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Lessons from the European sovereign debt crisis
BIS CEMLA Roundtable “Fiscal policy, public debt management and government bond market: issues for central banks”Mexico City, November 2012
Jose Luis Escrivá
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Contents
The dynamics of the crisis
Are there lessons for Latin America?
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Dynamics of the crisis: a vicious circle compounded by lack of action and disordered measures
GR
1Failure of European fiscal rules
3
PT
ITSP
GR
Peripheralcountries Low potential
growth with rigid labour and product markets
IR
22
SPIRInappropriate
responses at national level in the absence of European-wide instruments
Shortcomings in the architecture of the existing monetary union
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Negative feedback loops intensified this vicious circle
GR
1
IR
22
SPIR
3
PT
ITSP
GR
Peripheralcountries
State aid
Public debt purchases
Lack of pan-European policies
Uncertainty
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GR
1
3
PT
ITSP
GR
Peripheralcountries
IR
22
SPIR
Negative feedback loops intensified this vicious circle
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Actions to break up these negative loops
GR
1
3
PT
ITSP
GR
Peripheralcountries
IR
22
SPIR
Reinforcement of the SGP (Six-Pack, Fiscal Compact).
European Commission “growthinitiative”
Troika programs
ESM.
First steps towards fiscal union and, potentially, Eurobonds.
Banking union.
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Are there lessons for Latin America?
Though a major lesson is that the roots and dynamics of the Latin America debt crises of the 80’s and 90´s can be extended to more developed economies …
…. And unfortunately Europe might have not sufficiently grasped the lessons from these previous crises …
…. The European debt crisis contains a number of interesting developments from which some lessons can be drawn.
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1. Overestimation of fiscal revenues
In economies experiencing long-lasting economic booms, windfall revenues associated to asset price bubbles and certain features of the growth model can be mistakenly taken as permanent.
How large are the windfall revenues in Latin America associated to protracted price commodity booms?
Maximum (year)
2011
Ireland 37.3(2006)
34.9
Spain 41.1(2007)
35.7
Fiscal revenuesIn percentage of GDP
Note: In spite of significant tax increases over this period.
Source: European Commission
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2. Risk of excessive reliance on structural deficit indicators
Real-time cyclically adjusted fiscal indicators can be misleading. They are not a substitute for a comprehensive examination of fiscal
vulnerabilities and broad and prospective analyses of the various factors impinging on fiscal positions.
Cyclically adjusted fiscal balance for 2007In percentage of GDP
…as estimated in 2008
… as estimated in 2012
Ireland 1.2 -1.5
Spain 2.0 -1.0
Source: European Commission’ estimates based on production functions.
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3. Loopholes in fiscal discipline frameworks
In the face of a severe crisis, weaknesses in rules for fiscal discipline tend to emerge. The robustness of the institutional frameworks can be overestimated.
Examples of vulnerability: regional /local governments, public enterprises, contingent liabilities associated to bank rescue programs, large pockets of informal economy…
Discretionary fiscal measures should be confined to some very few specific policies.
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4. Avoid losing market confidence
Market sentiment can change very rapidly shifting from short-sighted approaches to very acute forward-lookingness. Potential vulnerabilities and contingencies can be very highly weighed.
Against this background, transparency and clarity regarding the fiscal stance and the presentation of current and prospective policies are of paramount importance.
Rating agencies remain important
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5. Avoid overburdening fiscal policy
Countries without debt or deficit problems at the beginning of the crisis have complicated a great deal their budgetary positions by overburdening fiscal policies with multiple objectives: restoring financial stability and clearing up of ailing banks:
more private sector involvement should be considered. using of discretionary fiscal policies as a bad substitute
for structural reforms. excessive social protection against the inability to convey
the need for long-term fiscal sustainability of public finances.
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6. Some lessons for debt management
When frictions in the debt market arise, remaining in the primary market across the whole maturity spectrum may pay off.
Work in tandem with the market makers to mitigate illiquidity in domestic debt markets.
Exacerbation of home bias and market fragmentation could be very challenging. Active search for new investor bases can be rewarded.
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Lessons from the European sovereign debt crisis
BIS CEMLA Roundtable “Fiscal policy, public debt management and government bond market: issues for central banks”Mexico City, November 2012
Jose Luis Escrivá
