A new Federal Reserve Bank of New York study finds that the euro area’s system for settling cross-border payments between member-country banks has helped the periphery countries—specifically, Spain, Italy, Portugal, and Greece—cope with the external financing gap that developed when the 2010 sovereign debt crisis set off widespread capital flight.
In the study, “The Balance of Payments Crisis in the Euro Area Periphery,” New York Fed economists Matthew Higgins and Thomas Klitgaard portray the euro area crisis as a balance of payments crisis, exacerbated by an overreliance on foreign capital. The withdrawal of private capital forced the periphery countries to bring total domestic spending—government and private—more closely into line with domestic incomes, producing a painful economic contraction.
Nevertheless, the tightening in credit conditions in the periphery economies proved less severe than what would ordinarily result from capital flight on the scale observed. The withdrawal of private capital was countered by cross-border credits to deficit countries’ central banks. The credits were extended collectively by other euro area central banks as part of the mechanism for managing payments imbalances among member countries. This financing was paired with policies to supply liquidity to periphery commercial banks to offset the drain of funds abroad.