Plan A*

Although he had a rough ride in Comments here, Lorenzo Bini Smaghis London Business School presentation provides a useful official take on the choice between the Plan A of fiscal adjustment and the Plan B of default. (From a narrowly Irish perspective, his identification of the costs of default probably puts too much emphasis on balance sheet contagion and too little emphasis on the reputational damage to an economy that is one of the world’s most dependent on international trade and investment. Understandably, he also does not dwell on possible costs of default for access to ongoing international assistance, not least from the ECB itself.)

However, I would put the case for Plan A in more dynamic terms a Plan A* perhaps. The literature on the option value of waiting provides a useful dynamic angle on the default decision. This applies to a decision that is costly and irreversible and must be taken under uncertainty that will lessen with time. An outstanding feature of our present predicament is that there is unusual disagreement about whether we can stabilise the debt to GDP ratio and regain market access. There is a good chance that the range of this uncertainty will narrow substantially over the coming year. Four major sources of (diminishing) uncertainty stand out: