Eurozone Periphery Research Articles

Political Credit Cycles: The Case of the Eurozone

We study the mechanisms through which the entry into the euro delayed, rather than advanced, key economic reforms in the eurozone periphery and led to the deterioration of important institutions in these countries. We show that the abandonment of the reform process and the institutional deterioration, in turn, not only reduced their growth prospects but also fed back into financial conditions, prolonging the credit boom and delaying the response to the bubble when the speculative nature of the cycle was already evident. We analyze empirically the interrelation between the financial boom and the reform process in Greece, Spain, Ireland, and Portugal and, by way of contrast, in Germany, a country that did experience a reform process after the creation of the euro.

The implications of TARGET2 in the European balance of payments crisis and beyond

The paper provides an account of the meaning and implications of TARGET2 in the eurozone (EZ) balance of payments crisis. In this context, it discusses Hans-Werner Sinn's thesis about a stealth bail-out of the EZ periphery by the ECB from a heterodox perspective. Financial liberalisation, a relatively loose monetary policy and the provisional fading of devaluation risks generated ephemeral growth in some peripheral EZ countries sustained by capital flows from core countries. This has been followed by real exchange rate revaluation and deterioration of foreign accounts. As a result, external financing flows dried up and the previous stock of loans began to be repatriated. TARGET2 has played a fundamental role in avoiding a precipitous crisis. This distinguishes the European crisis from more traditional balance of payments crises. However, the presence of TARGET2 does not offset the absence of the financial crisis prevention and resolution mechanisms that are characteristic of fully fledged political and currency unions.

What is the risk of European sovereign debt defaults? Fiscal space, CDS spreads and market pricing of risk

We estimate the pricing of sovereign risk for fifty countries based on fiscal space (debt/tax; deficits/tax) and other economic fundamentals over 2005–10. We focus in particular on five countries in the South-West Eurozone Periphery, Greece, Ireland, Italy, Portugal and Spain. Dynamic panel estimates show that fiscal space and other macroeconomic factors are statistically and economically important determinants of sovereign risk. However, risk-pricing of the Eurozone Periphery countries is not predicted accurately either in-sample or out-of-sample: unpredicted high spreads are evident during global crisis period, especially in 2010 when the sovereign debt crisis swept over the periphery area. We match the periphery group with five middle income countries outside Europe that were closest in terms of fiscal space during the European fiscal crisis. Eurozone Periphery default risk is priced much higher than the matched countries in 2010, even allowing for differences in fundamentals. One interpretation is that these economies switched to a “pessimistic” self-fulfilling expectational equilibrium. An alternative interpretation is that the market prices not on current but future fundamentals, expecting adjustment challenges in the Eurozone periphery to be more difficult for than the matched group of middle-income countries because of exchange rate and monetary constraints.

Short run stabilization and long run competitiveness: the Latvian case

Subject area Macroeconomics: fixed exchange rate regime, external and internal devaluation, international competitiveness, comparison to ongoing eurozone periphery problems. Study level/applicability The main audience for this case is undergraduate students in economics and business or graduate students in business or political science related studies. More particularly, the case suits a class on applied macroeconomics or general economic policy. Case overview The case investigates economic development in Latvia since it gained independence, the key focus is overheating in 2004-2007 and consequential extraordinary economic crisis of 2008-2009. This case gives a great starting point to discuss ongoing problems in peripheral eurozone (PIGS) in terms of internal versus external devaluation. Expected learning outcomes Students are expected to learn the differences between external and internal devaluation as well as a country's international competitiveness factors. Also, class discussion of similarities and differences between Latvia and PIGS should make students more aware of two types of devaluation. Supplementary learning materials Teaching notes are available. Please consult your librarian for access.

