International Banking Crisis and Sovereign Debt Sustainability: A Comparative Analysis of Five Countries under Varying Exchange Rate Regimes

Mark Niels Strøger Hansen

Student thesis: Master thesis


This thesis has set out to examine the financial crisis of 2008 including the preceding developments as well as the following Eurozone sovereign debt crisis. Although much literature has been written on the individual subjects investigated in the thesis, it has aimed at adding value to the existing research by providing a more complete account and analysis of developments. The perspective of the thesis is of the five countries Iceland, Ireland, Spain, the UK and the USA, which all experienced similar developments over the course of the 2000s before the financial crisis. These all countries experienced real estate booms, high economic growth and increasing domestic and external indebtedness, which led to the built up of large mainly private sector vulnerabilities in the economies. These vulnerabilities resulted in the largest international financial crisis in modern time, when economic conditions changed in 2007-2008. The financial crisis and ensuing banking crises are analyzed through the framework of Minsky (1978), who proposed the financial instability hypothesis to explain the inherent instability of capitalist economies. It explains how economies are inclined to move from steady states to more vulnerable situations as periods of benign environment tend to lead to overinvestment and indebtedness as in the five countries of interest. Following the financial crisis governments around the world engaged in large scale financial sector bailouts and fiscal expansions to counteract the subsequent recessions from private sector deleveraging. However, some Eurozone countries including Ireland and Spain found that the increasing public deficits and debt to GDP levels led to sovereign debt sustainability concerns, where financial markets priced sovereign risk differently than before the financial crisis. This is analyzed in relation to currency crisis models, where especially third generation models concerning private sector vulnerabilities have provided important insights. These models explain some of the mechanisms such as self-fulfilling crisis and contagion at work during the Eurozone debt crisis, providing a link from banking to sovereign debt crises in Ireland and Spain. An important result in this thesis is the fact that monetary unions such as the Eurozone have some features, which make member countries more prone to self-fulfilling crisis of confidence. It builds on the findings of De Grauwe (2011), who point out that because members of the Eurozone do not have a lender of last resort to ensure liquidity within government bonds markets. Without such a lender of last resort, the governments of Ireland and Spain in fact borrow in a currency over which they have no control, making them more susceptible to a liquidity crisis. This he finds has been important in explaining the different interest rates charged by financial markets to countries with similar economic fundamentals such as debt to GDP levels.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2013
Number of pages97