Talking One's Way Out of a Debt Crisis

The policy of Euro-area officialdom in the period 2010-2011 was to avoid, at all costs, a default and restructuring of the sovereign debt of a member of the monetary union. This policy was motivated principally, but not exclusively, by a fear that the international capital markets, if forcibly reminded of the precarious position of overindebted, growth-challenged members of a monetary union, might recoil generally from lending to European sovereigns. In short, they feared contagion.The only alternative to permitting a debt restructuring, of course, was an official sector bailout. The afflicted countries -- Greece (until 2012), Portugal, Ireland and Cyprus -- received loans from official sector sources sufficient to allow them to repay in full their maturing bond indebtedness. Whenever and wherever the crisis erupted, contagion was thus held in check by the blunt technique of smothering the outbreak -- in money.The proponents of this policy argued at the time, and argue now, that many European sovereigns in 2010 were far too fragile to endure a bout of market contagion. They argued that an acute crisis needed to be averted in order to buy time for the implementation of a gradual but more durable remedy. Had the intervening eight years been used to reduce the debt vulnerabilities of the peripheral (and even some core) states, this argument would now be powerful, indeed invincible.Unfortunately, the opposite happened. Average state indebtedness in Europe today is about one-third larger than it was in 2008. Both the member states and the market saw the reprieve as spreading a reliable official sector safety net under their exposure. So they kept on borrowing and lending. Only the zero interest rate policies of the world’s major central banks during this period have kept debt servicing costs at tolerable levels.