These cookies ensure basic functionalities and security features of the website, anonymously. Necessary cookies are absolutely essential for the website to function properly. Countries in the south of Europe have high unemployment and low growth because they are uncompetitive. Countries in the Eurozone who pursue fiscal tightening, cannot pursue monetary expansion (e.g. Because Eurozone countries don’t have a lender of last resort, markets are more concerned about liquidity this has led to rising bond yields. Debt Spiral and the EuroĬountries in the Euro are more susceptible to a debt spiral for three reasons. Unemployment in Spain is over 23%, austerity measures have led to a fall in economic growth. Spain has announced more spending cuts, but this may be insufficient to prevent debt to GDP increasing. The spending cuts in Greece have contributed to a prolonged recession which has led to the falling tax base. This is despite a period of austerity measures and spending cuts. Since 2008, Greece has seen an increase in its debt to GDP ratio. Rising bond yields can soon create a debt spiral. (However, a devaluation may lead to capital outflows, which is a problem with external debt. This provides a source of economic growth to offset the fiscal tightening. A devaluation can help boost exports by making them cheaper. A foreign agency like the IMF could give a temporary loan, which reduces the necessity for spending cuts. Increase the efficiency of tax collection.Therefore, economic growth may not fall, but the government can reduce its spending. If you increase the retirement age, the government will save pension spending, but also people may work longer, helping to maintain income tax receipts. Cut Government Spending which won’t harm economic growth.loosening of monetary policy, for example, quantitative easing or devaluation of the exchange rate which boosts domestic demand. However, the economy can avoid a downturn if there is something else to increase demand (e.g. If a country cuts spending and increases tax (fiscal austerity) This leads to lower demand and could cause a recession. Cut Fiscal deficit but monetary injection. ![]() But, because there was no Central Bank to intervene in the bond market and shore up confidence, governments were ‘panicked into austerity. At the start of the crisis, debt levels were not excessively high. This argued that the ‘debt crisis’ in Europe wasn’t a real problem of insolvency. Research has suggested that countries which pursued austerity have seen an increase in their debt to GDP ratios. Therefore, you fail on two fronts – you get the same high level of debt to GDP, but also lower economic output. However, this leads to lower growth, and therefore, the debt to GDP ratio may continue to grow. This means you cut government spending (trying to reduce the deficit). It is argued, some countries in a debt spiral are pursuing options known as lose-lose. Also markets no longer want to buy more government debt, leading to partial or total default. With a shrinking tax payments, the government struggles to meet interest payments.Bond yields remain high despite the spending cuts. The shrinking economy means it is harder to meet debt repayments.Lower economic growth leads to lower tax revenues. The Impact of spending cuts leads to lower aggregate demand more unemployment and lower economic growth. Trying to reduce debt can cause a recession.To reduce bond yields, governments need to cut spending and increase tax.This increases government spending even more. But, also Governments have to pay higher interest payments on debt because of rising bond yields. Rising debt increases debt interest payments. Markets become concerned about debt levels leading to higher bond yields (higher rate of interest).(This could be due to overspending, inefficient tax collection, bank bailouts or economic slowdown) However, if a country also has high levels of external debt, it makes a debt spiral more likely because foreign investors are more likely to withdraw funds at signs of difficulty this is termed ‘capital flight’. It includes both government external debt and private external debt.Ī debt spiral could occur with just government debt. This is debt that a country owes to other countries. ![]() Some government debt may also be sold to overseas investors. This is debt that the government owe to the private sector (e.g. This increasing levels of debt and debt interest become unsustainable, eventually leading to debt default. ![]() A debt spiral refers to a situation where a country (or firm or individual) sees ever-increasing levels of debt.
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