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

- 1 - Prof. Dr. Rainer Maure

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- 1 -Prof. Dr. Rainer Maurer

Digression:Digression: The Eurozone Debt Crisis 2010 The Eurozone Debt Crisis 2010


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Digression:Digression: The Eurozone Debt Crisis 2010 The Eurozone Debt Crisis 2010


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➤ The The ReturnReturn of the of the Interest Rate SpreadsInterest Rate Spreads::

■ After the foundation of the European Monetary Union (EMU) After the foundation of the European Monetary Union (EMU) interest rates spreads between the member states nearly interest rates spreads between the member states nearly disappeareddisappeared..

■ By the end of the year 2008, interest rate spreads By the end of the year 2008, interest rate spreads reappearedreappeared..

■ For some countries interest rate spreads have become For some countries interest rate spreads have become largelarge::

The Eurozone Debt Crisis 2010The Eurozone Debt Crisis 2010


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Jan. 99 Jan. 00 Jan. 01 Jan. 02 Jan. 03 Jan. 04 Jan. 05 Jan. 06 Jan. 07 Jan. 08 Jan. 09 Jan. 10

10Y Government Bond Interest Rate Germany (left scale) Interest Spread compared to Germany (left scale)

Spain Interest Rate Spread

Source: Eurostat, Central Bank of Spain, Own Calculations© www.rainer-maurer.com

Interest Rate

2,0%



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Ireland Interest Rate Spread

Source: Eurostat, Own Calculations © www.rainer-maurer.com

Interest Rate

2,5%



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1%

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Portugal Interest Rate Spread

Source: Eurostat, Central Bank of Portugal, Own Calculations© www.rainer-maurer.com

Interest Rate

3,4%



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1%

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9%

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Greece Interest Rate Spread

Source: Eurostat, Own Calculations© www.rainer-maurer.com

Interest Rate

6,9%



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➤ What caused the crisis?What caused the crisis?

■ IncreasingIncreasing public and private public and private debt debt positions positions

....have casted doubt on the ability of ....have casted doubt on the ability of governments and banks governments and banks safeguarded by governments safeguarded by governments to pay back debt.to pay back debt.

■ Investors Investors fear of a default of governments on theirfear of a default of governments on their debt and debt and

....demand therefore a ....demand therefore a higher risk premiumshigher risk premiums..



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Total Country Int. Net Debt Position GDP Ratio Total Government Debt GDP-to-Ratio

Spain Interest Rate Spread and Debt-to-GDP Ratios

Source: Eurostat, Central Bank of Spain, Own Calculations © www.rainer-maurer.com

Interest Rate Debt-to-GDP



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80%



Ireland Interest Rate Spread and Debt-to-GDP Ratios





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Portugal Interest Rate Spread and Debt-to-GDP Ratios

Source: Eurostat, Central Bank of Portugal, Own Calculations © www.rainer-maurer.com


0%

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Portugal Interest Rate Spread and Debt-to-GDP Ratios

Source: Eurostat, Central Bank of Portugal, Own Calculations © www.rainer-maurer.com




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Greece Interest Rate Spread and Debt-to-GDP Ratios





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➤ The situation is The situation is even worseeven worse than these figures suggest! than these figures suggest!

■ The The changechange of a country's total of a country's total debt positiondebt position is the is the negativenegative current account surpluscurrent account surplus..

■ We can calculate the We can calculate the current account surpluscurrent account surplus which is which is necessary to necessary to stabilizestabilize the current international the current international debt-to-GDPdebt-to-GDP ratio with the following formula (for a derivation see the ratio with the following formula (for a derivation see the digression):digression):


Y

D

Yi

Y

B dtdY

GDP

International Net Debt

Position of the Country

GDP Growth

Interest RatePrimary Current

Account Balance

EX-IM-i*D


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➤ ApplyingApplying this formula to the this formula to the datadata of the countries shows that of the countries shows that their actual account surplus is their actual account surplus is far away from the surplusfar away from the surplus necessary necessary to keepto keep their their debt-to-GDPdebt-to-GDP ratio ratio constantconstant::



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-15%

-10%

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0%

5%

10%

15%


-15%

-10%

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0%

5%

10%

15%

Constant Intern. Net Debt-to-GDP Ratio Current Account Surplus (right scale)Actual Current Account Surplus

Spain Current Account Surplus Gap


Percent of GDP

Current account surplus necessary to stabilize the International Debt-to-GDP ratio is 7,5% of GDP.


