1. “Debt and Credit, Growth and Crises” Bank of Spain and the World Bank Madrid, Spain 19 June, 2012 1

2.  Greece, Ireland and Portugal likely have “unsustainable” sovereign debt levels  But not themselves of systemic importance  Conversely, large peripheral countries (debtors) and core banking systems (creditors) are systemic  And the two are “joined at the hip”  Implying possible non linear outcomes  And even the breakup of the euro zone 2

3.  In spite of German rhetoric, fiscal excess in small peripherals only a small part of the problem  But general fiscal indiscipline has increased exposure elsewhere and hinders a policy response  Private sector excesses, in response to financial convergence across the zone, were of critical importance  Leading to real divergences in an already “sub optimal” currency area 3

4.  Strongly held economic beliefs, some likely wrong, but already hard wired into European institutions  Different visions of Europe  Many different countries with no effective mechanism for resolving disputes  No ex ante mechanisms for either bailouts or exit  A “democratic deficit” that hinders leadership and promotes division  Leaving the impression that policy is always “behind the curve” 4

5.  Short term challenges: meeting contagion  Ring fence large peripheral sovereigns and core banks  Avoid “triggering events” until ring fencing is adequate  Long term challenges: reducing contagion  Fiscal and financial oversight must move to the centre  Structural reforms affecting growth and “competitiveness” 5

6.  ECB could buy sovereign paper in required quantities, but conflicts with perceived mandate  EFSF and ESM could also buy sovereign paper and/or recapitalize banks, but too small  Initially many schemes for leveraging the EFSF, but non-starter  G 20 could help but many constraints 6

7.  Work with G20 to minimize global shocks  Having mismanaged Greece, need to convince markets that  Greece is unique among small peripheral countries  Debt restructuring does not imply leaving the euro zone  Measures to ring fence are adequate  But restoring confidence remains a “horse race” 7

8.  A permanent “transfer union” is not politically possible  Going back to the original framework is also not possible; fundamentally flawed  Must build stronger European institutions  To allow euro zone bond issues  To curb excesses which threaten banking systems  To better manage future crises But confront “should, could and would” problems 8

9.  All countries would benefit from structural reforms to promote growth and deal with assymetric shocks  Debtor countries must focus on tradables  Creditor countries must focus on non tradables  All members must embrace the full implications of being in a monetary union  But again confront “should, could and would problems” 9

10.  An orderly outcome as confidence comes back on the basis of measures announced end June  A disorderly outcome with a widening crisis eventually prompting required policy action  A very disorderly outcome as the crisis widens without an adequate policy response  With serious implications for the future of the euro zone and the broader global economy 10