© rainer maurer, pforzheim - 1 - prof. dr. rainer maure digression: the european debt crisis 2010

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- 1 -Prof. Dr. Rainer Maure

Digression: The European Debt Crisis 2010Digression: The European Debt Crisis 2010

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The European Debt Crisis 2010The European Debt Crisis 20101. The Causes of the Crisis1. The Causes of the Crisis


➤ The crisis can be seen as the result of The crisis can be seen as the result of two factorstwo factors::

1.1. One interest rate only One interest rate only for 17 member states!for 17 member states!

■ As seen in chapter 6.2.3., business banks of As seen in chapter 6.2.3., business banks of all member all member states states can borrow money from the ECB at can borrow money from the ECB at the same interest the same interest raterate..

■ A differentiation A differentiation of the interest rate according to the different of the interest rate according to the different home countries of the commercial banks home countries of the commercial banks is not practicedis not practiced..

■ As a consequence, the As a consequence, the interest rate for bank credits interest rate for bank credits (especially mortgage and firm credits) have aligned in all (especially mortgage and firm credits) have aligned in all member states („member states („interest-rate-pass-throughinterest-rate-pass-through“).“).

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2.2. Different inflation rates Different inflation rates in all 17 member states!in all 17 member states!

100%

105%

110%

115%

120%

125%

130%

19

99

20

00

20

01

20

02

20

03

20

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20

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20

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20

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Euro area (16 countries) Ireland Greece Spain Portugal

GDP Price Deflator Relative to GermanyIndices Relative to Germany (1999 = 100%)

Source: EU Commission, AMECO, Own Calculations www.rainer-maurer.com

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➤ If nominal interest rates are identical, but inflation rates If nominal interest rates are identical, but inflation rates diverge, diverge, real interest rate diverge tooreal interest rate diverge too::

=> Countries with => Countries with highhigh inflation rates inflation rates experience experience lowlow real interest real interest ratesrates!!

Countries with Countries with lowlow inflation rates inflation rates experience experience highhigh real interest real interest ratesrates!!

InflationRateInterestNominalRateInterestReal

ii i r

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➤ Convergence of nominal interestConvergence of nominal interest rates & rates & divergence of real divergence of real interestinterest rates using the example of 10 years govern. bonds : rates using the example of 10 years govern. bonds :

-0,1%

0,1%

0,3%

0,5%

0,7%

0,9%

1,1%

1,3%

1,5%

Jan. 97 Jan. 98 Jan. 99 Jan. 00 Jan. 01 Jan. 02 Jan. 03 Jan. 04 Jan. 05 Jan. 06 Jan. 07 Jan. 08 Jan. 09 Jan. 10

Nominal Interest Rates for 10-Year Government BondsInflation Rates (HCPI)Real Interest Rates for 10-Year Government Bonds

Variance Coefficients across the 12 EMU Founding Member States

Source: Eurostat, Own Calculations © www.rainer-maurer.com

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➤ Divergence of real interestDivergence of real interest rates using the example of 10 years rates using the example of 10 years government bondsgovernment bonds ::

-4,0%

-3,0%

-2,0%

-1,0%

0,0%

1,0%

2,0%

3,0%

4,0%

5,0%

6,0%

7,0%

8,0%

9,0%

Jan. 97 Jan. 98 Jan. 99 Jan. 00 Jan. 01 Jan. 02 Jan. 03 Jan. 04 Jan. 05 Jan. 06 Jan. 07 Jan. 08 Jan. 09 Jan. 10

Germany Spain Greece Ireland Portugal

Real Interest Rates for 10 Years Government Bonds (based on BIP-Deflator)


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0 1 2 3 4 5 6 7 8 9 10

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➤ What What consequencesconsequences have different real interest rates have different real interest rates forfor the the capital marketcapital market::

Low Inflation Country: rL* = i*- πL

Excess supply of credits

S(Y)

I(Y)S, I

rL*

High Inflation Country: rH* = i*- πH

Excess demand for credits

S(Y)

I(Y)

r = real interest rates

rH*

S, I

r*


Equilibrium interest rate, if all countries would experience the same inflation rate.

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0 1 2 3 4 5 6 7 8 9 10

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0 1 2 3 4 5 6 7 8 9 10

Excess Supply of credits

S(Y)

I(Y)S, I

rL*

Excess demand for credits

S(Y)

I(Y)


rH*

S, I

r*


The ECU total capital market is in equilibrium, while there is a disequilibrium on the capital market of the member countries!

The average interest rate is equal to the market equilibrium rate: (rL* + rH*) /2 = r*

Low Inflation Country: rL* = i*- πL

High Inflation Country: rH* = i*- πH

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➤ Result of diverging interest rates:Result of diverging interest rates:

■ The The high inflation countryhigh inflation country has an incentive to borrow from the has an incentive to borrow from the low inflation country, low inflation country, because ofbecause of its its low real interest ratelow real interest rate..

