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 (FA^d):

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, FA^d (= 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 (FA^d) 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:

Taking the desired stock of financial savings (FA^d) as given, when the private sector is unwilling to expand its debt (D_P), an increase in spending can only be the outcome of an increase in net exports (D_F), or an increase in government deficit (D_G). While an increase in D_G is financially viable as long as the ECB supports it, and it is also economically desirable as long as unemployment remains high, an increase in D_F can hardly be large enough to restore nominal income growth, entails rising risk on foreign assets, makes the euro area dependent on foreign demand conditions, and is not economically desirable as net exports reduce the output per capita below what the economy can produce.