Managing risks in european

Managing Risks in the European Periphery Debt Crisis


Also by George Christodoulakis
The Analytics of Risk Model Validation (edited with Stephen Satchell)


Managing Risks in the
European Periphery Debt
Crisis
Lessons from the Trade-Off between
Economics, Politics and the Financial Markets
Edited by

George Christodoulakis


Editorial matter and selection © George Christodoulakis 2015
Remaining chapters © Respective authors 2015
Softcover reprint of the hardcover 1st edition 2015 ISBN 978-1-137-30494-0

All rights reserved. No reproduction, copy or transmission of this
publication may be made without written permission.
No portion of this publication may be reproduced, copied or transmitted
save with written permission or in accordance with the provisions of the
Copyright, Designs and Patents Act 1988, or under the terms of any licence
permitting limited copying issued by the Copyright Licensing Agency,
Saffron House, 6-10 Kirby Street, London EC1N 8TS.
Any person who does any unauthorized act in relation to this publication
may be liable to criminal prosecution and civil claims for damages.

The authors have asserted their rights to be identified as the authors of this work
in accordance with the Copyright, Designs and Patents Act 1988.
First published 2015 by
PALGRAVE MACMILLAN
Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited,
registered in England, company number 785998, of Houndmills, Basingstoke,
Hampshire RG21 6XS.
Palgrave Macmillan in the US is a division of St Martin’s Press LLC,
175 Fifth Avenue, New York, NY 10010.
Palgrave Macmillan is the global academic imprint of the above companies
and has companies and representatives throughout the world.
Palgrave® and Macmillan® are registered trademarks in the United States,
the United Kingdom, Europe and other countries
ISBN 978-1-349-45463-1

ISBN 978-1-137-30495-7 (eBook)

DOI 10.1057/9781137304957

This book is printed on paper suitable for recycling and made from fully
managed and sustained forest sources. Logging, pulping and manufacturing
processes are expected to conform to the environmental regulations of the
country of origin.
A catalogue record for this book is available from the British Library.
A catalog record for this book is available from the Library of Congress.


In the memory of my parents Aristotle and Georgia Christodoulakis, who
taught me about qualities versus quantities

This page intentionally left blank


Contents

List of Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix
List of Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xii
Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xiii
Notes on Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xvii
Part I: Genesis of the Crisis, Use and Abuse of Economic Policies
1

The Genesis of the Eurozone Sovereign Debt Crisis . . . . . . . . . . . . . . . . . . . . . . 3
Philippe d’Arvisenet

2

The Trade-Off between Fiscal and Competitiveness Adjustments . . . . . . . . . 38
Daniel Gros with Cinzia Alcidi

3

Ireland and Greece: A Tale of Two Fiscal Adjustments. . . . . . . . . . . . . . . . . . . 55
Jeffrey D. Anderson and Jessica Stallings

4

Rating Agencies vs. Sovereign Debt Markets: A Tale of Interacting Risk
Preferences. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

George Christodoulakis

5

The 2012 Greek Debt Restructuring and its Aftermath . . . . . . . . . . . . . . . . . . 87
Miranda Xafa

6

Economic Theories that Influenced the Judges of Karlsruhe . . . . . . . . . . . . . 101
Paul De Grauwe

7

Privatization of State Assets in the Presence of Crisis . . . . . . . . . . . . . . . . . . . 108
George Christodoulakis

Part II: Crisis Resolution, Prospect and Retrospect
8

How to Manage Public Debts in the Euro Area? . . . . . . . . . . . . . . . . . . . . . . . 127
Catherine Mathieu and Henri Sterdyniak

9

Fiscal Risk Sharing and Stabilization in the EMU . . . . . . . . . . . . . . . . . . . . . . 148
Kerstin Bernoth and Philipp Engler

10

Sovereign Debt and its Restructuring Framework in the Eurozone . . . . . . . 163
Ashoka Mody

11

Funding Risks for Corporates in the Periphery: Disintermediation to
the Rescue for the Larger Ones, Challenges for the Others . . . . . . . . . . . . . . 198
vii


viii

12
13

Contents

Blaise Ganguin
On Solving Europe’s Financial Issues to Promote Sustainable Growth. . . . . 212
Adrian Blundell-Wignall and Caroline Roulet
European Banking Union as a Response to the
Fragmentation of the Internal Market Resulting from the
Financial and Sovereign Debt Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237
Dimitris Tsibanoulis with Gerry Kounadis
Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .273


List of Figures
1.1
1.2

1.3
1.4
1.5
1.6
1.7
1.8
1.9
1.10
1.11
1.12
1.13
1.14
1.15
1.16
1.17
1.18
1.19
1.20
1.21
1.22
2.1
2.2
2.3
2.4
3.1
3.2
3.3
3.4
3.5
3.6

