Category: EMU

Thinking the Unthinkable

Even as Greece appears willing to accept a larger austerity package in return for a much-expanded financing package, some leading economists are contemplating radical alternatives.  

Paul Krugman no longer sees a euro exit as impossible (NYT article here):

So what will happen to the euro? Until recently, most analysts, myself included, considered a euro breakup basically impossible, since any government that even hinted that it was considering leaving the euro would be inviting a catastrophic run on its banks. But if the crisis countries are forced into default, they’ll probably face severe bank runs anyway, forcing them into emergency measures like temporary restrictions on bank withdrawals. This would open the door to euro exit.

Nouriel Roubini  and Arnab Das argue in the Financial Times for a Plan B that involves a pre-emptive debt restructuring:

Continuing on the path of least resistance – a “Plan A” of official financing banking on a mix of deep fiscal cuts, inadequate structural reforms and hopes that markets will stay open, with growth doing much of the heavy lifting – is a risky bet that is very likely to fail. Already this week, financial markets and credit rating agencies have voted against this approach and started to price in a high probability that Greece will need to restructure its public debt coercively, with contagion to the rest of the eurozone periphery now a serious risk. Augmenting the programme for Greece alone – up to €100-€120bn as suggested by the IMF – will not work either.

Far better to move to Plan B. This would involve a pre-emptive debt restructuring for Greece; a strengthened fiscal adjustment plan in the eurozone periphery; far-reaching structural reforms; a larger IMF/European Union programme to help Greece and prevent contagion to others; further monetary easing by the European Central Bank; fiscal and domestic demand stimulus in Germany; and a co-ordinated effort to address the institutional weaknesses of Europe’s economic and monetary union.

Sovereign Risk in Europe and the Euro Area

The IIEA and Law Society are running a seminar on April 26th on this topic  – details here.  Among the speakers is Lee Buchheit who was a leader in sovereign debt restructuring in the 1980s and 1990s and is currently representing Iceland in the Icesave dispute with the Dutch and UK governments.

Reminder:  Bob Aliber talk on financial crises in TCD tomorrow Friday, 12.30-2, Room 3051, Arts Block.

Update:  Aliber seminar will be held in IIIS seminar room, not Room 3051.

Eichengreen and Gros on Greece

Barry Eichengreen writes about the Greek situation at Eurointelligence: you can read it here.

Daniel Gros has an FT comment here.

Both emphasise that the main challenge now is for Greece to undertake a very sizeable fiscal adjustment.

Update: The Economist has a nice article on the Greek situation here.

The Impending EU\Greece Deal

It appears that a deal involving the EU and Greece is imminent. Greek bond yields hit their peak level in the current crisis, the ECB has altered its rules for collateral and the media are reporting that a deal is in place (here and here.)

The FT reports on the negotiations over the terms of the deal:

Officials added that Germany was sticking to its demand that the eurozone portion of the loans would have to be made at or near Greek market rates of 6 per cent or more, though this could lead to different rates being charged by other countries.

One said the agreement “reflects high rates … it is not a ‘subsidy’ and thus not a climbdown. Not even the Germans regard most recent rates as market rates”.

The FT also editorialises on this, blaming the Germans for failing to calm the bond markets sufficiently:

Berlin is also adamant liquidity support be given at market rates. This makes no sense: a rescue is needed precisely when debt markets cease to function and refuse to refinance Greece at sustainable rates. Insisting that a rescue takes place at “market rates” is to insist no rescue takes place at all. Market yields reflect this contradiction, and show that Europe has not yet put its money where its mouth is.

I have a tendency to question agreed wisdom so let me play the role of academic devil’s advocate here for a second. Ultimately, Greek fiscal stability will require a combination of lower spending and higher taxes. Yes, bond yields at current levels—if sustained—would be unlikely to be consistent with long-run fiscal stability.

However, a program that

(a) Made it clear that Greece would be able to roll over private sector debt because the EU will intervene to provide the funds

(b) Credibly lead to the adjustments in Greece’s structural deficit.

should stabilise the fiscal situation in Greece and lead to a return to lower borrowing rates for Greece. That the EU should charge a high interest rate for providing the funds for (a) and overseeing the program for (b) is, it could be argued, not unreasonable. Indeed, if the rates associated with (a) are not high enough to be painful then it may be difficult to get much traction going on (b).

Of course, the Greek government is going to look to get the interest rates on its assistant loans set as low as possible. But that doesn’t mean that a percent here or there on these loans is the key issue right now.

The other major unknown here is how any deal will affect the sovereign bond market’s attitude to Ireland.

Greek Bond Yields

The yield on Greek government bonds has now crept up to more or less where it was prior to all the EU meetings of the past few months (see here.) I’m not sure why the various annoucements haven’t helped and newspaper reports like this one and this one don’t explain as much as I’d like.

If the high bond yields are a sign of doubts about whether a rescue is actually going to happen, and thus the debt may be defaulted on, then the eventual arrival of the cavalry (in the form of the EU) to keep the debt rolling over would end up bring the yields down to more sustainable levels and hopefully stabilise the situation. A less sanguine interpretation of current events offered to me by a colleague is that the terms of the deal being offered by the EU—in which any lending would be at current market rates—doesn’t really offer Greece a route out of insolvency because bond yields at this level are not consistent with stabilisation of the public finances.

I’m more inclined to believe the former intepretation and that the EU will prevent Greece defaulting. Whether it should is a different matter.