As long as the Euro area enforces balanced budget constraints at ALL levels of government, the Euro area will not be sustainable.

I have summarized here the argument behind the statement above.

What follows is a simple model that shows the logic of the argument.

1. In a monetary economy where the private sector demands financial assets as a vehicle to store wealth (aka ‘financial savings’), spending (by the private sector) can be assumed to depend on saving desires. Specifically, in any given period of reference, the change in total spending (ΔE) is a function (α) of the difference between the available stock of financial assets (FA) and the desired stock of financial savings (FAd):

The intuition is that if the value of available financial assets exceeds the desired stock, spending will increase, and vice versa.

2. In this simple model, FAd (= the desired stock of financial savings) is taken as a given:

3. The nominal value of available financial assets to private residents must equal the sum of all liabilities outstanding, including those issued by the private resident sector (D P ), the domestic public sector (D G ), and the foreign sector (D F ). D P is the outstanding value of private debt. D G is the oustanding value of public debt. D F is the net position with foreigners (when positive, it is the value of residents’ claims on foreign entities). This means:

4. This model explains spending with saving desires (FAd) and the available stock of financial assets (FA) which depends on the existing liabilities issued by private, public, and foreign entities.

Thus, an increase in spending requires that: