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Adjustment Difficulties and Debt Overhangs in the Eurozone Periphery

  • Gros, Daniel
  • Alcidi, Cinzia

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.

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Paper provided by Centre for European Policy Studies in its series CEPS Papers with number 5525.

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Length: 27 pages
Date of creation: May 2011
Date of revision:
Handle: RePEc:eps:cepswp:5525
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  1. Giavazzi, Francesco & Pagano, Marco, 1995. "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," CEPR Discussion Papers 1284, C.E.P.R. Discussion Papers.
  2. Francesco Giavazzi & Marco Pagano, 1990. "Can Severe Fiscal Contractions Be Expansionary? Tales of Two Small European Countries," NBER Chapters, in: NBER Macroeconomics Annual 1990, Volume 5, pages 75-122 National Bureau of Economic Research, Inc.
  3. Giavazzi, Francesco & Jappelli, Tullio & Pagano, Marco, 2000. "Searching for non-linear effects of fiscal policy: Evidence from industrial and developing countries," European Economic Review, Elsevier, vol. 44(7), pages 1259-1289, June.
  4. Udaibir S. Das & Michael G. Papaioannou & Christoph Trebesch, 2010. "Sovereign Default Risk and Private Sector Access to Capital in Emerging Markets," IMF Working Papers 10/10, International Monetary Fund.
  5. Carlo Cottarelli & Paolo Mauro & Lorenzo Forni & Jan Gottschalk, 2010. "Default in Today's Advanced Economies; Unnecessary, Undesirable, and Unlikely," IMF Staff Position Notes 2010/12, International Monetary Fund.
  6. Daniel Gros & Cinzia Alcidi, 2011. "euro zone crisis 2010," The New Palgrave Dictionary of Economics, Palgrave Macmillan.
  7. Daniel Gros & Cinzia Alcidi, 2009. "Why Europe will suffer more," Intereconomics: Review of European Economic Policy, Springer, vol. 44(4), pages 255-260, July.
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