David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 20 Monetary and fiscal policy
PIGS might fly
By 2009 financial markets were concerned about the fiscal solvency of a number of countries.
Within Europe, attention focused especially on the PIGS - Portugal, Italy, Greece and Spain -
which had three characteristics: high government debt, high budget deficits and membership of the eurozone.
Markets wondered if fiscal problems of the PIGS might cause the first real crisis of the eurozone.
Pessimists argued that markets were now penalizing these countries. For example, by the end of January 2010,
despite sharing a common currency, interest yields on Greek bonds were nearly 4 percentage points higher than
interest yields on German bonds. Future Greek bond issues were going to be expensive for Greek taxpayers.
Optimists, such as Nobel Laureate Professor Joseph Stiglitz, argued that both interest rates and budget deficit
indicators were misleading. If the crisis could be solved, risk premia embedded in the PIGS' interest rates
would evaporate as quickly as they had arisen. Budget deficits were also misleading because, as we saw in
Chapter 17, the size of the budget deficit fluctuates with the level of output - in a slump tax revenue falls but,
as output recovery occurs, tax revenue automatically rises again. Focusing on budget deficit data at the bottom
of the slump gives a misleading impression of how bad the fiscal situation had become. Stiglitz therefore
argued that Germany and France could help PIGS at little risk to themselves. If the speculators could be
defeated, the situation would correct itself and the PIGS would survive without having to default.
How sensitive are budget deficits to fluctuations in output? The Organization for Economic Cooperation and
Development (OECD) makes estimates of what the budget deficit would have been if output had been at
'normal' rather than 'actual' levels. We call this the cyclically-adjusted budget deficit. The charts below show
actual and cyclically-adjusted budget surpluses for the UK and three of the PIGS - Italy, Greece and Spain.
6.0 0.0
4.0
2.0 -2.0
0.0
-2.0
-6.0
-6.0
-8.0 -8.0
-10.0
- UK Actual
-12.0
-
-10.0
-14.0
UK CA
-16.0 -12.0
-4.0
-4.0
4.0 0.0
2.0 -2.0
0.0
-4.0
-2.0
-6.0
-4.0
-6.0 -8.0
-8.0 -10.0
-10.0 -12.0
-12.0
-14.0
- Italy Actual
- Italy CA
-Greece Actual
-Greece CA
0
0
N
Budget surplus (0/o of GDP), actual and cyclically adiusted, 1992-2010
Source: OECD, Economic Outlook.
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