The problem
In many ways the four peripheral countries share common traits. Since the run-up to the euro and especially after joining the Eurozone, they have spent and lived beyond their means by accumulating private and/or public debtand running large current-account deficits. Regaining sustainability will require a combination of lower living standards and higher production levels, especially in the tradable sector. Efforts by the private and the public sectors to pay up their debts will have a negative impact on growth, and low growth will it make more difficult to reduce debt levels. These countries are also confronted with the risk of debt deflation, as restoring competitiveness in the tradable sector will require low price increases and perhaps even deflation.Given the high level of financial interdependency within the Eurozone, the private and public debt difficulties of the peripheral countries also translate into risks for other Eurozone countries. Our estimates (Table 1) show that peripheral banks hold about €340 billion of peripheral sovereign debts and that banks in the rest of the Eurozone are exposed to peripheral countries to the tune of about €400 billion, 60% via exposure to banks and 40% via the holding of sovereign debt. By far the biggest exposure of Eurozone banks is to Spain (53% of the total exposure), through both sovereign and banking channels. The second largest exposure is to Ireland (18% of the total), mainly through the banking channel, and then Portugal (16%). Exposure to Greece is the smallest (13 %) and is almost entirely through the sovereign channel.
Table 1. Estimated exposure to periphery government debt and banking system (€ bn), end-2010
Source: Bruegel. For data sources and explanations see Darvas et al (2011). [....]
Table 2. Assessment of alternative policies
Source: Bruegel.
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