In Saturday’s Irish Times, Alan Ahearne does a good job laying out the dangers of unfolding events in Greece (see here). Political support for the adjustment programme has been lost, with the Greek population understandably perhaps blaming much of their disastrous economic performance on the conditions of the programme. While the austerity measures have certainly played a role in the growth performance, they are just one component, with the confidence-sapping effect of the fear of a melt-down situation itself playing a major role. The correlation between austerity and weak growth is now deeply established in the minds of many Greek voters – whatever the actual contribution of the austerity measures. A rejection of the programme in the elections is a real possibility. So too is a tough response from official creditors to an unwillingness to meet the programme conditions.
A Greek exit from the euro zone could be containable with sufficient will. However, there is a likelihood that moral hazard concerns could lead the response might be too halting, leading the crisis to easily spin out of control. As Alan argues, even with a successful containment, the precedent of a country leaving the euro would fundamentally change the stability of the monetary union, making it more prone to the runs that plague fixed-exchange rate regimes. (See also Martin Wolf here.)
Is there room to give Greece more time, providing at least some political counterweight to the massive anger at the programme? The stronger euro zone countries are understandably concerned about the moral hazard problems of any backtracking on the conditionality being applied to Greece.
This is where the weaker countries could play an important role. They could do so by making it clear that they see no interest in seeking relief through default or in a relaxation of formal/informal commitments, regardless of any additional accommodations for Greece. This need not include measures currently under discussion for strengthening the overall crisis management, including the lengthening of the maturity of the promissory notes, direct injections from the ESM into undercapitalised banking systems, or relaxing the aggregate stance of the Excessive Deficit procedure (especially for countries with fiscal space). I think this goes with the grain with the approach of governments in Ireland, Italy, Portugal and Spain. (Indeed, in the case of Spain, their unwillingness to accept a one-year extension for reaching the 3 percent target under their Excessive Deficit Procedure (EDP) may show excessive unwillingness to accept the easing of conditions, given that it can be viewed as part of broader easing of the aggregate stance of the EDP on the basis of the aggregate euro zone considerations.)
I don’t want to exaggerate the impact of leadership of the weaker countries on this issue, but it could help tilt the steering wheel from what looks now like a very dangerous course. Greece has got itself into a mess, much of it of its own making. Greece has no choice but to make tough adjustments, but giving more time may be the only way to prevent political rejection. Solidarity – but most of all self interest – should lead all euro zone countries to work hard at finding a workable way out.