“Prior to the introduction of the Euro, the presence of independent central banks prepared to serve as a lender of last resort for the fiscal authorities meant that there was no serious default risk. There would, of course, be inflation (soft-default) and exchange rate risk, but no hard-default risk. You can’t really default when you can print the currency in which your debt is denominated. After Lehman, though, the possibility of default appears, and the ECB does nothing to dispel such fears. Moreover, the Greek debt restructurings dispelled any remaining doubts about European sovereign debt – the lack of a central bank backstops means serious default risk.”
The lack of default risk is huge. It changes everything, and drives government interest rates to their inflation risk/exchange rate risk levels.
I had a post on the crucial distinction between default risk and debasement risk which helped the dialogue a while back, even though it seems I overstated the inability to default back then. JKH’s post on the Central Treasury Bank is an attempt to make the obscure and sometimes implied institutional arrangement(s) between the Treasury and the Central bank obvious and explicit.
Inflation risk is something which can be modeled decently with existing financial technology. Default can be/is a political process, which is nearly impossible to model.
If expectations mean anything in the world, the future Eurozone economic growth path is being destroyed by uncertainty of a default.