3.7
3.8

Exchange rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Exports of G & S, volume (index Q1/1991 = 100) . . . . . . . . . . . . . . . . . . . . . 4
Real three-month interbank rates, % . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Financial conditions in Germany . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Eurozone: credit to non financial corporate. . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Eurozone: credit to households . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Debt of the private sector as % of GDP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Domestic demand volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Goods and services balance, % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Structural budget balance as % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Ten-year government bond yield, % . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Real interest rate and external imbalances . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Current account balance as % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Eurozone: five-year CDS by sector (basis points) . . . . . . . . . . . . . . . . . . . . . 15
Eurozone trade (as % of total trade) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Eurozone: real growth dispersion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Eurozone: core inflation dispersion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Eurozone: output gap correlation among eurozone countries
(eight-year rolling sample) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Structural budget balance as % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Current account balance as % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Exports of goods and services in volume, index qi/2000=100 . . . . . . . . . . 29
Nominal unit labour cost, country vs Germany (index 2005=100) . . . . . . 29
Government debt as % of GDP: sovereign debt ratios not yet
under control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40
ECB competitiveness indicator, unit labour cost, index, 1999Q1=100 . . . 41
GDP deflator, change between 1999 and 2012

(price index, 1999Q1=100). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Italy: selected governance indicators. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
Read GDP level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
Ten-year government bond spreads vs. German bund. . . . . . . . . . . . . . . . . 56
Unemployment rate. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
Inward FDI, 2000–11. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Employment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59
Fixed capital formation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
Relative unit labour costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
Export volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61

ix


x

3.9
3.10
4.1
4.2
4.3
5.1
5.2
5.3
5.4
5.5
5.6
5.7
5.8
7.1

8.1
9.1
9.2
9.3
9.4

List of Figures

Greece: output gap. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62
Ireland: output gap. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62
Ten-year European periphery bond yield. . . . . . . . . . . . . . . . . . . . . . . . .80
Five-year implied probability to default for Greece . . . . . . . . . . . . . . . .82
Evolution of relative market and CRA pessimism 2008–11 . . . . . . . . .84
PIGS: general government gross debt (% GDP) . . . . . . . . . . . . . . . . . . .88
PIGS: real GDP, 1999=100 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88
PIGS: investment ratios, 2007–14 (% GDP) . . . . . . . . . . . . . . . . . . . . . .89
PIGS: general government deficit (% GDP). . . . . . . . . . . . . . . . . . . . . . .91
Spreads over ten-year German bond yield (bps). . . . . . . . . . . . . . . . . . .91
Distribution of PSI losses on €198bn of accepted bids (€bn) . . . . . . . .93
Outcome of debt buyback targeting €62bn of new GGBs (€bn) . . . . . .96
Greece: breakdown of public debt by creditor, 2013 (€bn) . . . . . . . . . .96
Privatization activity in the EU – 15 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110
Ten-year government interest rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .128
Output gaps “German bloc” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .154
Output gaps “French bloc” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .155
Output gaps France, Germany and Eurozone average . . . . . . . . . . . . . .155
Standard deviations of output gaps and GDP: all eurozone
countries but “big four” . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .156
9.5
Standard deviations of output gaps and GDP: the “big four”

economies (GER, F, I, ES). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .156
10.1
Trends in public debt ratios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170
10.2(a) Household debt/income ratios: eurozone vs USA . . . . . . . . . . . . . . . . .172
10.2(b) Corporate debt/GDP ratios: eurozone countries and USA . . . . . . . . . .173
10.3
Sovereign bond market reactions to policy announcements
(cumulative abnormal change (basis points)) . . . . . . . . . . . . . . . . . . . . .185
11.1
Funding mix by country . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .199
11.2
Loans to euro area non-financial corporates . . . . . . . . . . . . . . . . . . . . . .200
11.3
Sales growth GIPS vs Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .200
11.4
Profitability – GIPS vs Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .201
11.5
Interest coverage – GIPS vs Europe. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .201
11.6
Cash balance – GIPS vs Europe. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .202
11.7
European default rate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .203
11.8
National insolvency statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .203
11.9
Average % of debt sourced from seven categories of debt for
European non-financial firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .205
11.10
Capital expenditures/sales (%). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .205
11.11

US and European non-investment grade issuance . . . . . . . . . . . . . . . . .207
11.12
New speculative grade ratings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .207
11.13
Disintermediation potential 2014–16 . . . . . . . . . . . . . . . . . . . . . . . . . . . .208
11.14 Funding preferences and investors’ appetite. . . . . . . . . . . . . . . . . . . . . . . .209


