Adjustment Difficulties and debt overhangs in the Eurozone periphery. CEPS Working Document No. 347, May 2011

Gros, Daniel. and Alcidi, Cinzia. (2011) Adjustment Difficulties and debt overhangs in the Eurozone periphery. CEPS Working Document No. 347, May 2011. [Working Paper]

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Abstract

This paper describes four key drivers behind the adjustment difficulties in the periphery of the eurozone: • The adjustment will be particularly difficult for Greece and Portugal, as two relatively closed economies with low savings rates. Both of these countries combine high external debt levels with low growth rates, which suggest they are facing a solvency problem. In both countries fiscal adjustment is a necessary condition for overall sustainability, but it not sufficient by itself. A sharp cut in domestic consumption (or an unrealistically large jump in exports) is required to quickly establish external sustainability. An internal devaluation (a cut in nominal wages in the private sector) is unavoidable in the longer run. Without such this adjustment in the private sector, even continuing large-scale provision of official funding will not stave off default. • Ireland’s problems are different. They stem from the exceptionally large losses in the Irish banks, which were taken on by the national government, leading to an explosion of government debt. However, the Irish sovereign should be solvent because the country has little net foreign debt. • Spain faces a similar problem as Ireland, although its foreign debt is somewhat higher but its construction bubble has been less extreme. The government should thus also be solvent, although further losses in the banking system seem unavoidable. • Italy seems to have a better starting position on almost on all accounts. But its domestic savings rate has deteriorated substantially over the last decade.

Available Versions of this Item

• Adjustment Difficulties in the GIPSY Club. CEPS Working Document No. 326, March 2010. (deposited 13 Aug 2010)
  • Adjustment Difficulties and debt overhangs in the Eurozone periphery. CEPS Working Document No. 347, May 2011. (deposited 05 May 2011 17:11)[Currently Displayed]

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