Interest rate differentials and the debt in the euro-zone

The paper deals with unintended consequences of the monetary union for the level of debt in the member countries of the eurozone. First, it is shown that there exist systematic inflation and real interest rate differentials among the member countries. These differentials reach up to 3 percentage points per year between the high inflation countries (e.g. Ireland) and the low inflation ones (e.g. Germany). Different rates of growth of private or total domestic debt in individual countries were closely connected to inflation differentials. Thus the debt was rising very rapidly in high inflation countries. Surprisingly, national saving rates remained stable in most countries so they cannot explain the differences in growth rates of the debt. Instead we proposed a portfolio model of the debt according to which the change in the debt is due to a reshuffle of individual portfolios. The model also implies that asset prices should change in the same direction as does the debt. This seems to have been the case in the eurozone as well.

Keywords: asset prices, real interest rate, debt, inflation differentials, monetary union, portfolio model