List of Figures

12.1
12.2
12.3
12.4
12.5
12.6
12.7
12.8
12.9
12.10
12.11

xi

Inflation and deflation risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .216
Unemployment rates across Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .217
Central Bank QE, Europe lagging . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .218
Core Tier 1 capital versus IFRS assets of banks by country . . . . . . . . . . .219
Distance to default: US and European bank comparisons . . . . . . . . . . . .221
Bank versus sovereign CDS spreads . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .223

Spreads before and after monetary union. . . . . . . . . . . . . . . . . . . . . . . . . .225
Bank lending and the prime rate spread to cash and sovereign bonds. .226
Policy problems in Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .231
UK and Ireland currency union 1820–1920. . . . . . . . . . . . . . . . . . . . . . . .233
Unemployment 15–24-year olds in Europe . . . . . . . . . . . . . . . . . . . . . . . .234


List of Tables
1.1
1.2
2.1
2.2
2.3
2.4
2.5
2.6
2.7
3.1
3.2
3.3
7.1
7.2
7.3
7.4
7.5
8.1
8.2
8.3
8.4
8.5

9.1
10.1
10.2
12.1
12.2
12.3
12.4

xii

Correlations between supply disturbances . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Size and speed of adjustment following supply shocks . . . . . . . . . . . . . . . . . 18
Competitiveness-adjusted debt-to-GDP ratios
(reference year 1999 for equilibrium price level) vis-à-vis EA-11 . . . . . . . .44
Competitiveness-adjusted debt-to-GDP ratios
(reference year 1995 for the equilibrium level) vis-à-vis EA-12 . . . . . . . . . .44
Competitiveness-adjusted debt-to-GDP ratios
(reference year 1999 for equilibrium price level) vis-à-vis Germany. . . . . .46
Interest rate–growth rate differential (government debt),
selected countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46
Interest rate–growth rate differential for the non-financial sector,
selected countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47
Average size of firms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48
A continuing squeeze on the non-financial sector? . . . . . . . . . . . . . . . . . . . .49
General government developments, 2007–15: Ireland and Greece . . . . . . .66
Relative effects of fiscal consolidation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67
Fiscal consolidation measures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67
Banks, credit institutions, gambling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
Transport . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
Telecoms, energy, water . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116

Defence, exhibitions, other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116
Real estate, state rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117
Public debts in 2007 and 2013, as % of GDP . . . . . . . . . . . . . . . . . . . . . . . . . 127
Public debt stability in 2007 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130
Government balances in 2012 % of GDP. . . . . . . . . . . . . . . . . . . . . . . . . . . . 132
Ten-year government interest rates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133
Net position in the Target 2 system. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
Correlations of output gaps within eurozone . . . . . . . . . . . . . . . . . . . . . . . . 154
Fiscal solvency estimates: all advanced economies, 1995–2013 . . . . . . . . . 174
Fiscal solvency: how the euro area responded to the Great Recession . . . 174
Alternative policies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214
Bank exposures by country to the sovereign debt of eight countries. . . . . 225
Cross-border exposures of banks: millions of US dollars, 2013 Q3 . . . . . . 228
Sovereign, household and corporate debt: % GDP averages . . . . . . . . . . . . 231


Preface
The origin of the European Periphery Debt Crisis is rooted primarily in the structural
characteristics of the European Union (EU) member state economies, trading-off
a number of European and international economic, regulatory, institutional and
political factors as well as the financial markets. The emergence and evolution of
the crisis can now be assessed both in prospect and in retrospect, learning lessons
on what policy measures could have been designed and introduced in order to
avoid or at least manage the crisis more efficiently and what policy measures could
potentially minimize the risk of future crises.
In late 2009 I was given the opportunity of participating in the government of Greece
as a secretary of state and chief executive for asset restructuring and privatization,
a role I kept until early 2012, thus spanning both the George Papandreou and the
Lucas Papademos governments. The escalation of the crisis quickly turned this role
into a lifetime experience, triggering reflections on the plethora of factors involved,

