European Debt Crisis: Snow Ball Effect

The phrase Snow Ball effect draws its analogy with the rolling of a small snow ball down a snow-covered hillside. As it rolls the ball will pick up more snow, gaining more mass and surface area, and picking up even more snow and momentum as it rolls along.

This is precisely what is happening with the European financial crisis. Starting from an initial state of small significance it is building upon itself, becoming larger (graver, more serious), and perhaps potentially dangerous or disastrous for the global financial markets.

The problem is that the Debt to GDP ratio (D/Y) in most of the EU countries is far higher than, those mandated by the ECB's guidelines. The biggest task with the EU nations currently is to reduce this D/Y as much as they can in the coming years in order to avoid a mess. The Two ways in which this can be reduced are

• Rising Nominal GDP (which would lead to a fall in denominator Y)
• A falling Nominal interest rate, which would lead to a fall in the current expenses on interest and hence the deficit (The numerator D)

But what is happening in the EU zone currently, is that everyday when the government of these debt ridden countries are coming to the bond markets for an auction are paying higher and higher yield to sell those bonds (which means higher nominal interest rates) and also the budget cuts/ new taxes levied on the people will lead to a fall in the GDP growth rate. Thus, creating by what I mean a snow ball effect.

Its being said by the noted economists that A "1%-decrease in average funding costs from 2010 results in a 5-17%-point lower debt-to-GDP ratio in 2020". But the funding cost is continuously on an up trend, creating a risk of contagion (crisis spreading from one country to other).

Thus, the investors who are demanding higher yield to buy those EU countries bond because of a higher risk, need to understand that the higher yield they command the tougher it would be for these countries to pay back their debt in future because it will create a snow ball effect and make it virtually impossible for them to pay them back.

I hope some one from EU understand simple graduate level economics read this blog or.. :D