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The debt challenge in Europe

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  • Alan Ahearne
  • Guntram B. Wolff

Abstract

The euro area faces a double challenge - debt overhang and the need for price adjustment. This paper reviews the debt challenges in the household and corporate sectors and maps out some policy options. In particular, we document the increase in private debt prior to the crisis and consider how the corporate and household sectors have adjusted their balance sheets during the crisis. We examine previous experiences with corporate and household deleveraging and draw lessons for policymakers. We show how the macroeconomic effects of balance-sheet adjustments have been in part offset by the use of fiscal deficits, and we discuss the resulting challenges. A key lesson is the importance of maintaining economic growth and avoiding a prolonged doubledip recession in the euro area while facilitating necessary deleveraging in some over-indebted sectors and countries. We also emphasise the need for a growth strategy tailored to southern Europe.

Suggested Citation

  • Alan Ahearne & Guntram B. Wolff, 2012. "The debt challenge in Europe," Working Papers 686, Bruegel.
  • Handle: RePEc:bre:wpaper:686
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    References listed on IDEAS

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    1. Backus, David K & Kehoe, Patrick J & Kydland, Finn E, 1994. "Dynamics of the Trade Balance and the Terms of Trade: The J-Curve?," American Economic Review, American Economic Association, vol. 84(1), pages 84-103, March.
    2. David Backus & Patrick Kehoe & Finn Kydland, 1992. "Dynamics of the trade balance and the terms of trade: the J-curve revisited," Discussion Paper / Institute for Empirical Macroeconomics 65, Federal Reserve Bank of Minneapolis.
    3. Kok, Christoffer & Rossi, Carlotta & Marqués-Ibáñez, David, 2009. "Modelling loans to non-financial corporations in the euro area," Working Paper Series 989, European Central Bank.
    4. Castrén, Olli & Kavonius, Ilja Kristian, 2009. "Balance Sheet Interlinkages and Macro-Financial Risk Analysis in the Euro Area," Working Paper Series 1124, European Central Bank.
    5. Zsolt Darvas & Jean Pisani-Ferry, 2011. "Europe's growth emergency," Policy Contributions 623, Bruegel.
    6. Stephen Cecchetti & Madhusudan Mohanty & Fabrizio Zampolli, 2011. "The real effects of debt," BIS Working Papers 352, Bank for International Settlements.
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    Cited by:

    1. Zsolt Darvas, 2012. "The euro crisis: ten roots, but fewer solutions," Policy Contributions 755, Bruegel.

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