analysing problems and synthesizing solutions. In the presence of a prolonged
crisis and extensive contagion and spillover effects, I was motivated to edit a book
that I hoped would contribute to its diagnosis and provide an analysis from a risk
management point of view of the available policy options, both prospectively
and retrospectively. The group of contributors I have assembled comprises senior
policy makers, regulators, active policy advisors, bankers, and decision makers in
the markets, drawing experience from the peripheral EU member states, the EU
itself and other Western economies. The book is intended to be a practical reference
source for all those involved in the decision-making process in banking, the financial
markets, investment, business, policy making and regulation.
Part I ‘Genesis of the Crisis, Use and Abuse of Economic Policies’, occupies
Chapters 1–7, while Part II, ‘Crisis Resolution, Prospect and Retrospect’, occupies
Chapters 8–13.
Chapter 1, by Philippe D’Arvisenet, contributes an analysis on the genesis of the
crisis and its association with the divergent structural characteristics of member
state economies, institutional inadequacies and concurrent market conditions. It is
argued that the EU policy steps that have been taken are insufficient and asymmetric;
deficit countries have been invited to adjust but surplus countries have not, showing
up the lack of cooperation. Although the possibility for mutualization of liabilities,
subject to conditions, could partially address the debt issue, stability would also
require a mechanism to help smooth the effects of the business cycle, thus raising
political trade-offs among member states.
In Chapter 2 Daniel Gros and Cinzia Alcidi argue that the EU authorities have
failed to recognize the trade-off between these two recommendations for indebted

xiii


xiv

Preface

countries, since internal devaluation would improve competitiveness, but that
lowering nominal GDP growth would also worsen the debt-to-GDP ratio. Therefore
one should look at the value of the debt-to-GDP ratio only after competiveness
adjustments.
Chapter 3, by Jeff Anderson with Jessica Stallings, contributes a comparative study
of the different fiscal adjustments of Ireland and Greece. The authors show how fiscal
consolidation helped Ireland succeed in triggering the growth needed to restore
debt sustainability, while at the same time the far more severe adjustment required
of Greece has had a severe negative effect on its GDP, thus further undermining
its creditworthiness. It is argued that applying the Irish example in Greece would
require some additional funding, but the final cost would be much less than might
eventually be needed in the case of continuing output fall.
In Chapter 4 George Christodoulakis presents a discussion on the role of rating
agencies’ and sovereign debt markets’ risk preferences for the evolution of credit
spreads in the five EU periphery crisis countries. It discusses the propagation
mechanisms of market attitudes towards sovereign risk, and describes how attitudes
to risk evolve during a period of crisis. It is shown that a ranking of the relative
optimism and pessimism is present, revealing different preference asymmetries for
countries of Hellenic, Latin and Celtic origin, with the striking result that although
the interaction between credit default swap and bond markets played a primary role
in the escalation of conservatism for all countries, this was overshot by the credit
rating agencies’ risk preferences in the case of Greece in particular.
Chapter 5, by Miranda Xafa, contributes to the ongoing debate on the trade-off
between the need to ensure debt sustainability upfront, versus the risks of contagion
and euro area bank insolvency. The author concludes that although the restructuring
was effective in achieving considerable debt relief, the subsequent underperformance
of Greece’s adjustment programme thwarted this result. Moreover, Greece’s
enormous financing needs and worse-than-expected growth path put the possibility

of improved debt sustainability at risk as a result of an earlier restructuring.
In Chapter 6 Paul De Grauwe presents a discussion on the attitude of Germany
towards the European Central Bank’s Outright Monetary Transactions (OMT)
programme in the sovereign bond markets. While the German constitutional court
has declared the OMT programme illegal according to EU law, De Grauwe argues
that this ruling is based on economic theories such as the efficient market theory and
the central bank positive equity theory, and explains why that should be rejected.
In Chapter 7 George Christodoulakis reviews the importance of state asset
management, restructuring and privatizations for the control of government deficit,
national debt and economic efficiency. It presents a discussion on the trade-offs
between economic rationality and the politics underpinning various European
privatization plans, especially those imposed on countries receiving Troika
funding. It is shown why Greece constitutes a genuine special case, in which the
interconnection between economic events and European and national politics led


Preface

xv

to massive underperformance. The chapter concludes with international evidence
on the performance of privatization asset classes.
Part II commences with Chapter 8 by Catherine Mathieu and Henri Sterdyniak,
who contribute an analysis of two main issues. The first concerns the sustainability
of high debt levels in developed countries and whether these countries should aim
for pre-crisis public debt levels. The second question concerns the re-establishment
of public debt homogeneity within the euro area member states in the presence of
a single monetary policy and autonomous fiscal policies. The authors contribute a
comparative discussion on alternative options for euro area governance as well as
public debt governance.

