1. The European Sovereign Debt Crisis
Philip R. Lane

2. Overview Pre-Crisis Risk Factors
The Financial Crisis and the Sovereign Debt Crisis
Prospects for Post-Crisis Reduction in Sovereign Debt

3. Pre-Crisis Risk Factors
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

5. Pre-Crisis Factors
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

7. Pre-Crisis Factors
Financial imbalances and external imbalances posed risks
Credit boom during the period
Ultimately, national governments failed to tighten fiscal policy during the period of growth from

8. The Financial Crisis and the Sovereign Debt Crisis
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 budget deficit of 12.7 percent of GDP

10. The Financial Crisis and the Sovereign Debt Crisis
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

11. Prospects for Post-Crisis Reduction in Sovereign Debt
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

12. Prospects for Post-Crisis Reduction in Sovereign Debt
New Fiscal Compact Treaty set to go in effect in 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

13. Conclusion
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”

14. Questions?