Managing sovereign debt in fiscally troubled countries

On September 26, William R. Cline, Senior Fellow at the Peterson Institute for International Economics, held a SAFE Policy Lecture entitled “Managing the Euro Area Debt Crisis”. Cline presented insights from his brand-new book. He was introduced by Michael Haliassos, Professor for Macroeconomics and Finance at Goethe University, Frankfurt and SAFE Director.

In his lecture, Cline argued that the status of sovereign debt in the euro area has now reached a phase in which it is manageable without having to recur to formal debt restructuring mechanisms. According to Cline, relief for sovereign risk spreads was most importantly achieved in 2012, when the ECB pledged to do "whatever it takes" to preserve the euro, meaning that it would buy government bonds, if necessary. Since this pledge, sovereign risk spreads have come down substantially, allowing the fiscally troubled countries of Europe to plan their return to sustainable debt levels through fiscal adjustments and privatizations. As an important aspect, Cline mentioned that large write-offs in the banking industry are also no longer to be expected, which has further reduced the level of risk for sovereign debt.

Cline cautioned that a formal debt restructuring mechanism for the euro area would entail moral hazard. The credibility of public finances hinges on the proposition that modern industrialized countries do not default on their debt. Cline urged fiscally troubled countries to use their fiscal space to support this proposition and presented realistic scenarios for all fiscally troubled countries to return to debt sustainability. He employed a new method for analyzing public debt sustainability, which he develops in his book.