The Eurozone’s debt crisis certainly looks quite intractable, but in fact several options could stabilize or even mitigate the situation. The problem? They are all hard sells for elected politicians.
Let’s call them the three Es: Eurobonds, the EFSF and the ECB. Each could play a role in tackling the ongoing Eurozone crisis, but each would also entail costs that electorates are unlikely to accept. As Euro Group President and Luxembourg Prime Minister Jean-Claude Juncker once said of other unpopular economic reforms: “We all know what to do, we just don’t know how to get reelected after we’ve done it.”
Eurobonds – so goes the theory – would replace country-specific bonds with a common bond that pools Eurozone governments’ sovereign debt. The conditions governing issuance would presumably ensure that no single country puts itself into excessive debt. This solution seems to have a lot going for it at first glance, as the Eurozone ratio of sovereign debt to gross domestic product is better than that of the UK, the US or Japan. But this doesn’t guarantee that rating agencies will play ball: Standard & Poor’s has already warned that it won’t rate Eurobonds any higher than their lowest-rated participants.
During the subprime crisis, we learned the hard way that you can’t mix AAA- and CCC-rated debt and expect to get untainted AAA debt as a result. I don’t think you can call it CCC, either – but nevertheless, presenting Germany, France and the Netherlands with the prospect of losing their AAA ratings makes this solution rather difficult from a purely political perspective.
The European Financial Stability Facility (EFSF) could also mitigate the current crisis. But many analysts and market participants think it would need far greater means at its disposal, especially if Italy keeps looking vulnerable. We often hear two trillion euro as a target figure. This would certainly exceed Germany’s financing capability, and with so much depending on German taxpayers, politicians there won’t be able to win elections even with a lower number.
Finally, the European Central Bank (ECB) could play a part in taming the crisis by buying more government bonds from troubled countries. It used this tactic at the beginning of the crisis, and revived it again in the last few weeks as Spain and Italy came under increasing attack. Nevertheless, detractors claim that a policy like this raises the long-term risk of inflation. In fact, ECB chief economist Jürgen Stark recently resigned over this very issue, showing that the bond-buying option won’t win many friends in inflation-phobic Germany.
Creating the euro was a political project, not an economic one, and rescuing it will therefore require a political decision. Economics can only help to identify the costs associated with the possible solutions, and these costs will of course make it difficult for decision makers to get reelected. Forced to choose among various costly and unpopular options, European politicians just can’t win.
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