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the Eurozone crisis, bury the debt forever
6 August 2013
The Eurozone’s debt crisis
is getting worse despite appearances to the contrary. How can we end it? This
column presents five major options for reducing crisis countries’ debt. Looking
into the details, it seems the only option that is both realistic and effective
is for countries to default by selling monetised debt to the ECB. Moral hazard
aside, burying the debt seems to be the only way we can end the crisis.
gauge the Eurozone debt crisis
This leaves us with a
coarser measure – the evolution of public debts – as a ratio to GDP. Spreads
were clearly better indicators before OMT. There are plenty of problems with
In most countries the
unfunded liabilities – which include the potential costs of bailing out banks
when and if they fail – are vastly bigger than the public assets that can be
- Gross debts are gross, i.e. they ignore
- Gross debts ignore unfunded public
liabilities such as pensions and healthcare.
Noting that Eurozone growth
seems to have slipped into a go-slow phase, the GDP denominator is likely to
grow slower than it did in the 1990s.
The three points taken
together suggest that debt-to-GDP ratios of the 2010s paint a more optimistic
picture of sustainability than the same levels in the 1990s.
Be that as it may, Figure 1
displays the public debt to GDP ratio for the Eurozone as a whole, along with
the highest and lowest member country ratios (ignoring the two special cases of
Estonia and Luxembourg).
- GDP is a static measure of the ability to
pay; GDP growth also matters.3
If public debt seemed
likely to be unsustainable in 2008, the likelihood is even higher now.
Strikingly, this holds even for Greece,
in spite of the restructuring of its public debt in 2011, which was large
enough to bankrupt the Cypriot banking system. Put differently, not only the
initial problem has not been solved, it has also been made worse.
There can be no surprise
here. Budget stabilisation cannot work during a recession as was pointed out at
the outset of crisis (Giavazzi 2010, Wyplosz 2010).
Figure 1. Debt to GDP ratios in the Eurozone
Source: AMECO-on-line, European
- Even including optimistic forecasts for
2013, the figure can only confirm that the situation is getting worse.
As often when numbers
become too big for governments, the central bank emerges as the lender of last
resort. De Grauwe (2011) has made the crucial observation that the fundamental
reason why the debt crisis has been circumscribed to the Eurozone is that the
markets did not believe that the ECB was ready to backstop public debts.
The success of the ECB’s
OMT programme so far, in spite of its conditional nature, shows the role that a
central bank can play when it moves in the direction of accepting its role as a
lender of last resort. But stabilising spreads is merely a temporary stopgap.
The legacy of crippling and threatening public debts remains to be dealt with.
This is why debt monetisation
emerges as another solution.5 But a mere purchase of bonds by the ECB will
not work for two reasons:
These payments would go
into the ECB’s profits to be paid back to its shareholders, i.e. to all member
countries. As shown by De Grauwe and Ji (2013), this would be a transfer “in
the wrong direction” from the country being “helped” to the “helping”
countries. The only relief to a country would be through its own share of
- First, each country must pay interest on
its bonds, including those held by the central bank.
All in all, the relief is
bound to be very limited.6
- Second, when the debt matures, the country
will have to pay back the principal.
ECB could deal with the debt
For debt monetisation to
allow for relief, the debt must be somehow eliminated once it has been acquired
by the ECB.
One way of achieving this goal is as follows:
The loan will remain
indefinitely as an asset on the book of the ECB but, in effect, it will never
be paid back (unless the ECB is liquidated).
The counterpart of this
operation will appear on the liability side of the ECB’s balance sheet as a
€100 increase in the monetary base. This is the cost of the debt monetisation.
Debt monetisation has a bad
reputation, which is justified by the fact that it has often led in the past to
Under current conditions,
this is most unlikely to be inflationary. Given the icy state of credit
markets, increases in the money base do not translate into increases of the
actual money supply; in effect, the money multiplier is about zero.
In addition, high
unemployment has created a deflationary environment. But, hopefully, the credit
market will be revived one day and the recession will come to an end. At this
stage, the money base will have to be shrunk. This is the exit problem (Wyplosz
2013). An alternative is to raise reserve requirements to reduce the size of
the money multiplier. Either way, the balance sheet expansion need not lead to
One solution is for the ECB
to sterilise its entire bond buying under this programme by issuing its own
debt instruments, leaving the size of the money base unchanged. This can be
done at the time of bond purchases or later, when exit will be undertaken.
Of course, the ECB will
have to pay interest on its debt instruments, which will reduce profits and
seigniorage to all member countries, both the defaulting ones and the others.
This transfer ‘in the right direction’ is the way all member countries will
share the loss inherent to debt restructuring.7
As always, we have to
accept the tyranny of numbers. Today’s balance sheet of the ECB amounts to
€2430 billion. The big bang example examined above would add €1200 billion, an
increase of 50%. This is huge, but not unprecedented. In July 2007, the ECB
balance sheet was €1190 billion – half of what it is today.
- First, the ECB buys bonds of a country,
say for a value of €100.
- Second, it exchanges these bonds against a
perpetual, interest-free loan of €100.
At the end of the day,
except for Option 1, which is the classic virtuous approach, and Option 2, the
disposable of public assets, none of the other options is appealing.
But if Options 1 and 2 are
impossible, one has to choose among bad options.
Option 3 is clearly the
least desirable because it would shake the markets and possibly take down large
segments of the banking system. Option 4 is not just politically explosive; it
could trigger a debt crisis among the countries currently perceived as healthy.
This leaves us with Option 5.
Of course, defaulting
through the ECB is merely a fig leaf to hide the cost of debt restructuring. In
addition to spreading the impact over the long run, it has the advantage that
the non-virtuous countries will share the costs in the form of reduced profit
transfers from the ECB over the long run.
cancellation entails a huge moral hazard that needs to be dealt with. Here it
bears to emphasise that bringing the crisis to an end requires two conceptually
This calls for the adoption
of a rock-solid fiscal discipline framework. Solutions other than the
ineffective Stability and Growth Pact exist, but this is not the topic of this
article. The ECB must require that this be done, and done well, before stepping
into the quagmire.
Topics: EU institutions, Macroeconomic policy
- One is dealing with the legacy of
unsustainable debts, which is what the options presented here do (note
that it is proposed to deal with the debt stock legacy, not to finance
on-going deficits. A once-for-all action is far less dangerous than a
permanent moral hazard).
- The other is to make sure that it will
never happen again.
Tags: Debt crisis, debt monetisation, Eurozone crisis
CEO and Founding partner,
Banque Pâris Bertrand Sturdza
Professor of International
Economics, Graduate Institute, Geneva;
Director, International Centre for Money and Banking Studies; CEPR Research
Labels: 6 DE AGOSTO 2013, CRISIS DE DEUDA DE LA EUROZONA, MONETIZACION, PARIS Y WYPLOSZ