■ The The low inflation countrylow inflation country has an incentive to lend money to the has an incentive to lend money to the low inflation country, low inflation country, because ofbecause of its the its the high real interest ratehigh real interest rate..

➤ If this scenario holds on over several years, the If this scenario holds on over several years, the high inflation high inflation countrycountry will accumulatewill accumulate more and more more and more debtdebt hold by the low hold by the low inflation country:inflation country:

■ The following diagram shows that this mechanism has been at The following diagram shows that this mechanism has been at work in the ECU over a long span of time:work in the ECU over a long span of time:

T

ttD

0

CreditsforDemandsExcessYearlyofSumDebt Cumulative

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Austria

BelgiumGermany

Spain

Finland

France

Greece

Ireland

Italy

Netherlands

Portugal

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

1,4% 1,9% 2,4% 2,9%

Bis April 2010 aufgelaufene Nettoauslandsverschuldung in Prozent des BIP und durchschnittlicher Realzins von Januar 1999 bis Dezember 2009

Realzins

Quelle: Eurostat, Eigene Berechnungen

Nettoauslandsverschuldungin % des BIP

The lower the real interest rate, the higher the accumulated net debt position.

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Austria

BelgiumGermany

Spain

FinlandFrance

Greece

Ireland

Italy

Netherlands

Portugal

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

1,4% 1,6% 1,8% 2,0% 2,2% 2,4% 2,6% 2,8% 3,0% 3,2%

Bis Dezember 2009 aufgelaufene Nettoauslandsverschuldung in Prozent des BIP und durchschnittliche HVPI Inflationsrate von Januar 1999 bis Dezember 2009

Inflationsrate

Nettoauslandsverschuldung in % des BIP

Quelle: Eurostat, Eigene Berechnungen

The higher the inflation rate (the lower the real interest rate), the higher the accumulated net debt position.

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-1500

-1000

-500

0

500

1000

1500

Jan. 98 Jan. 99 Jan. 00 Jan. 01 Jan. 02 Jan. 03 Jan. 04 Jan. 05 Jan. 06 Jan. 07 Jan. 08 Jan. 09 Jan. 10

Sum of Net International Debt Position of Spain, Greece, Ireland, Portugal

Sum of Net International Debt Position of Germany, Belgium, Luxembourg, Netherlands


International Net Debt Position of Eurozone Debtor and Creditor Countries

Bn. Euro



The rise of the net debt position of the high inflation countries went hand in hand with the rise of a net savings position of the low inflation counties.

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➤ Why did this process continue over a period of nearly 10 years?Why did this process continue over a period of nearly 10 years?

■ The above process can give rise to a The above process can give rise to a self-enforcing debt spiralself-enforcing debt spiral (positive feed-back loop) :(positive feed-back loop) :

◆ CreditsCredits flow from the flow from the low inflation countrylow inflation country to the to the high inflation high inflation countrycountry..

◆ In the In the high inflation countryhigh inflation country, these credits are used to buy goods. , these credits are used to buy goods. The demand for goods grows therefore over the supply of goods The demand for goods grows therefore over the supply of goods in the high inflation country.in the high inflation country.

◆ If the If the goodsgoods demandeddemanded in the high inflation country in the high inflation country are not are not tradabletradable (e.g. real estate or services), an (e.g. real estate or services), an excess demand for excess demand for goodsgoods produced in the high inflation country results. produced in the high inflation country results.

◆ This This excess demandexcess demand causes then causes then again inflationagain inflation!!

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◆ In the In the low inflation country,low inflation country, the credit flow to the high inflation the credit flow to the high inflation country causes a country causes a loss of purchasing powerloss of purchasing power. .

◆ If this loss of purchasing power is If this loss of purchasing power is not compensatednot compensated by an export by an export demanddemand from the high inflation country, from the high inflation country, excess supplyexcess supply results in results in the the low inflation countrylow inflation country..

◆ This This excess supplyexcess supply causes then again a causes then again a lower inflation ratelower inflation rate in the in the low inflation country.low inflation country.

■ Consequently, Consequently, if the goodsif the goods demanded for by the high inflation demanded for by the high inflation country country are not perfectly tradableare not perfectly tradable, the , the inflationary differences inflationary differences will prevailwill prevail!!

■ The following The following circular flow presentationcircular flow presentation displays this relationship displays this relationship graphically:graphically:

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➤ Self-enforcing debt-spiral:Self-enforcing debt-spiral:

High (low) inflation in HIC (LIC).

High (low) real interest rate in HIC

(LIC).

Indebtedness (Net savings) in

HIC (LIC).

Reduction of demand for

goods in LIC.


Demand for non-tradable goods in

HIC grows.

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➤ When will the debt spiral come to a standstill?When will the debt spiral come to a standstill?

■The The growing indebtednessgrowing indebtedness of the high inflation country of the high inflation country causes a causes a higherhigher credit default probabilitycredit default probability. .

