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The authors conclude that a model-based credit rating would have identified and signalled to market participants signs of the impending European sovereign debt crisis well before 2010, when the rating agencies first reacted to the crisis. In comparing the two sets of credit ratings, it should be borne in mind that the rating agencies may well have taken into account additional factors to those that arise solely from a country’s fiscal stance, and may therefore be measuring something different and less transparent.
Wickens and Polito offer a further thought concerning the implications of these findings for the sustainability of the euro. They argue that the common monetary policy resulted in high-inflation countries – also the crisis countries – being able to borrow at the same nominal interest rate, but negative real interest rates. This led them to over-borrow and caused the debt crisis in these countries. One solution is for countries for which the common monetary policy is inappropriate to correct for this using their fiscal policy. This requires not a common deficit limit but an even tighter fiscal policy in high inflation countries.
There is, however, an alternative solution. If credit risk were accurately assessed, then the probability of default would be reflected in borrowing rates. In this way the market could automatically correct for the inherent and unavoidable limitations of eurozone monetary policy. Treaty changes, a Banking Union, and common restrictions on fiscal deficits may then be unnecessary.