Chapter 9, by Kerstin Bernoth and Philipp Engler, contributes an elaboration
on policy options for the stability of the European Monetary Union (EMU).
In the absence of monetary and exchange rate policies as stabilization tools, the
authors propose a system of compensatory payments between the member states,
and identify the degree of fiscal sovereignty that needs to be surrendered as a
requirement. Higher compensatory payments could be a more effective stabilization
tool but require less fiscal sovereignty; therefore the optimal balance between the
two is left as a challenge for political debate.
In Chapter 10 Ashoka Mody argues that in the presence of fixed exchange rates
the eurozone needs flexibility through a system of orderly debt restructuring, by
recognizing debt as an equity-like residual claim on the sovereign, which could
become operational by automatically lowering the nominal debt when it crosses an
agreed level. Moreover, the author argues for the implications of this framework for
private deleveraging as well as its role in stability.
Chapter 11, by Blaise Ganguin, focuses on the implications of the European
periphery crisis on corporate financing. He discusses empirical evidence showing
that rated corporates enjoy more diversified funding sources than unrated ones,
and lower funding costs even in stress periods, signifying that information
asymmetries between the companies and the creditors are costly since the
creditors pay attention to rating assessments. Moreover, while corporate financing
in Europe is still bank-based, there is a recent trend in Greece, Italy, Spain and
Portugal where corporations are seeking ratings, thus raising expectations for
the development of corporate bond markets in Europe. However, family-owned
businesses and SMEs are shown to be reluctant in sharing information outside the
traditional banking relationship.
Chapter 12, by Adrian Blundell-Wignall and Caroline Roulet, provides a
comparative analysis and assessment of the main policy proposals that have been
made in Europe in the light of key economic constraints. The authors provide
justification and support for a mix of policies focusing on growth and structural
changes, thus giving a chance for Europe to resolve its problems without risking

the euro. In the presence of the euro, the authors argue that Europe should choose
between either the costly path of monetizing its debts and adopting exchange rate


xvi

Preface

management as a growth strategy, or a fiscal union which would trigger political
trade-offs on sovereignty.
In Chapter 13 Dimitris Tsibanoulis and Gerry Kounadis identify a number of
institutional loopholes in the EU legislation which, in the presence of the sovereign
debt crisis, played a role in the fragmentation of the single market for banking
services. Moreover, the chapter contributes an analysis of the European Banking
Union and its remedial implications for the institutional gaps in EU law and the
enhancement of the supervisory process, as well as a discussion of the single bank
resolution regime as a necessary step towards the restoration of the single market.
The book constitutes a collective effort, providing analysis and understanding of
how to manage the European Periphery Debt Crisis and the associated risks from
both a prospective and a retrospective point of view. The evolving nature of the
crisis and the institutional and structural complexities of the EU and member state
economies make such an effort difficult, but hopefully this book has contributed to
the advancement of our knowledge. I would like to thank all the authors for their
excellent work and expert insights.
George Christodoulakis


Notes on Contributors
Cinzia Alcidi is Head of the Economic Policy Unit at the Centre for European Policy
Studies (CEPS) in Brussels and a research fellow at the LUISS School of European

Political Economy . Prior to joining CEPS in 2009, she worked at the International
Labour Office in Geneva, and taught International Economics at University of
Perugia. Since her arrival at CEPS she has worked extensively on the macroeconomic and financial aspects of crisis in Europe as well as on the policy response to
it. During this process she has acquired a deep knowledge of the functioning of the
European Union, and the EMU in particular; she has written and lectured widely
on these topics. She participates regularly in international conferences. Her research
interests include international economics, macroeconomics, central banking and
EU governance. She holds a PhD in International Economics from the Graduate
Institute of International and Development Studies, Geneva.
Jeffrey Anderson has been with the Institute of International Finance (IIF) since
1984. He is Senior Director for European Affairs, focusing on key issues arising from
the eurozone crisis, including implications for banks and impediments to financing
for small businesses in Europe. He was Director of the Institute’s European Department from 1992 to 2012, where he followed the economic progress of central and
Eastern Europe, as well as Russia and Turkey, and led the expansion of the Institute’s
country coverage to the eurozone periphery. Before that, he was Director of the
Comparative Country Analysis Department and Senior Economist in the Institute’s
Asia Department. Prior to joining the Institute, he was part of the World Economic
Service at Wharton Econometric Forecasting Associates. He received an MA in
International Studies from the Johns Hopkins University School for Advanced
International Studies in 1983.
Kerstin Bernoth is Professor of Economics at the Hertie School of Governance, and
Deputy Head of the Macroeconomics Department at the German economic think
tank DIW Berlin. She holds a PhD from the University of Bonn, and worked from
2004 to 2009 as a researcher in the economic policy and research department of the
Central Bank of the Netherlands. Her research interests include empirical finance,
monetary and fiscal policy, and financial stability. Her articles have appeared in the
Journal of Banking and Finance and Journal of International Money and Finance.
Adrian Blundell-Wignall is the Special Advisor to the Secretary-General on Financial Markets and Deputy Director in the Directorate for Financial and Enterprise
Affairs (DAF) at the OECD, effective from 14 February 2007. He is founder and
chairman of a charitable foundation (the Anika Foundation) that raises and invests