Delivering economic stimulus, addressing rising public debt and avoiding inflation

PurposeThe purpose of this paper is to review monetary policy options in countries assumed to be suffering from two common economic problems: deficient private demand and high and rising public debt.Design/methodology/approachThe analytical approach assumes that relevant authorities have decided that new money creation is necessary to address their economic problems. The paper asks the question: how should this new money creation best be deployed to create the required economic stimulus in the context of rising public debt?FindingsThe first finding is that the latest rounds of “quantitative easing” in the USA (QE2) and Japan are likely to be inefficient, largely ineffective and have adverse side‐effects, and that in periphery countries the risk of debt default is being increased by current defensive policy settings. The second finding is that the policy of financing budget deficits by printing new money is likely to be more effective (than “quantitative easing” and current Eurozone policy) in raising demand, output and employment without adding unnecessarily to already high levels of public debt.Practical implicationsThere are very substantial practical policy implications, involving a potential change of monetary policy strategies for two of the world's largest economies and for Eurozone periphery countries. Post‐earthquake reconstruction in Japan could be financed in the manner recommended in this paper.Originality/valueThe originality/value lies in demonstrating that current monetary policy orthodoxy is misplaced, and that an alternative policy strategy has been overlooked and is likely to be more effective.

Comment

Comment

Cohesion in the European Union: Economic, Political, Cultural Challenges

European Union (EU) cohesion policy in particular and the idea of European integration in general are currently facing some challenges of ability and willingness, both determined by economic, political and cultural factors. Some factors, however, continue to hold EU countries together. The economic crisis of 2008-10 and its aftermaths further reduced ability and readiness of net contributors to the EU budget to finance EU cohesion policy, even more because these countries have to save indebted eurozone periphery. The economic crisis and problems of the euro further weakened ability and willingness of some countries, like Poland, to join the euro- zone, thus strengthening the internal division of the EU. Growing unemployment and sense of insecurity in richer EU member states and the increased immigration to these countries from poorer new member states have produced negative attitudes towards immigrants and Eastern in general. The absence of a clear-cut enemy of and the variety of external political challenges differently interpreted by governments and societies of individual states hinder the development of a common external policy and sense of internal solidarity. Europe is becoming playground for world powers: USA, Russia and China. Different responses to external challenges, e.g. increased migration from Northern Africa, put at risk some European achievements like the Schengen treaty. The Eastern enlargement together with economic problems revealed weakness of the sense of European identity, and especially unwillingness of Western societies to accept Eastern Europeans as Europeans. Even within the old Europe the divide between hard working North and leisure South is becoming more evident. In such circumstances the ability and willingness to continue generous cohesion policy is declining. However, deep changes in the European cohesion policy or disintegration of the EU are unlikely as European leaders fear of taking dramatic decisions given economic interdependence of EU countries.

Adjustment Difficulties and Debt Overhangs in the Eurozone Periphery

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.

Dancing Spreads: Market Assessment of Contagion from the Crisis in the Euro Periphery based on Distress Dependence Analysis

The crisis in the eurozone periphery has so far affected markets substantially more than the size of the countries in the region would suggest. Data on direct exposures and simple correlations also fail to explain the cross-border impact of the crisis. Following Segoviano (2006), this paper uses distress dependence analysis to measure market assessment of contagion risks from Greece and Ireland to the rest of Europe during the peaks of the crises in these countries. The results provide insights to possible contagion risks through cross-border negative feedback loops between sovereigns and banking sectors in Europe that help explain the severe impact of the crisis.

The World Economy

•Euroland will start in 1999 with interest rates around 3.75 per cent, growth of 2.6 per cent and subdued inflation.•Economies on the periphery of the Euro-zone are diverging sharply from those in the core.•Japan's Y16 trillion fiscal package will lift output by under 1 per cent in 1998 and 0.5 per cent in 1999.•A clean-up of the Japanese financial sector is needed to restore consumer confidence and allow a sustained recovery.•Asian export recovery has been delayed because of the Japanese downturn and difficulties in restoring trade finance.•US interest rates will remain on hold as buoyant domestic demand is offset by the disinflationary impact of the Asian crisis.