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European Sovereign Debt Crisis – Which path to follow next?

 

With the outburst of the 2008 crisis, also came along the problem of the European countries sovereign debt. Countries like Portugal, Greece or Spain rapidly increased their debt-to GDP ratio and started to have bigger and bigger deficits (following a Keynesian policy), as a way to respond to the beginning of the crisis, but the real problem for those countries arrived by 2010. By that time, creditors started to doubt about the possibilities of those countries repaying their debts. As a consequence, yields on their sovereign debts started to increase, making impossible for some of the European countries to continue paying their debts, especially the “periphery” ones. Confidence was decreasing day by day!

So as sovereign debt bonds interest rates were increasing rapidly, the situation became unsustainable. Countries like Portugal or Greece asked for international help so that they could have enough funds, not only for them to use in their home country but also to pay to their creditors. But with such help also came very harsh austerity measures in order to regain fiscal consolidation and to give them the possibility of returning to the international markets as soon as possible. But the question here is: are these heavy austerity measures the real solution for the European countries?

In the beginning of the euro zone crisis the main response was austerity. The huge debts of these countries (both private and public) needed to be contained with credible austere fiscal and monetary policies adding to the creation of structural measures. These measures were especially regarding the long-run future.

As we already know, such responses also had their negative consequences. Economic growth in euro zone started to decrease abruptly and unemployment reached to record levels in some of these countries. We can see that although the main priority should be containing debt, measures that restore economic growth and create job opportunities should also be taken into account. So we should not only be concerned with the economy’s long-run but also create measures regarding the short-run.

There is no general consensus about which way to follow but a mix of both visions should be considered, an opinion also defended by the IMF manager director Christine Lagarde; “On the Fund’s part, we are favorably considering that this be done in as timely and flexible a manner as possible: slowing the pace of fiscal adjustment where needed; focusing on measures rather than targets; and, above all, keeping the emphasis not just on austerity, but also on growth as we believe that the two can be reconciled and should not be mutually exclusive.”

Independently of the path policy makers choose, we know that the next few years will be long and painful but nevertheless long-run and short-run stability must always be on our minds so that such events like the ones happening nowadays don’t repeat again.

 

Renato Poirier

 

 

 

References:

http://www.imf.org/external/np/speeches/2012/092412.htm

 

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Author: studentnovasbe

Master student in Nova Sbe

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