Acutal current account surplus - 5,5% of GDP!

=> Current account surplus gap = 13 % of GDP!


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-15%

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Constant International Net Debt-to-GDP Ratio Current Account SurplusActual Current Account Surplus

Portugal Current Account Surplus Gap


Percent of GDP

Current account surplus gap = 18,5 % of GDP!


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-15%

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Ireland Current Account Surplus Gap


Percent of GDP

Current account surplus gap = 15 % of GDP!


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-15%

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10%

15%


Greece Current Account Surplus Gap


Percent of GDP

Current account surplus gap = 25 % of GDP!


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Austria

Belgium

Cyprus

Germany

Spain

FinlandFrance

Greece

Ireland

Italy

Luxembourg

Malta

Netherlands

Portugal

Slovenia

Slovakia

United Kingdom

3,0%

3,5%

4,0%

4,5%

5,0%

5,5%

6,0%

-15% -10% -5% 0% 5% 10% 15% 20%

Constant IDP-to-GDP Ratio Current Account Surplus Gap

Correlation Coefficient: 70,1%


Interest Rates (Average: Sept. 2009 - May 2010) and Constant International Debt Position-to-GDP Ratio Primary Current Account Gap (Average: Jan. 2009 - Aug. 2009)

Nominal Interest Rates 10Y Bonds

The larger the current account

gap, the higher the risk premium!



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➤ The situation is The situation is precariousprecarious!!

➤ How to get out of this???How to get out of this???

➤ To help countries like Greece, Portugal, Spain and Ireland To help countries like Greece, Portugal, Spain and Ireland their " their " Current Account Gap" Current Account Gap" must be must be reducedreduced::

Depressed EMU


t

t

t

t

t

dtdY

tt

to

Y

B

Y

D

Yi

Y

B

Y

B t


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➤ Special problem of Special problem of indebted countriesindebted countries, which are , which are member member states of a monetary unionstates of a monetary union::

1.1. They have They have no own currencyno own currency they can they can depreciatedepreciate to improve to improve their current account:their current account:

2.2. They have They have no own currencyno own currency to to inflate away debtinflate away debt!!

↓↓e$€

=> P€ e$€ => ( EX – IM )↓↓ ↓↓↑ ↑< P$

Reduction of current account gap!



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- 27 -Prof. Dr. Rainer Maurer

Digression: How to "inflate away" government debt ???

The present value (=PVt,T=market value) of government debt with a face value of 1€ is given by the formula:

If the market interest rate it,T=2% is equal to fixed interest rate of government debt zt,T =2%, the market value is equal to the face value = 1€:

If an increase of inflation by 3% increases the nominal market interest rate (=real interest rate + inflation rate) by 3% and the average maturity of government debt is T=10 years, the market value of government debt falls by nearly one quarter:

TT,tT,t

TT

T,tT,t )i1(

1

i

z

)i1(

11PV

1)%21(

1

%2

%2

)%21(

11PV

TT,tT,t

TT

T,tT,t

The Dark Corners of

Fiscal Policy

77,0)%51(

1

%5

%2

)%51(

11PV

10T,tT,t

T10

T,tT,t

Create a little bit inflation and buy

back your debt !


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➤ Special problem of Special problem of member states of a monetary unionmember states of a monetary union::

3.3. Leaving the monetary union will cause the countries debt Leaving the monetary union will cause the countries debt position to position to explodeexplode !!! !!!

◆ If Greece would leave the eurozone:If Greece would leave the eurozone:

Its new currency (the Neodrachmae) will depreciate against Its new currency (the Neodrachmae) will depreciate against the Euro: the Euro: ee€€

NeodramaeNeodramae

However, Greek government bonds (as well as private debt) However, Greek government bonds (as well as private debt) are are denominateddenominated in in EuroEuro DD€ € !!

The Greek debt measuredThe Greek debt measured in Neodramae in Neodramae will grow in case of will grow in case of a depreciation:a depreciation:

DDNeodramaeNeodramae = D = D€ € / e/ e€€NeodramaeNeodramae

↓↓

↓↓

↓↓ ↓↓( )



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➤ HowHow has it come to this? has it come to this?