■As soon as capital markets become aware of this, As soon as capital markets become aware of this, risk risk premiums in the interest rates start to growpremiums in the interest rates start to grow an cause an cause higher real interest rates for the high inflation country.higher real interest rates for the high inflation country.

■This sets an incentive for the high inflation country to This sets an incentive for the high inflation country to reduce its demand for debt.reduce its demand for debt.

■As the As the historical experiencehistorical experience shows, in needs some time shows, in needs some time before capital markets become aware of this.before capital markets become aware of this.


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➤ Consequently, the European debt crisis is Consequently, the European debt crisis is not a not a sovereign debt crisissovereign debt crisis, but a debt , but a debt crisis of the private crisis of the private sectorsector of the high inflation countries. of the high inflation countries.

➤ The following diagrams display this:The following diagrams display this:


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Je

0%

10%

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Jan. 99 Jan. 00 Jan. 01 Jan. 02 Jan. 03 Jan. 04 Jan. 05 Jan. 06 Jan. 07 Jan. 08 Jan. 09 Jan. 10

0%

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100%

Nettogesamtverschuldungsquote des Landes Schuldenstandsquote des Staates Reihe1

Spanien Verschuldungsquoten in Prozent des BIP und Entwicklung der Realzinsen

Prozent des BIP

Quelle: Eurostat, Europäische Zentralbank, Eigene Berechnungen

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-60%

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Nettogesamtverschuldungsquote des Landes Schuldenstandsquote des Staates Reihe1 Reihe6

Irland Verschuldungsquoten in Prozent des BIP

Prozent des BIP


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Nettogesamtverschuldungsquote des Landes Schuldenstandsquote des StaatesReihe1 Reihe2

Griechenland Verschuldungsquoten in Prozent des BIP und Entwicklung der Realzinsen

Prozent des BIP


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Nettogesamtverschuldungsquote des Landes Schuldenstandsquote des Staates Reihe1 Reihe6

Portugal Verschuldungsquoten in Prozent des BIP

Prozent des BIP


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➤ In the short runIn the short run: What measures are necessary to : What measures are necessary to overcome overcome the crisisthe crisis??■The Governments of indebted countries have overtaken the The Governments of indebted countries have overtaken the

bad debt losses of the commercial banks in their countries. bad debt losses of the commercial banks in their countries. This has caused an increase of the government indebtedness.This has caused an increase of the government indebtedness.◆ Debt restructuringDebt restructuring (=„haircut“=partial bankruptcy) => Problem: (=„haircut“=partial bankruptcy) => Problem:

Loss of receivables of creditor banks endangers stability of the Loss of receivables of creditor banks endangers stability of the financial sector („Lehman Brothers”-effect, “financial sector („Lehman Brothers”-effect, “Banking DominoBanking Domino”)”)

◆Macro economic restructuring by a „Macro economic restructuring by a „European Monetary FundEuropean Monetary Fund“ “ => Will countries like Greece, Portugal, Spain and Ireland be => Will countries like Greece, Portugal, Spain and Ireland be able to sustain this: violent protest rallies? general strikes? able to sustain this: violent protest rallies? general strikes? Political stability strong enough?Political stability strong enough?

◆Introduction of Introduction of Euro-BondsEuro-Bonds: A volume of 40% or 60% of their : A volume of 40% or 60% of their GDP can be financed with a uniformly issued “E-Bond”, whose GDP can be financed with a uniformly issued “E-Bond”, whose back payment is guaranteed by the EU. => Higher interest rate back payment is guaranteed by the EU. => Higher interest rate burden for Germany? Incentive for more government debt?burden for Germany? Incentive for more government debt?

The European Debt Crisis 2010The European Debt Crisis 20102. Ho to overcome the crisis2. Ho to overcome the crisis

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➤ In the long runIn the long run the ECU needs a the ECU needs a mechanismmechanism, which , which prevents debt spiralsprevents debt spirals. . ■Debt spirals are caused by inflation differences in a Debt spirals are caused by inflation differences in a

currency union. How can currency union. How can inflation differencesinflation differences be be preventedprevented??◆Macroeconomic coordinationMacroeconomic coordination of economic policy, „European of economic policy, „European

economic government“?economic government“?

◆Country-specific monetary policy Country-specific monetary policy of the ECB: Different main of the ECB: Different main refinancing rates for commercial banks (=banks in high refinancing rates for commercial banks (=banks in high inflation countries have to pay higher interest rateinflation countries have to pay higher interest rate to the to the ECB)?, ECB)?, different reserve requirementsdifferent reserve requirements (banks in high inflation (banks in high inflation countries have to pay higher reserve ratios)?, country-specific countries have to pay higher reserve ratios)?, country-specific taxation of credits by the ECB?taxation of credits by the ECB?

The European Debt Crisis 2010The European Debt Crisis 2010 2. Ho to overcome the crisis 2. Ho to overcome the crisis

© rainer maurer, pforzheim - 1 - prof. dr. rainer maure digression: the european debt crisis 2010

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