Strong pressure on the ECB
The high level of long-term interest rates in
Massive purchases of government bonds by the ECB: Would the eurozone crisis be ended?
If massive purchases of government bonds by the ECB were to resolve the debt situation in Spain and Italy, the consequential fall in interest rates would need to restore fiscal solvency, restore external solvency and bring back acceptable growth.
Let’s look at these three points now:
1. Fiscal solvency
Fiscal solvency is ensured if the primary budget surplus is greater than the public debt multiplied by the differential between the long-term interest rate and nominal long-run growth.
If long-term interest rates were lowered by ECB interventions to close to the eurozone average, a primary surplus of 4.2 percentage points of GDP would be needed in Italy and 2.8 percentage points of GDP in Spain to ensure fiscal solvency. Italy’s primary surplus is forecast to meet 4% of GDP next year, while Spain’s primary deficit is due to exceed 3%.With lower interest rates Italy would be fiscally solvent in 2013, but by no means would Spain be.
2. External solvency
External solvency is ensured if the primary surplus (excluding interest on external debt) of the current-account balance is greater than the external debt multiplied by the differential between the long-term interest rate and nominal growth.
If the ECB moved long-term interest rates closer to the eurozone average, a primary current-account surplus of 0.8 percentage point of GDP would be needed in Italy, and 3.1 percentage points of GDP in Spain. At present, Italy has a deficit of 1.8 percentage points of GDP, and Spain has a deficit of 2.5 percentage points. As such, with lower interest rates, external solvency would not be guaranteed in Italy, while in Spain, again, the situation is far worse – external solvency would be very far from guaranteed.
The growth prospects are dramatic for
While consumption is declining in both countries, the decline in investment is far more dramatic in
Conclusion: Would massive purchases of Spanish and Italian government bonds by the ECB stop the eurozone crisis?
In conclusion, if the ECB were to purchase massive amounts of government bonds issued by struggling eurozone countries, a sharp fall in long-term interest rates in
- restore fiscal solvency in
Italybut not in ; Spain
- restore external solvency in neither of the two countries, though the problem is far more serious in
Spainthan in ; Italy
- revive growth in
Italy, but not in where the decline in activity does not stem mostly from high interest rates. Spain
Massive intervention by the ECB in government bond markets would therefore be decisive for