1. 1 The Systemic Character of the Sovereign Debt Crisis: Policy Implications and Governance Issues Argentino Pessoa CEF.UP, Faculdade de Economia do Porto, Portugal Email: apessoa@fep.up.pt

2. 2 The Euro Area Debt Crisis: structural mechanisms Single currency Exchange risk Interest rate Foreign borrowing Saving rate 2008 crisis Automatic stabilizers Sovereign debt

3. 3 The Euro Area Debt Crisis: the beginning Current account deficits Budget deficit Heavy borrowing TrustDebt yields Concerns over fiscal sustainability Political factors

4. 4 How do increase competitiveness? Competitiveness Currency devaluation Internal devaluation deflationary policies Economic growth Automatic stabilizers Budget deficit Financial markets Interest rate

5. 5 The need for fiscal discipline and the coordination failure Single currencySingle fiscal structure National fiscal rules Coordination SGP EDP Debt ? Current account ???

6. 6 The Euro zone’s vulnerability Budget deficit Interest rates on gov. bonds Economic growth Banking crisis Other member countries RecessionLiquidity stopsSolvency crisis Credit reduction Fear of default

7. 7 Systemic nature of the crisis Implications: –Financial markets can force member states into default; –The fear of default in a member makes more fragile the banking system of the other members. Two problems: –Coordination failure; –Negative externalities (contagion)

8. 8 Optimal solution Coordination failure Externalities (contagion) Collective action Internalisation Central bank: ECB (limitless intervention in the market) Gov. budget: budgetary union (issue debt)

9. 9 “Second best” New institutions: EFSF ESMEMF Drawbacks: Collective action clauses Level of interest rates Amount of funds/leverage

10. 10 Economic growth 63 Italy 1.62 0.17 Spain 1.08 - 0.41 Source: WDI (2011) Note: * only 1991-2000. Growth rate of GDP per person employed (constant 1990 PPP $)

11. 11 Disequilibria inside Euro zone Surplus countries Peripheral countries Lower interest rates consumption supply of funds Higher risk premia Demand for funds Spending Export-led growth Austerity ? ?

12. 12 The solvency condition With the current level of interest rates and without growth prospects all the austerity will be vain

13. 13 Thank you very much Argentino Pessoa CEF.UP, Faculdade de Economia do Porto, Portugal Email: apessoa@fep.up.pt