Tag Archives: eurozone crisis

By Simon Johnson

Last weekend official Washington was gripped by euphoria, at least briefly, as people attending the IMF annual meetings began to talk about how much money it would take to stabilize the situation in Europe.  At least one eminence grise suggested that 1.5 trillion euros should do the trick, while others were more inclined to err on the side of caution – 4 trillion euros was the highest estimate I heard.

This is a lot of money: Germany’s annual Gross Domestic Product (GDP) is only about 2.5 trillion euros, and the combined GDP of the entire eurozone is about 9.5 trillion euros.  The idea is that providing a massive package of financial support would “awe” the markets “into submission” – meaning that people would stop selling their holdings of Italian or Spanish debt and thus stop pushing up interest rates.  Ideally, investors would also give Greece and Portugal some time to find their way to back to growth.

But this is the wrong way to think about the problem.  The issue is not money in the form of external financial support – provided by the IMF or other countries to parts of the European Union.  The real questions are: will Italy get complete and unfettered access to the European Central Bank, and when will we know this? Continue reading →

By Simon Johnson

In today’s Financial Times, Peter Boone and I have an op-ed with proposals for reforming how the eurozone operates.  The current arrangements have proved unstable – encouraging countries to run excessive budget deficits while also giving banks an incentive to both finance profligate governments and also fuel real estate bubbles.

Addressing these problems would require creating a “core” of countries that keep the euro, agree to much more unification of fiscal policy, and put in a place a single strong bank regulator/supervisor.  A move in this direction may not seem likely in the short-term, but the pressures are still building.

By Peter Boone and Simon Johnson

The eurozone self-rescue plan announced last night has three main elements:

1. 750bn euros in a fiscal support program, with 1/3 coming from the IMF (although this was apparently news to the IMF).
2. The European Central Bank promises to buy bonds in dysfunctional markets.
3. Swap lines with the Federal Reserve, to provide dollars.

At first pass this package might seem to be in with what we recommended a week ago and again on Thursday.

But the European central banks have come in very early – with government bond prices still high – and there is no sign yet of credible fiscal adjustment for Spain and Portugal.  The eurozone apparently did not even discuss the situation in Ireland, which seems increasingly troubling.

This is a whole new level of global moral hazard – the result of an alliance of convenience between troubled governments in the south of Europe and the north European banks (and implicitly, north American banks) who enabled their debt habit.  The Europeans promise to unveil a mechanism this week that will “prevent abuse” by borrowing countries, but it is hard to see how this would really work in Europe today.

Overall, this is our assessment: Continue reading →

By Peter Boone and Simon Johnson

Europe needs a new recovery plan, bigger and broader than anything put together so far.  This weekend is the perfect time to put such a plan together.  But be wary of committing official resources too early in this market downdraft – smart policymakers will calmly let the markets fall further, in order to benefit from the rebound potential.

In the last few days, bond markets have decided that the deflationary adjustments – cutting wages and prices — needed in large parts of the eurozone are not politically feasible.  The deflationary spiral that will come with fiscal cuts causes political turmoil and reduces revenues – that in turn makes it ever harder to service debt; see Greece this week.  Eurozone countries running large budget deficits with substantial outstanding public debt are finding they are cut off from credit markets as a result.  This is a solvency issue, not a liquidity issue.

But do not rush into this gap.  If the European Central Bank (ECB) were to start buying Spanish debt today, for example, they would find an abundance of sellers because the bonds are fundamentally overvalued.  Continue reading →