NEW YORK—The Federal Reserve Bank of New York today released Saving Imbalances and the Euro Area Sovereign Debt Crisis, the latest article in its series Current Issues in Economics and Finance.
In this study, authors Matthew Higgins and Thomas Klitgaard trace the debt
crises in the countries of the euro area periphery to saving imbalances—a
shortfall in national saving that left these countries dependent upon foreign
borrowing to finance domestic capital expenditures. The challenge for
the periphery countries in the current environment, the authors argue, is to
bring spending back into line with national income now that credit risk concerns
have prompted foreign investors to halt further lending.
Higgins and Klitgaard show that in the years leading up to 2010, domestic saving in the periphery countries dropped to low levels. In Greece saving fell to just 8 percent of GDP in 2007; while in Portugal the rate fell to 13 percent. The decline in the saving rate was not as marked in Spain but still significant.
These saving deficits meant that the periphery countries had to borrow heavily from foreign private investors to support both current consumption and domestic capital expenditures. The "turn to foreign borrowing," the authors observe, was facilitated by the countries’ admission to the European Economic and Monetary Union in the late 1990s. This development reassured foreign lenders that investments in periphery countries’ debt instruments would not lose value because of inflation or currency depreciation, and enabled the periphery countries to obtain financing at significantly lower rates than they had been granted before.
According to Higgins and Klitgaard, the periphery countries’ increased access to relatively low-cost foreign funds contributed to a sharp rise in spending. Irish real consumption spending rose 55 percent from 1999 to 2007. Meanwhile, over the same period, consumption spending climbed 35 percent in Greece and Spain. While foreign borrowing also supported investment spending, that spending was largely channeled into housing and other nontradable sectors that do not yield income to support repayment.
In the latter part of their analysis, Higgins and Klitgaard consider how the periphery countries will repair their finances while adjusting to sharply reduced access to private foreign capital. One route would be to boost national saving by implementing fiscal austerity measures. As the authors note, Greece, Spain, Ireland, and Portugal have all taken steps to reduce fiscal deficits—albeit at the cost of weakened economic performance. A second route would be to replace borrowed funds from abroad with increased export revenues. While in the past, a weaker currency might have boosted export revenues in the periphery, membership in a monetary union now sharply limits this possibility. Instead, Higgins and Klitgaard note that, "price competitiveness gains must come via a mix of superior productivity gains or wage and price restraints." The authors report that the periphery countries show some signs of increased labor productivity, but "given the challenges of boosting productivity and the stickiness of wages and prices, only gradual progress is likely."
Matthew Higgins is a vice president in the Emerging Markets and International Affairs Group of the Federal Reserve Bank of New York; Thomas Klitgaard is a vice president in the Research and Statistics Group.