply with the Pact reqirements
The situation worsened when the governments
had to fight the consequences of the crisis
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The reaction of the financial
markets
 High volatility of equity and bond markets
 Downgrades of country ratings exerted
additional upward pressure on government
bond yields
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The reaction of the financial
markets
The financial markets demanded higher
risk premia- financing contsraint
Additionaly- bank funding problems
This created the need of policy measures
to restore confidence
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Political measures
Debt remission for Greece
Leveraging of the European Financial Stability
Facility
Recapitalisation of banks
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Political measures
 The political measures undertaken
contradict the no-bailout clause
The need of redefining the fiscal rules of
the eurozone
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Securities Markets Programme
 Interventions by the Eurosystem in public and
private debt securities markets in the euro area
to ensure depth and liquidity
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Securities Markets Programme
Source: Nicholas Vause, Goetz von Peter, Euro area sovereign crisis drives global financial markets,
BIS Quarterly Review, December 2011
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Global spillovers
After the decrease of the euro area soveriegn
debt and bank debt the financial institutions
which held the securities were exposed to
increased costs
This affected institutions globally
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Debt crisis resolution
In the past debt crises were resolved by:
Economic growth
Substantive fiscal adjustment/austerity plans;
Explicit default or restructuring of private and/or
public debt;
A sudden surprise burst in inflation
Financial repression
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Financial repression
„Directed lending to government by captive
domestic audiences (such as pension
funds), explicit or implicit caps on interest
rates, regulation of cross-border capital
movements„
Source:Carmen M. Reinhart, M. Belen Sbrancia, The Liquidation of Government Debt, BIS Working
Papers 2011
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Debt crisis resolution
The resolution of the euro area sovereign
debt crisis should consider:
 Changing economic conditions
 Demographical tendencies
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Summing up
 Governments can borrow financial resources by
means of issuing bonds
Bonds can be issued in national currency
(national bonds) or foreign currency (sovereign
bonds)
Usually governments bonds are regarded as risk
free securities
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Summing up
 The excessive accummulation of debt
leads to an increase of risk premia and
increases to costs of debt servicing
A debt crisis occurs if a country can jot
repay its debt without the help of a third
party
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Literature
Source: Stephen G Cecchetti, M S Mohanty and Fabrizio
Zampolli, The future of public debt: prospects and
implications, BIS Working Paper 2010
Nicholas Vause, Goetz von Peter, Euro area sovereign
crisis drives global financial markets, BIS Quarterly Review,
December 2011
Carmen M. Reinhart, M. Belen Sbrancia, The Liquidation of
Government Debt, BIS Working Papers 2011
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