STOCK MARKET WATCH - Friday, 17 February 2012

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32. How 3 Myths Drive Europe’s Response to Debt Crisis: Harald Uhlig

http://www.bloomberg.com/news/2012-02-17/how-3-myths-drive-europe-s-response-to-debt-crisis-harald-uhlig.html

In many ways, things in Europe look better than they did just a month or two ago. The European Central Bank is providing banks with almost unlimited cash to buy their governments’ bonds. Yields on Italian debt have declined.

This breather is a perfect opportunity to examine some pernicious -- and widely circulated -- myths that have emerged from the crisis and could still do much harm.

Myth No. 1: Italy’s interest burden was unmanageable.

Let’s do some math. On Nov. 25, the yield on 10-year Italian debt was 7.2 percent; it’s around 5.7 percent now. Suppose Italy had to pay that difference of 1.5 percentage points on debt it issues over the next two years that probably amounts to less than half of gross domestic product. That payment would be an additional interest burden of less than 1 percent of GDP, in a country where the government share accounts for half of output.

In December, the Bank for International Settlements conducted a more detailed calculation than mine and estimated that the interest burden would be about 2 percent of GDP; still less than 5 percent of total government spending.