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Christopher Waller, senior vice president and director of Research, led the presentation and discussion on “Sovereign Debt: A Modern Greek Tragedy” on May 8, 2012, as part of the St. Louis Fed’s “Dialogue with the Fed” series. After his presentation, Waller and economists Christopher Neely and Fernando Martin took questions from the audience. The Q&A was moderated by Julie Stackhouse, senior vice president of Banking Supervision and Regulation.
In 2012, the world faced a major financial crisis for the second time in five years. Whereas the first crisis in 2007-2008 was driven by excessive mortgage debt owed by households, the crisis in 2012 was driven by excessive government debt owed by entire countries. Waller first explored the reasons why a country’s ability to borrow to finance current spending can be very beneficial. However, since the rewards of borrowing are felt immediately and the pain is postponed until the future, it can be very tempting to borrow for short-term gains while downplaying the pain to come. As a result, debt burdens can rise to unsustainable levels, leading to crisis and austerityâ€”the tragedy of sovereign debt. In examining the reasons behind the current sovereign debt crisis in Europe, Waller explained the history of the formation of the European Union (EU), which focused on the creation of a monetary union, not a fiscal union. While it established five criteria for membership (concerning long-term interest rates, inflation, exchange rates, deficit-to-GDP and debt-to-GDP), no contingencies were made for a secession or ouster of a nation. In addition, when Greece won entry to the EU in 2000, it met none of the five criteria.
Several “great shocks” in 2009 and 2010 then woke up the financial markets to the risk of default on European sovereign debt, which led to increased interest rates because financial markets no longer viewed Italian, Greek, Irish, Portuguese and Spanish debt as close substitutes for German bonds.