xvii


xviii

Notes on Contributors

an endowment fund to provide scholarships in a critical area of healthcare. An
Australian citizen, he obtained his PhD in Economics from Cambridge University.
He is the author of numerous publications on financial markets and monetary
policy in journals and books, as well as broker analyst studies and reports. Senior
positions held in the past include Director and Head of Equity Strategy Research at
Citigroup (Australia, Ltd), Executive Vice-President and Head of Asset Allocation
at BT Funds Management, Head of Derivative Overlays and Levered Products at
Bankers Trust Funds Management, building a new $4 billion business, and Head
of the Research Department at the Reserve Bank of Australia, directing a department and participating in monetary policy discussions at the internal pre-Board
meetings. Early in his career he held economist positions in: the OECD Economics
Department, the Reserve Bank of Australia and the Economic Planning Advisory
Council of Australia.
George Christodoulakis is Associate Professor of Finance at Manchester Business
School, University of Manchester, an active financial advisor and entrepreneur
internationally, and a member of the Hellenic Corporate Governance Council. He
served as the Secretary of State and Chief Executive for Asset Restructuring and
Privatizations of Greece between 2009 and 2012. He was formerly employed as
an Advisor to the Governor of the Bank of Greece, an academic at Cass Business
School, the University of Exeter, as well as an advisor in the international financial
sector. Dr Christodoulakis holds a PhD from the University of London. His research
expertise concentrates on quantitative finance, credit and market risk, which has
applied in the market, to risk management, asset management and pricing, asset

privatization and restructuring transactions, forecasting, systemic financial stability
and regulation. Dr Christodoulakis is frequently invited as a speaker at international
professional conferences, expert panels and media. He has published extensive
research work in leading international refereed journals and books. He co-edited
the book The Analytics of Risk Model Validation and is Associate Editor of the Journal
of Risk Model Validation.
Philippe D’Arvisenet is currently an adviser to BNP Paribas. From 1974 to 1977 he
was a research fellow at Lille Catholic University, where he also taught econometrics.
From 1978 to 1982 he was with the French planning unit (Commissariat au Plan)
in charge of incomes policy. He then joined the banking sector, was appointed chief
economist of BNP in 1994 and of BNP Paribas in 2000. He has been an associate
professor at Panthéon-Assas University since 1996 (economy and finance), and is a
member of the Commission Economique de la Nation chaired by the Minister of
Finance. He is the author of nine books, including Finance Internationale (2nd ed,
2008), and Les Politiques Monétaires dans la Tempête (2014).
Paul De Grauwe is John Paulson Professor at the London School of Economics. He
was a member of the Belgian parliament from 1991 to 2003. He is an honorary doctor
of the University of Sankt Gallen (Switzerland), the University of Turku (Finland),
the University of Genoa and the University of Valencia. He was a visiting professor


Notes on Contributors

xix

at various universities: Paris, Amsterdam, Berlin, Kiel, Milan, Pennsylvania and
Michigan. He obtained his PhD from the Johns Hopkins University in 1974. He
is a research fellow at the Centre for European Policy Studies in Brussels and Area
Director “Macro, Money and Finance” at CESifo in Munich. His research interests
are in the economics of monetary unions and behavioural macroeconomics. Books

include The Economics of Monetary Union (9th ed. 2012) and Lectures on Behavioral
Macroeconomics (2012).
Philipp Engler is Junior-Professor of Economics at Freie Universität Berlin and
he joined the University of Hamburg during summer 2014. He holds a PhD from
Freie Universität. His research interests include monetary and fiscal policy, financial
stability and European integration. Philipp Engler has published several articles in
highly ranked international journals such as the Review of International Economics.
Blaise Ganguin is Head of Standard & Poor’s Corporate and Infrastructure Ratings
in EMEA, and Managing Director. He coordinates a group of 170 analysts spanning
ten offices, and over 1500 credit opinions on corporate and infrastructure issuers,
and is part of the European Executive Committee. Blaise joined Standard & Poor’s
in 1994 as a corporate analyst in Toronto, Canada, and previously worked in banking with UBS in Geneva, New York and Toronto. He is the co-author, with John J.
Bilardello, of Fundamentals of Corporate Credit Analysis (2005). He holds an MBA
from the University of Toronto, Canada; a post-graduate degree in International
Development and Cooperation from the University of Ottawa, Canada; and an MA
in History and International Affairs from the University of Lausanne, Switzerland.
Daniel Gros has been Director of the Centre for European Policy Studies (CEPS)
since 2000. He holds a PhD in economics from the University of Chicago. In the
past, Daniel worked at the IMF, collaborated with the European Commission as
economic adviser to the Delors Committee that developed plans for the EMU, and
taught at several leading European universities. He has been member of high-level
advisory bodies to the French and Belgian governments, and has provided advice to
numerous central banks and governments, including Greece, the UK and the US, at
the highest political level. Daniel is currently an adviser to the European Parliament
and a member of the Advisory Scientific Council (ASC) to the European Systemic
Risk Board (ESRB). He has published extensively on international monetary affairs
in scientific journals, is the author of several books and is the editor of Economie
Internationale and International Finance. He contributes a globally syndicated
column on European economic issues to Project Syndicate.
Gerry Kounadis started his studies at Athens Law School in 2004 and successfully

