No Exit from the Sovereign Debt Crisis Against German Will
Roberto Perotti (Department of Economics) discussed the sovereign debt crisis in Europe at the Federal Reserve Board's Academic Consultants Meeting on May, 6th, with Fed's chairman Ben Bernanke and other members of the Board of Governors. Perotti's paper, Lessons from the Past, Questions for the Future, reviews the literature about the likely effects of fiscal consolidations, the measures taken so far to cope with the sovereign debt crisis, and the proposals under discussion for further measures.
Following the lines of a recent paper of his, Perotti cautions against the idea of "expansionary fiscal consolidations", i.e. the idea thatfiscal consolidations based on spending cuts are good for growth even in the short run. A thorough review of often cited episodes of "expansionary fiscal consolidations" shows that the spending cuts actually implemented were smaller than previously thought, and growth was obtained thanks to transmission channels no longer available to our economies in current circumstances.
"The key feature of the European sovereign debt crisis", Perotti writes, "is the close, two-way interaction between sovereign risk and financial sector risk", and some measures, namely the Long Term Refinancing Operations, have made the loop between sovereign and banking sector risk even tighter.
Perotti's main concern is the long-term political feasibility of the tools put forth by European authorities. The containment of the sovereign debt crisis has been accomplished in spite of strong opposition by German monetary authorities to the large government debt purchasing programmes. "I argue that the main German concerns are not entirely unfounded", Perotti concludes, "and that the Eurozone is not likely to be able to pursue for long a monetary policy that is opposed by Germany".
Perotti had previously participated in the "Fiscal Policy" session of the International Monetary Fund Rethinking Macro Policy II conference, along with Swedish Minister of Finance Anders Borg and New York University's Nouriel Roubini. Click here for the video of the session.