Euro Update (19): Bruegel on Banking and Sovereign Debt

I’ve decided to take a break, but as if to taunt me it seems people have decided to write more interesting things… More on that break later.

For now I’d like to bring your attention to a group of articles concerning European woes. This started as a single article, but if you look at my activity in the last 36 hours you can see that I’m on a furious race to publish. This article concerns the latest studies about the banking and sovereign debt dynamics of the Euro-zone.

VoxEU is always a fantastic source of cutting edge economic research, and a good way to come accross the latest insights from the discipline about current events. In that spirit, Bruegel wrote a little summary piece of their article on solutions to the sovereign debt crisis. It doesn’t so much provide a solution into the debt crisis, but it provides enormous insights into the banking and the sovereign debt situations of the peripheral countries. They also provide some simulations of the levels of fiscal adjustment necessary for stabilisation under four scenarios. This information is summarised in the two tables below, which I have taken the liberty to copy paste from the article.

Table 1 doesn’t require much description. As we know, the biggest sovereign debtor is Greece, ireland and Spain are the biggest banking problem and apparently 10% of all sovereign debt of the PIIGs is parked at the ECB.The only comment I would add is that the data has not yet been made available to the general public, so its difficult to study their methodology, a comment which also applies to table 2. It’s a normal thing with these articles, but I’ll try to lookout for that.

Regarding table 2, he “three policies” that they consider are the ones they believe to be under consideration by the EU and are listed a: “1)a lowering of the interest rate on all official EU loans, 2)maturity extensions on EU and IMF loans, and 3)the repurchase by the European Financial Stability Facility (EFSF) of all sovereign bonds held by the ECB at market value and the retrocession of the corresponding haircut to the issuing country”. The “market reaction” corresponds to “a drop of 100 basis points in market yields, which can be broadly interpreted as an increase in market confidence.”
Note that according to their simulations, the situation would improve immensely if the EU was to take action. This is an imperative!

They do mention some solutions but to me those contributions are certainly secondary to the above information. They list three steps in the direction of sustainable reform and solution of the Euro-zone sovereign debt crisis: “1)cleaning up the banks, 2)reducing the public debt in Greece, the only Eurozone country which has likely become insolvent” and 3) fostering adjustment and growth in peripheral countries. Now I like all of these ideas, but I have to admit that whereas the first two are possible to be direct and effectively affected by government policy, the later is much slower and uncertain. It kind of goes back to my comment on the ability of governments to control the economy and the fact that the discourse does not match the reality. There are some things that can be done, like productive private investment targeted policy. I have to admit I like their idea of using earmarked EU structural funds for the periphery to sustain such a development and growth strategy (even though I’m not sure that that’s actually legally feasible). However it is not clear what that path would be, although it would certainly require a change in the status quo of those countries, where the largest chunk of “investment” has gone for construction (housing and highways), turning them into “mortar economies”. Lowering wages is ok for this generation of workers, who are not very productive, so that you make them artificially productive by making them cheaper. But this hurts them and needs to be explained and campaigned for well to ensure the coherent implementation of these policies. However, for real sustainable development and growth, economies such as these require a lot of human capital, given that they lack natural resources (thanks god… Portugal and Spain already had a resource rich boom in the 16th and 17th centuries and that didn’t really prove to be a sustainable success). The problem is that when you look at the latest data from the OECD (Check table I.A, page 15) or from the EU (play around with the data, particularly the GERD bit, see where the PIGS are in relation to the rest. It’s not horrible, unless you are Greece, but it should be much better.), these countries aren’t exactly rushing to the final line. It takes a lot more effort than it sounds. At least a decade if not two. And that assumes that their education systems improve…

Notwithstanding my disbelief that countries can efficiently plan growth paths, the other ideas are indeed good. In relation to that, I would like to highlight the Commission’s recent calls for reform of the rescue packages to Greece and Ireland, very much in light with the proposals of this article. Moreover, and more so than I had thought, it seems as though the pieces are falling in nicely for that to take place, according to this article from the IrishTimes. It’s also interesting to see the different party families (EPP and PES) getting together, articulating a common strategy and message. I wonder where that’ll go…