Body
The frantic spectacle of European leaders struggling to avert a financial crisis caused by Greece has seemed unsettling and at times amateurish. It is certainly easy to point fingers at policymakers patching solutions together—solutions that immediately unravel under pressure from the markets—and to do so again and again over the last several weeks.
But if you look less at the sausage-making process and more at the final result, you have to be impressed. There are, of course, many painful steps that still need to be undertaken by all sides—the Greeks, the weaker European economies, the European banks, and the European governments. But the derision of some commentators and the uneasiness of the markets seem overstated.
Recall the disdain, for example, when the Troubled Asset Relief Program (TARP) was introduced in late 2008 or the bank stress tests were carried out last year. Today most would argue that they ultimately played a large and constructive role in containing the immediate crisis contagion. In time, Europe's response to the Greek crisis will be viewed in a similar positive light.
Though numerous and poorly timed, Europe's policy reversals during this crisis have at least been in the right direction. European leaders went from a "small number with no IMF involvement" to the required "BIG number with 100 percent IMF conditionality" for all the money involved. It is difficult to imagine a stronger endorsement of the much-maligned multilateral organizations than the willingness of large eurozone governments to commit hundreds of billions of taxpayers' money exclusively under conditions imposed by the IMF.
Second, and more important, European leaders have produced a constructive political "grand bargain" between member states and the European Central Bank (ECB) concerning the future of European monetary union.
For its part, the ECB agreed to move beyond its minimalist obsession with price stability, a legacy of the Bundesbank mentality and in defiance of Germans on the central bank's council. It has effectively agreed to become a credible "lender of last resort" and crisis manager for the entire eurozone by granting its own governing board the ability to buy essentially whatever asset—public or private—it wants through the central bank's new "Securities Market Program." With the new powers it essentially granted itself, the ECB now has the ability to counter most of the contagion risk from a future Greek default.
The crucial and politically more important question, however, is what the EU member states are now prepared to contribute to this "grand bargain." It would seem logical that the next step involve a European fiscal—as well as monetary—union permitting massive intra-European fiscal transfers from the richest to the neediest countries. But that prospect does not exactly lie around the corner. No revision of the Lisbon Treaty (which would be required for this scenario) institutionalizing regular budget transfers will be passed by the European Union or the key eurozone members any time soon.
Instead, member states have agreed to put on a "fiscal straight jacket" and accept "legislated deflation," following the path of Latvia, Ireland, Greece (too late of course), Spain, Portugal, and now Italy. In these cases, governments have cut public wages (wages in Europe have proved far less sticky in this crisis than economic theory would predict) and taken a host of other fiscal austerity measures. The negative short-term effects on European growth prospects are obvious.
The volte-face of the leftwing Spanish government after the "grand bargain" was announced—which risks political suicide because of cuts in public wages and a freeze on pensions—means that the resolve of eurozone governments to act in the face of crisis must be taken seriously. Europe really does seem prepared to embark on "coordinated fiscal austerity" and move back to Maastricht Treaty basics.
Will this new political commitment to a new Stability and Growth Pact (SGP) be more credible than it was in 1997 (when the 60 percent debt stock criteria was abandoned) or in 2004 (when the big eurozone countries undermined the 3 percent deficit criteria)? It is early, but the signs from Madrid and elsewhere are good. A Greek default (or debt restructuring), would produce devastating results, proving to one and all the political cost of running unsustainable fiscal policies. The price paid by fiscally wayward countries is certain to shock European electorates and alter what kind of fiscal policies are politically sustainable.
One lesson of this crisis is that the days of a phony eurozone government bond yield convergence are gone for good. Financial markets now happily and rapidly apply very significant default premiums on irresponsible eurozone countries. The "new SGP" envisioned by the grand bargain of this month will not have to be pressed on errant countries by politically reticent European governments. Instead it will be enforced in real time by financial markets. The chimera of "political peer pressure" is gone, replaced by the iron law of the marketplace. This is a positive step.
Without a unified fiscal or political authority, the European house does remain "half built." But now the world gets to find out whether the European project is based on a fundamentally flawed design or whether it works when member countries actually stick to the rules.
Finally, the European actions, while painful, have accomplished what is necessary to prevent a contagion from a medium-term Greek default—for example, in the form of a debt restructuring next year. In that sense, it could well serve as an important stress test for the "grand bargain" negotiated this month. Any new SGP cannot hope to function in the long term without a willingness by the European Union to let insolvent countries go while protecting the solvent members from the associated contagion. A Greek default might therefore be politically necessary to mark the limits of moral hazard for the rest of Europe.
