Is the eurozone crisis a sovereign fiscal crisis?

It is fashionable to say no (Greece aside), citing the low reported deficits before the crisis.  Spain even had a budget surplus for a while.

Yet the correct answer is “yes, the eurozone crisis is a sovereign fiscal crisis.”

It is not only a fiscal crisis, by any means, but a sovereign fiscal crisis it is and not just ex post.

Let’s say a government had on paper a balanced budget, but wrote a very large naked put, large relative to gdp.  That is not a fiscally sound position, even though it may look OK in the published budget.  If the implicit financial position becomes a vulnerable one,  that government is then insolvent or nearly insolvent, even though you can point to their ex ante balanced budget.

That situation is analogous to the EU, pre-crisis.  The implied naked put was the commitment of governments and banking systems to maintain a one-to-one price between euros in German banks and euros in the banks of the periphery countries. That position has now gone bad.

In bad times, and when accounting gimmicks are rampant, a government’s fiscal policy is best understood as a portfolio of options positions, not in terms of a static balance sheet.

To point to the initial balance sheet is to miss why the whole system didn’t work in the first place.

That said, it remains the case that fiscal austerity on the published balance sheet isn’t a solution.  The governments either have to stop writing the naked puts or prove they can make good on them.


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