■ The EMU is a monetary union across countries which have The EMU is a monetary union across countries which have asynchronous business cyclesasynchronous business cycles::

-8%-7%-6%-5%-4%-3%-2%-1%0%1%2%3%4%5%6%7%8%

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-0,020

-0,015

-0,010

-0,005

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0,020

Germany (left scale)USA (left scale)Standard Deviation without Cyprus, Malta, Slovenia, Slovakia, USA (right scale)

GDP Gaps of ECU Member States and the USA(Trend Deviation of GDP in Percent of Trend measured by Hodrick-Prescott-Filter)

Source: Eurostat, Own www.rainer-maurer.com

GDP Gap = Actual GDP minus trend GDP in % of trend GDP



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■ As a result, As a result, inflation ratesinflation rates across the EMU member state are across the EMU member state are typically quite typically quite differentdifferent::


100%

105%

110%

115%

120%

125%

130%

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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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■ The The European Central BankEuropean Central Bank can set only can set only one main refinancing one main refinancing raterate..

■ Therefore, after the start of the EMU, Therefore, after the start of the EMU, nominal interest ratesnominal interest rates across the eurozone across the eurozone convergedconverged..

■ However, However, convergence of nominal interest rateconvergence of nominal interest rate and different and different country-specific interest rates causes a country-specific interest rates causes a divergencedivergence of real of real interest ratesinterest rates!!

=> Countries with a => Countries with a high inflationhigh inflation rate have rate have low real interestlow real interest rates! rates!

Countries with a Countries with a low inflationlow inflation rate have rate have high real interesthigh real interest rates! rates!

InflationInterestNominalInterestReal

i r



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■ Convergence of nominal interest rate & divergence of real Convergence of nominal interest rate & divergence of real interest rates:interest rates:


-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



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■ Real interest rates compared to Germany:Real interest rates compared to Germany:


-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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■ Real interestReal interest rates and net international debt position: rates and net international debt position:


Portugal

Netherlands

Italy

Ireland

Greece

France

Finland

Spain

GermanyBelgium

Austria

-40%

-20%

0%

20%

40%

60%

80%

100%

120%

1,3% 1,5% 1,7% 1,9% 2,1% 2,3% 2,5% 2,7%

December 2009 Accumulated Net Debt Position in Percent of GDP and Average Real Interest Rate from Januar 1999 to December 2009

Real Interest Rate

Quelle: Eurostat, Eigene Berechnungen© www.rainer-maurer.com

Net Debt Position in % of GDPin % of GDP


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■ InflationInflation rates and net international debt position: rates and net international debt position:


Portugal

Netherlands

Italy

Ireland

Greece

FranceFinland

Spain

GermanyBelgium

Austria

-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%

December 2009 Accumulated Net Debt Position in Percent of GDP and Average HCPI Price Index from Januar 1999 to December 2009

Inflation Rate

Net Debt Position in % of GDPin % of GDP

Quelle: Eurostat, Eigene Berechnungen© www.rainer-maurer.com


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10

0 1 2 3 4 5 6 7 8 9 10

0

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10

0 1 2 3 4 5 6 7 8 9 10


■ Consequently, high inflation countries experienced on average Consequently, high inflation countries experienced on average lower real interest rates than low inflation countries:lower real interest rates than low inflation countries:


Low inflation country: rL*= i*- πL

Excess Supply

S(Y)

I(Y)S, I

r

rL*

High inflation country: rH*= i*- πH

Excess Demand

S(Y)

I(Y)

r

rH*

S, I

The integrated EMU capital market is in equilibrium, while there is a disequilibrium in single countries!

r*


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➤ HowHow has it come to this? has it come to this?■ Countries with Countries with high inflationhigh inflation rates built up a net international rates built up a net international

debt positiondebt position..■ Countries with Countries with low inflationlow inflation rates built up a net international rates built up a net international

wealth positionwealth position..


-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


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■ Consequently, the eurozone debt crisis is Consequently, the eurozone debt crisis is not by chancenot by chance!!

■ It is caused by a It is caused by a design faulty of the EMUdesign faulty of the EMU!!

■ What can be done to built a What can be done to built a more stable EMUmore stable EMU??

4.2. Financial Market Crises4.2. Financial Market Crises 4.2.5. The Eurozone Debt Crisis 2010 4.2.5. The Eurozone Debt Crisis 2010

Documents

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