December 15, 2009
The Greek case is moving markets – and minds. Over the last few weeks, for instance the German government including Angela Merkel has become a strong proponent of economic policy coordination in the Eurozone. Not only financial markets are nervous these days. Politicians and high officials in particular in the Eurozone are stressed, not only because they wish for nothing less than bailing out Greece, but because they fear contagion to other Euro states such as Spain or Ireland if markets get even more nervous.
We are convinced that the strangely coordinated good-cop-bad-cop game played between member governments, Eurogroup President, European Commission and other interested actors of blaming Greece and saying it has to get out of its mess alone on one day, and politically guaranteeing a bail-out the next, has proven rather useless. The rising spreads on Greece government bonds seem to prove that markets are indeed not calmed by this two-faced-strategy.
In our view, one of the underlying problems is the following: On the one hand, a bail-out is most likely to happen (how could it not in the Eurozone?). But on the other, no one really wants to say so because no one wants to give a Carte Blanche to Greece. In particular as the Greek Prime Minister yesterday put forward a consolidation programme which does not deserve this name. The measures he announced yesterday will most likely not prevent insolvency of Greece because the problems of the country cannot be solved by some minor budget cuts alone and markets will have little reason not to further increase risk premiums.
Not knowing yet how weak the Greek fiscal proposals would actually be (but expecting them to be so), we put forward a proposal for crisis management in Greece in Tuesday’s edition of Handelsblatt.
We argue that there is a danger that market reactions drive Greece into sovereign default, if politics does not succeed to construct a clear link between a bail-out promise and very clear conditionality (in terms of reforms expected from Greece).
Soverign default is not only a danger for Greece but also for other member states with high deficits such as Ireland or Spain or high debt such as Italy or Belgium. In all cases, self-fulling prophecies (i.e. risk premiums) could drive countries into fiscal disaster.
In order to calm market reactions and especially prevent contagion, we argue that the EU should immediately set-out conditionality under which countries would get rescue packages. One condition could be that the national budget would have to be approved of the European Commission and the member states, for instance in the Eurogroup. This would imply a temporary limitation of fiscal sovereignty. Such a new treaty would then be offered to any country which wants to accept it. As soon as a country signs this treaty, it would be sheltered against speculative attacks as financial markets then know that default is impossible as there is the guarantee by partners. Countries which are afraid of contagion from the Greece disease would thus find an immediate protection.
At the same time, the idea would give a bigger leverage over Greece: First, the fall-out from a Greek default would be limitied as contagion is prevented. So, if Greece decides not to agree and to continue to run an irresponsible fiscal policy, the rest of the EU could more credibly threaten to let Greece fall. If Greece agrees, however, the EU would have a much stronger tool to solve the Greece mass than the current Stability and Growth Pact. The strategy chosen so far, namely to try to oblige Greece to make promises more or less about when it will comply with the Stability and Growth Pact, is obviously no adequate means of crisis management.