completed (cum laude) a Master of Laws (LLM) in Finance at the Institute for Law and
Finance (ILF) of Goethe University Frankfurt with a first class LLM thesis (“Evolving
International and European Regulatory Regimes for Netting in Financial Transactions”). Gerry has also recently graduated from the ICMA Centre of University of
Reading, where he completed a MSc in Capital Markets, Regulation and Compliance


xx

Notes on Contributors

with a research project titled “OTC Derivatives Regulatory Reform: Current Topics in
Central Counterparty Clearing”. He is currently studying for the Qualified Lawyers
Transfer Scheme, with a view to qualifying as a solicitor in England and Wales. From
a professional standpoint, he has spent more than four years as a legal and compliance
trainee, trainee lawyer and lawyer (Athens Bar) working for major banking institutions
across Europe, including the European Central Bank and Lloyds Banking Group. He
is currently employed in Tsibanoulis & Partners, one of the largest Greek law firms, as
an associate (Banking and Finance, Capital Markets).
Catherine Mathieu is a senior economist in the Analysis and Forecasting Department of the OFCE (Observatoire français des conjonctures économiques). Her
main research areas are the European monetary union, macroeconomic policies,
policy-mix, and macroeconomic forecasting. She is a member of the AIECE
(Association of European Conjuncture Institutes) steering committee and Chair
of the Working Group on Longer Term Prospects and Structural Changes. She is
currently President of the EUROFRAME group of research institutes. Catherine
Mathieu co-edited with Henri Sterdyniak “Towards a better governance in the EU?”,
papers of the 10th EUROFRAME Conference, in the Revue de l’OFCE / Debates
and Policies 132 (2014); “The euro area in crisis”, papers of the 9th EUROFRAME
Conference, in the Revue de l’OFCE / Debates and Policies 127 (2013). She and
Henri Sterdyniak co-authored “Redemption?” in Revue de l’OFCE 132 (2014), “Do
we need fiscal rules?” in From crisis to growth? The challenge of debt and imbalances

(2012). “EU public finances in the crisis” in Stabilising an unequal economy? Public
debt, financial regulation, and income distribution (2011).
Ashoka Mody is Charles and Marie Robertson Visiting Professor in International
Economic Policy at the Woodrow Wilson School, Princeton University, and a
non-resident senior fellow at the Bruegel think tank in Brussels. Previously, he was
Deputy Director in the International Monetary Fund’s Research and European
Departments. Earlier, he was at the World Bank, and at AT&T’s Bell Laboratories.
He has advised governments worldwide on macroeconomic and crisis management issues, as well as on developmental and financial projects and policies. He
has written extensively for policy and scholarly audiences. He received his PhD in
Economics from Boston University.
Caroline Roulet is currently an economist in the Financial Affairs Division of
the OECD, which she joined in 2012. Her work covers issues related to banking,
financial markets and monetary policy. She has published various articles in books
and academic journals. Previously, she worked at the JPLC, an advisory firm in
financial markets, derivatives and credit risk. She has a PhD in Economics from the
University of Limoges, France.
Jessica Stallings is a research associate in the European Affairs department at the
Institute of International Finance (IIF). She focuses on macroeconomic, financial


Notes on Contributors

xxi

and political developments in the euro area countries, particularly in the periphery.
She also contributes to the IIF’s work on policy issues, and is part of the Institute’s
ongoing efforts on access to finance for small and medium-sized enterprises (SMEs).
Prior to joining the IIF, Jessica served as the Special Assistant to the Ambassador at
the Embassy of the Republic of Korea. Jessica received an MA from Johns Hopkins
School of Advanced International Studies (SAIS), with a concentration in international economics and European studies, and a BA from the University of Virginia.

