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Posted on May 6th, 2014, by

The global games framework may be used to reconcile the sunspot and fundamental views in a model of sovereign liquidity crises. Panics can still arise once a change In the nature of the game is anticipated by investors, and the costs of coordination failure are manifest in premature liquidation. But the uniqueness of equilibrium means that it is possible to conduct meaningful comparative statics, allowing a rich set of policy alternatives to be explored. In particular, the effects of a stay on payments and prudent liquidity management on the probability of a ‘belief’-based run is made amenable to analysis.

In most emerging market economies, government liabilities or government-guaranteed liabilities dominate the national balance sheet. Therefore, the coordination failure, by driving speculative runs on the exchange rate and the banking sector, can allow financial crises to ultimately manifest themselves as a sovereign debt problem. Sovereign debt lacks collateral and the judicial contract enforcement that typifies domestic lending so, as a result, countries are able to decide whether to repay their creditors or declare outright default. A country’s willingness to pay may determine repayment, long before its ability to repay acts as a binding constraint.  This notion may be formalized in a model where sovereign debt facilitates consumption smoothing. They show that the debtor only pays as much as it is worth to avoid some threatened sanctions by creditors. Such sanctions might include a permanent embargo on new loans in the event of non-payment or refusal to roll over lines of credit. Countries choose to repay because they realize that, at some point in the future, they will likely face situations where they need to borrow.

The disciplining role of the threat of a financial crisis can be costly and indiscriminate. If a debtor’s financial condition is weak through adverse conditions rather than mismanagement, then the severe punishment meted out by creditors may be no fault of the debtor. As a result, policymakers attach considerable importance to identifying symptoms of financial crises ahead of time. And since crises can quickly spread between countries, knowledge of the ways in which financial distress is transmitted across borders also becomes important since it allows policymakers to anticipate possible ‘second round’ casualties of crisis. (Chui and Gai, 2005)

  1. 1.     Lessons from the Euro zone debt crisis (the analysis of the situation in Greece, Ireland, Portugal, Spain and Italy)

It is known that such sovereign debt crises like the one that the EU faces now are quite usual for the global economy, in general more than 250 cases of  government defaults  because external debt they wasn’t repaid (no matter, whole or partial) are known. A situation when countries at first borrowed the money internationally and then were not able to pay these borrowed means back happened quite often.

Bullard (2010) explains that even if sovereign debt crisis is often being associated with market volatility, but in the majority of cases such situation doesn’t lead to the global recession.

The problem and at the same time the advantage of the EU is the interconnection of the financial markets and economies of the different countries-members, which means that such countries that face the of inability to repay their borrowings still will be supported by the strongest members of the union, and they will still have an access to international financial markets. The most popular approach of dealing with this problem is debt restructuring. Actually this approach is not unusual and it even may be implemented without significant disruptions.

Bullard (2010) concludes that the most important lesson of the current crisis states that borrowing on international markets is a delicate matter. Such international debt may offer some benefits and also it can harm the country’s credibility and lead to the sovereign debt crises. Therefore, we can make a conclusion that international borrowing should not be the way to achieve prosperity, it simply will not happen that way.

Staehr (2010) indicates three measures that should be implemented by the affected countries: First, the countries affected by the crisis will have to implement fiscal consolidation in order to improve the structural fiscal balance and contain future debt build-up.  Second, the governments of the new EU countries have to consider measures in order to reduce the fallouts of illiquidity in government debt markets. Third, a strengthening of fiscal management and budgetary institutions will serve as a contribution to the improved budgetary outcomes and facilitate fiscal consolidation.’ (Staehr, 2010)

Greece, Ireland, Portugal, Spain and Italy are considered the weakest in the context of repaying the borrowings countries, although their cases are different. For instance, in the case of Greece we can state that the reasons of this debt crisis are that the government has lost its credibility and also that the deficit in balance of its payment was constant.  On the contrary to Greece, Ireland has faced the possibility of crisis because of the losses in the banking system.

The discussion about Portugal is extremely important because it is possibly the next market that will face debt sovereign crisis. Crespo, Fontoura, and Barry (2004) indicate that there are problems that Portugal experience nowadays with the entrance of new members from Central and Eastern Europe.  Authors argue that the elimination of trade barriers will have two trade-related effects on EU: an increase in bilateral flows with the CEEC and a shift effect as the CEEC displace some incumbent exports to EU markets. The first effect is likely to be strongest for those incumbents for whom there is a strong overlap between their export structure and the import structure of the CEEC. Portugal emerges as one of the economies with the least overlap between their export structure and the import structure of the CEEC.  In the result of the trade inequalities, Portugal faces substantial industrial disruption. (Crespo, Fontoura, and Barry, 2004)

Also there are a number of the implications of enlargement for Portugal’s budgetary relations the EU. (Crespo, Fontoura, and Barry, 2004)

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