Philip R. Lane
 Pre-Crisis Risk Factors
 The Financial Crisis and the Sovereign
Debt Crisis
 Prospects for Post-Crisis Reduction in
Sovereign Debt
 Capacity of Euro-member countries to withstand
financial shocks known to be a challenge
 Through 90’s and mid 2000’s public debt didn’t appear
to be a looming problem.
 With the creation of the Euro, 60% ceiling on
debt/GDP ratio established, along with maximum of a
3% deficit/GDP ratio
 Some countries that would get into fiscal crisis looked
healthy around 2007
 Low spread on sovereign debt showed markets didn’t
expect default risk
 Good growth performance masked the vulnerabilities
 Financial imbalances and external imbalances posed
risks
 Credit boom during the 2003-2007 period
 Ultimately, national governments failed to tighten
fiscal policy during the period of growth from 20032007
 Global financial crisis of late 2008 had asymmetric
effects across the euro zone.
 Even with financial crisis, euro area sovereign debt
markets remained calm through most of 2009
 In late 2009, sovereign debt crisis emerges
 Ireland and Spain had larger-than-expected increases in
deficit/GDP ratios
 Most shocking new came from Greece, with 2009
budget deficit of 12.7 percent of GDP
 Bailouts established under which three-year funding
would be provided if certain conditions met
 Scale of funding far exceeded IMF lending levels, so
EU was the major provider
 Several issues arose in the funding:
 Plausible time scale was longer than three-year term
 Fiscal targets not conditional on state of Euro zone
 Original bailouts included standard IMF penalty
 Increased volatility in debt markets leads to self-
fulfilling speculative attacks
 Many European countries will have elevated public
debt ratios
 Even if current austerity measure are sufficient to
stabilize debt ratios, the challenge will be reduction to
safer levels
 Growth in nominal GDP will likely be slow
 Maintaining political environment will be difficult
 New Fiscal Compact Treaty set to go in effect in 2013
with two primary principles
 High public debt levels pose a threat to stability
 Fiscal balance should be close to zero “over the cycle”
 Reformed system allows for cyclical effects and
stronger enforcement of the 60% ceiling
 Primary source of fiscal discipline will be at the
national level
 More extensive reforms possible in the future
 Origin and propagation of the European sovereign
debt crisis can be attributed to the flawed design of
the euro
 Positive perspective is that the debt crisis will
implement reforms to save the monetary union
 Alternative scenario could result in the “mother of all
financial crises”