Thursday, January 5, 2012

Understanding Eurozone debt developments by nation

by Gianluca Cafiso


January 5, 2012

2011 was the year the Eurozone began to buckle. The weight of debt taken on following the global financial crisis two years earlier proved too much for some member countries. This column examines how debt-to-GDP ratios increased over that period, the reasons why some economies fared better than others, and what may be in store for debt in 2012 and beyond.

Fiscal discipline looks set to start 2012 as it ended 2011: centre-stage in the Eurozone debate (Wyplosz 2011). While the fiscal compact agreed upon in December 2011 sets out new fiscal rules, many are expecting another round of emergency summits. This column studies the evolution of debt-to-GDP ratios in some of the EU’s most troubled economies in hopes of finding the right policy responses.

Debt-to-GDP ratios started to increase in Europe in 2008 (Cafiso 2011a). This was when governments undertook measures in an effort to avoid things getting any worse – they put in place stimulus packages and rescued large financial institutions. In previous research, we disentangled the average debt-to-GDP ratio variation in the period 2008–10 by considering its structural drivers: primary balance, real growth and interest payments (Cottarelli et al 2010). Our discussion here focuses on six particularly troubled EU countries: Greece, Ireland, Italy, Portugal, Spain, and the UK. Apart from Italy, these are the countries that have experienced a debt-to-GDP ratio increase above that of the EU15 average in 2008–10 (see Table 1).

The contribution of each component to the debt-to-GDP ratio variation is reported in Table 1 in percentage of GDP and in percentage share (w%) over the total variation; the contribution in w% is also plotted in Figure 1.


Figure 1. Decomposition of debt-to-GDP ratio, percentage shares

Notes: • Above each pie, the debt-to-GDP ratio variation for the specific country is reported. • sfa-w% is the Stock-Flow Adjustment share, pb-w% is the primary-balance share, rgc-w% is the real growth contribution share, rib-w% is the real interest bill share.

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