© 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

04

20

05

20

06

20

07

20

08

20

09

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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1

2

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10

0 1 2 3 4 5 6 7 8 9 10

0

1

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9

10

0 1 2 3 4 5 6 7 8 9 10

➤ 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

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9

10

0 1 2 3 4 5 6 7 8 9 10

0

1

2

3

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7

8

9

10

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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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Net International Debt Position in Percent of GDP Total Government Debt in Percent of GDP

SpainPercent of GDP

Source: Eurostat



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-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

140%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012


IrelandPercent of GDP

Source: Eurostat



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0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Net International Debt Position in Percent of GDP Total Government Debt in Percent of GDP

GreecePercent of GDP

Source: Eurostat



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-60%

-40%

-20%

0%

20%

40%

60%

80%

100%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012


GermanyPercent of GDP

Source: Eurostat

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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”)”)

◆Budget reorganization Budget reorganization with „with „ESM-creditsESM-credits“ => Will countries like “ => Will countries like Greece, Portugal, Spain and Ireland be able to sustain the Greece, Portugal, Spain and Ireland be able to sustain the consequences of austerity policies: violent protest rallies? consequences of austerity policies: violent protest rallies? general strikes? Political stability strong enough?general strikes? Political stability strong enough?

◆Up to know budget reorganization based on austerity policies Up to know budget reorganization based on austerity policies has has not been very successfulnot been very successful::

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

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0

50.000

100.000

150.000

200.000

250.000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012Total general government expenditure Total general government revenue GDP

GreeceMillion Euro

Source: Eurostat

4.2.6. Die Schuldenkrise der EWU 20104.2.6. Die Schuldenkrise der EWU 20104.2.6.1. Die Ursachen der Krise4.2.6.1. Die Ursachen der Krise


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20.000

40.000

60.000

80.000

100.000

120.000

140.000

160.000

180.000

200.000


PortugalMillion Euro

Source: Eurostat



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200.000

400.000

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800.000

1.000.000

1.200.000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Total general government expenditure Total general government revenue GDP

SpainMillion Euro

Source: Eurostat



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20.000

40.000

60.000

80.000

100.000

120.000

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180.000

200.000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Total general government expenditure Total general government revenue GDP

IrelandMillion Euro

Source: Eurostat



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500.000

1.000.000

1.500.000

2.000.000

2.500.000

3.000.000


GermanyMillion Euro

Source: Eurostat



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➤ Current situationCurrent situation::■As a result total government debt levels have become even As a result total government debt levels have become even

larger and unemployment rates have reached levels that can larger and unemployment rates have reached levels that can threaten political stability:threaten political stability:

4.2.6. Die Schuldenkrise der EWU 20104.2.6. Die Schuldenkrise der EWU 20104.2.6.2. Auswege aus der Krise4.2.6.2. Auswege aus der Krise

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0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0

50.000

100.000

150.000

200.000

250.000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012GDP Total Government Debt Unemployment Rate (right scale)

PortugalMillion Euro

Source: Eurostat



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0%

5%

10%

15%

20%

25%

30%

0

200.000

400.000

600.000

800.000

1.000.000

1.200.000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

GDP Total Government Debt Unemployment Rate (right scale)

SpainMillion Euro

Source: Eurostat



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0%

2%

4%

6%

8%

10%

12%

14%

16%

0

50.000

100.000

150.000

200.000

250.000

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

GDP Total Government Debt Unemployment Rate (right scale)

IrelandMillion Euro

Source: Eurostat

Percent of Labor Force

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20%

25%

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0

50.000

100.000

150.000

200.000

250.000

300.000

350.000

400.000


GreeceMillion Euro

Source: Eurostat



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0%

2%

4%

6%

8%

10%

12%

0

500.000

1.000.000

1.500.000

2.000.000

2.500.000

3.000.000


GermanyMillion Euro

Source: Eurostat

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➤ Current situationCurrent situation::■3 Years have 3 Years have passed by now, since the beginning of the crisispassed by now, since the beginning of the crisis

■Neither the ESM (European Stability Mechanism =„European Neither the ESM (European Stability Mechanism =„European Rescue Fund“) nor the „Fiscal Compact“ had been able to Rescue Fund“) nor the „Fiscal Compact“ had been able to calm the markets.calm the markets.

■Risk premiums Risk premiums for government bonds crisis country kept on for government bonds crisis country kept on growing until summer 2012 (see next diagram).growing until summer 2012 (see next diagram).

■Then, the president of the European Central Bank, Mario Then, the president of the European Central Bank, Mario DraghiDraghi, was able to trigger a turnaround of markets when he , was able to trigger a turnaround of markets when he declared “Within our mandate, declared “Within our mandate, the ECB is ready to do the ECB is ready to do whatever it takes to preserve the eurowhatever it takes to preserve the euro. And believe me, it will . And believe me, it will be enough (…)”be enough (…)”


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02468

101214161820222426283032

2010M01D04 2010M06D21 2010M12D06 2011M05D23 2011M11D07 2012M04D23 2012M10D08 2013M03D25

Irland Griechenland Spanien Italien Portugal Frankreich

Prozent

Zinsdifferenzen 10-jähriger Staatsanleihen im Vergleich zu Deutschland

Quelle: EUROSTAT, Zinssätze des "Maastricht-Kriteriums"2013M06D14

Irland unter EFSF:

28.11.10

Gründung des EFSF &

Beginn der Griechenland-

hilfen:09.05.10

Portugal unter EFSF:

07.04.11

EZB LTRO: 21.12.11 & 29.02.12

Bernanke Congress

Rede:22.05.13

Draghi "Whatever it takes.." 27.06.12

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➤ Current situationCurrent situation::■Currently, financial markets expect a turn of monetary policy in Currently, financial markets expect a turn of monetary policy in

the USA.the USA.

■As a result, market interest rates for bonds are growing and As a result, market interest rates for bonds are growing and with them risk premiums (see diagram).with them risk premiums (see diagram).

■As it seems, As it seems, the situation could soon get critical again the situation could soon get critical again for the for the European crisis countries.European crisis countries.


Documents

© RAINER MAURER, Pforzheim - 1 - Prof. Dr. Rainer Maure Digression: The European Debt Crisis 2010