Henri Sterdyniak is Director of the Economics of Globalisation Department at the
OFCE (Observatoire français des conjonctures économiques). He has published
many books and articles on macroeconomics, economic policy, monetary and
international economics, European economy, fiscal and social issues. See entry on
Catherine Mathieu for recent publications.
Dimitris Tsibanoulis is the managing partner of Tsibanoulis & Partners Law Firm
and legal adviser to the Bank of Greece. He studied in Athens (1980 LLB) and in
Frankfurt am Main (1986 PhD). He practises banking, capital markets and corporate law. He is member of the BoD of the Hellenic Deposit and Investment Guarantee Fund (since 2009), of the Hellenic European Law Association (FIDE-Greece,
since 2002) and of the European Society for Banking and Financial Law (AEDBF)
(since 2003 and from 1.1.2012 Chairman of the BoD). He has been a member of
the EFMLG since 1999. He was the legal Advisor to the Republic of Cyprus on
the implementation of the European capital markets legislation (2000–2004) and
to the Albanian Financial Supervisory Authority for corporate and capital market
issues (2006–2010). He participated in several legal groups in the ECB and the
European Commission advising on matters pertaining to the regulation of Banking
and Financial Markets, and in numerous legislative groups advising on the drafting
of Greek Banking and Securities Laws (since 1988). He is the author of three books
and several articles published in Greek and foreign legal magazines on company
law, banking and finance law.
Miranda Xafa started her career at the International Monetary Fund in Washington
in 1980, where she focused on stabilization programs in Latin America. In 1991–93
she served as Chief Economic Advisor to the government of Prime Minister Mitsotakis in Athens, and subsequently worked as a financial market analyst at Salomon
Brothers/Citigroup in London. After serving as a member of the board of the IMF
in Washington in 2004–09, she worked as Senior Investment Strategist and member
of the advisory board of I. J. Partners in Geneva, and is now CEO of E. F. Consulting in Athens. She holds a PhD in Economics from the University of Pennsylvania,
and has taught economics at the Universities of Pennsylvania and Princeton. She
has published several articles and papers on international economic and financial
issues.

Part I
Genesis of the Crisis, Use and Abuse of
Economic Policies


1

The Genesis of the Eurozone
Sovereign Debt Crisis
Philippe d’Arvisenet

1

Introduction

The euro crisis is often said to have been the consequence of an excessive debt,
private or public, and finally both. But that excessive debt would not have resulted
in such a serious crisis had the eurozone institutions properly ensured the correct
working of the mechanisms of a monetary union.
The euro was seen as instrumental in eliminating the risk of competitive devaluations and possible protectionist pressures, obviously something that would not
be welcome in a deep integrated single market with freedom of trade in goods and
services and capital movements. History shows that European countries have repeatedly shown little appetite for floating exchange rates. Following the collapse
of Bretton Woods, they launched the “snake”, then the European monetary system
(EMS), a regime of fixed but adjustable exchange rates. When the EMS collapsed
in the early 1990s, with huge exchange rate adjustments (Figure 1.1), considerable
changes in exports performances followed (Figure 1.2). Beside political considerations, such disturbances were a good argument in favour of a single currency, a
much more robust arrangement than a classic fixed exchange rate regime.
When the euro was launched, it did not comply with the requirements of an optimal currency area. Some suggested that the features of an optimal currency area
that justify the adoption of a monetary union would progressively show up (the
so-called “endogenous currency area theory”). Until the crisis burst, the cycles

became more correlated, as we document below (regarding the rates of growth,
inflation, output gaps, etc), but simultaneously, labour costs diverged, and rates
of indebtedness were not kept under control, resulting in a widening of external
imbalances. The conjunction of high debt together with the rise in risk aversion
resulted in “sudden stops”; the appetite of investors to finance external and public
deficits disappeared, and the crisis erupted. In a true monetary union that would
not have happened, the deficits being automatically financed; the euro eliminated
exchange rate speculation, but not speculation in debt. Things happened just as if
3


4

The Euro Zone Sovereign Debt Crisis

170
160
150
140
130
120
110
100
90
88

89

90

91

92

93

DEM/ITL

94

95

96

DEM/PTE

97

98

99

DEM/ESP

Figure 1.1 Exchange rates
180
160
140
120
100

80
1991

1992
Italy

1993
Portugal

1994

1995
Spain

1996
Germany

Figure 1.2 Exports of G & S, volume (index Q1/1991 = 100)
Sources: Eurostats, OECD

member countries had issued debt in a foreign currency without control over their
own currency by a central bank that could act as a lender of last resort. Official
support, together with policies aiming at reducing imbalance became inevitable.
At the beginning of the crisis, policies that were implemented aimed at reducing
fiscal deficits with the implementation of austerity programs, on a case-by-case
basis. Delays and errors were made with respect to the distinction between liquidity and solvency, the involvement of the private sector, and the size and scope