March 1, 2010
Assessing options for Greece
After weeks of contradictory statements on the question how to handle Greece, the Heads of State and Government of the EU member states used their informal European Council meeting on February 11th for a strong political signal that aimed at calming markets and giving political support to the Greek Prime Minister’s budgetary consolidation efforts and structural reform programme. The subsequent meeting of the EU’s Finance Ministers on February 16th meanwhile increased pressure on the Greek government for further consolidation, taking the Excessive Deficit Procedure to its next step in which the Finance Ministers issue precise recommendations for Greece and increase surveillance in the country.
The European Council’s announcement that the EU “will take determined and co-ordinated action, if needed, to safeguard financial stability in the euro area as a whole” was widely interpreted as a bail-out promise. But only a few days after the summit, new doubts arose whether the EU or its larger member states would indeed step in for Greece. So, the options that are discussed still range from default and a Eurozone exit to a strong engagement of the EU and the creation of new crisis management and coordination mechanism for the Eurozone. Despite increasing market instabilities and the rapidly approaching moment of truth when Greece will have to refinance its debt in March/April 2010, policy makers still assess options. This is not surprising, as there is no cheap and safe solution. Any political choice in this current situation has downsides. And no matter how the Greek case is handled, it will be a precedence for the future of EMU governance.
On the website Eurointelligence, we have published an assessment of four policy options for Greece and their pros and cons that have been put forward in the discussion. We argue that letting Greece default (option I) is neither a likely nor a reasonable scenario given the current set-up of the EU. We would not entirely exclude the possibility that the EU commits serious political mistakes in handling the problem so that Greece has to call in the IMF for help unilaterally (option III), but the most likely scenario from our perspective is that the EU member states will come up with a rescue package for Greece if needed (option II). The argument then is whether this should be done in a concerted action with the IMF or not. Given the current state of governance mechanisms in the EU, the risk of political tensions within the EU and problems of legitimacy of a bail-out, we rather expect an involvement of the IMF. But we suggest that this should be clearly limited in time while, in parallel, the Eurozone should be equipped with its own European Monetary Fund and a default procedure in order to limit moral-hazard problems in future cases.
Comments(6)
I contend that the solution is more integration in the EU framework that is Option IIa: The EU provides a rescue package alone.
I suggest at http://mgiannini.blogspot.com/2010/02/too-little-to-fail-or-when-you-do-not.html a nice way to get out of this crisis and give a strong signal to markets, particularly speculators. A EU financial transaction tax which would raise a large sum of money painlessly, and would help to limit the sort of speculative attacks against the euro-zone.
Moreover funds collected under a financial transaction tax (a kind of VAT at EU level -EU budget additional own resource – with a Pigouvian character) could also, via a EU fund (European Monetary Fund ?), cover the issuance of EU bonds.
Thus the most effective solution to the present EU sovereign debt crisis would be to issue jointly EU bonds to refinance gradually all the maturing debt of Greece and other PIGS. This would not only significantly reduce the cost of financing of PIGS debt, while creating a EU bond market, but it would replace any International Monetary Fund role and/or conditional loans.
The devil is in the details of the above scheme which would in any case comply with treaties. Euro bond can’t solve all problems of deficits, but a common, joint and/or coordinated issuance and use of EU bonds (including recapitalization of banks, European budget, common guarantee funds, EU projects, rescue loans and packages, IMF resources, etc.) could also create an efficient and effective bill or bond euro zone market. Different arrangements could then be studied concerning the issuing institution (single issuer) or coordinated agencies and its guarantees. A bond clearing house, i.e., a vehicle for sharing information to improve fiscal coordination could also be set up under EU umbrella. Some of the technicalities and arrangements would be the same as for the introduction of the Euro as a common currency.
It would help I.M.F. intervention if Eurozone member states merge their quotas and number of votes. Then, the Eurozone would become the economy with the largest quota and percentage of votes (around 20%) even if the U.S. would keep the right to veto I.M.F. decissions as majority of 85% is needed and the U.S. alone gets 17%…the same way the Eurozone will keep its right to veto IMF decissions.
But it is true that the same way the U.S. doesn´t call the I.M.F. to rescue California, then the Eurozone will need its own mechanism without the interference of third parties, extra-Eurozone nations with their own agendas and interests.
This week we are witnessing a new attack to the British pound as a consequence of both a large UK budget deficit (-12% according to The Economist) and high inflation (3.5% according to The Economist), something which will lead the Bank of England to raise interest rates which can curtail the incipient recovery.
A weak currency like the pound, a large deficit, an increase in the price of the oil barrel; British inflation surpassing 3% compared to the 1% in the Eurozone means the UK is losing competitiveness even if the weak pound was at first an opportunity for exporters.
Before the Euro international investors would have attacked the drachma or the peseta…but know that is not possible because drachmas and pesetas doesn´t exist. There is no possibility to speculate with drachmas and pesetas as they did with thai bahts, argentinian pesos or british pounds.
The British pound will continue being battered until the Bank of England starts raising interest rates again, and that will happen during the next months.
Meanwhile, the Eurozone still has margin to cut interest rates at least twice: 0.5 points each time.
correction: “Before the Euro international currency traders and investors like Soros would have attacked the drachma and the peseta… but now that is not possible because drachmas and pesestas DON´T EXIST! There is no possibility to speculate with drachmas and pesetas as they did with thai bahts, argentinian pesos and british pounds.”
Are hedge funds against the Euro? If they sell Euros that is not a problem now that inflation is under control in the Eurozone; all the opposite: what the Eurozone needs is a weaker Euro for exports to the Dollar area, including China. So, thanks hedge funds for the service.
International investors know the only mandate of the ECB is price stability, so as far as inflation is under 2% there is no problem for a weaker Euro. With Eurozone inflation under 1% we can expect a next interest rate cut from the ECB, perhaps as large as 1% if Greece and Spain go ahead with projected budget cuts. That would be a good exchange. An important stimulous from the E.C.B. in exchange for buget tightening. At the same time, that would lead to a weaker Euro which will increase Eurozone exports to the rest of the World.
Mr Costas Mira – sounds like your article is more subjective than objective. “ECB to cut rates 1% if Greece and Spain go ahead with projected budget cuts” — is that a wish or a facts based forecast?
I think what Europeans have to worry about, and especially Spain, is not the “extra-Eurozone nations with their own agendas and interests”, but the INTRA EUROZONE nations with their own agendas and interests. Germanys and Frances interests are directly opposite to Greeces and Spains, and even Italys for that matter.
The austerity programme being imposed on Greece in exchange for lower bond yields is complete madness. We better wake up to what is going on here or else we will all have this type of ‘austerity’ imposed on us by Germany. This is madness.
http://fxtalks.blogspot.com/2010/05/barbarians-at-gate.html#links