by Don Alexander, MBA
Associate, RSD Solutions Inc.
Eurozone policymakers have put together another plan to save the euro. Will it work – only time will tell? Charles Wyplosz, in a communiqué They still don’t get it (VOXEU, 25th Oct.) reviews recent progress. He is not optimistic they will take the necessary steps. He notes that by rejecting an ECB role, leaders have guaranteed that any package will fail as too little too late. They are addressing two of the three needed steps: putting Greece on a sustainable path and backstopping banks. The last stop still needed is to backstop all European sovereign debt to avoid contagion.
The author identified three issues in an earlier VOXEU column (22nd Aug 2011) for policymakers: a clear misunderstanding of the situation, understanding the danger ahead, and unwilling to take the necessary steps to resolve the situation. The real danger is contagion has spread to Italy and Spain pass the point of no return and the risk of spreading to core countries.
The European Financial Stability Facility (EFSF) is too small to deal with the amounts involved, even under the new proposal. The authorities must move ahead of the curve and put together policies to contain the crisis and avoid further contagion – the new proposal may not be enough. This can be accomplished by placing a floor under public debt valuation. This can be accomplished two ways: the ECB can act as a guarantor of public debt as maturing debt is rolled over and the second approach is to replace maturing Eurozone debt with Eurobonds.
The ECB is the only institution that can deal with the amounts involved and provide breathing space to address bank recapitalization. The continued rescue packages for banks and government are creating moral hazard problems. Long-term, authorities must address the weakness of the Stability and Growth Pact and enact restrictive fiscal policies with monitoring. Wyplosz notes that recapitalizing Greek banks is a temporary solution, but could undermine its purpose by increasing debt levels. The only solution is to tap the EFSF short-term and involve the ECB to provide a backstop for public debt.
The worst outcome is to reject a role for the ECB. The lack of a backstop for public debt prices will allow the crisis to fester and deepen pushing up the cost of resolution.
For more on this follow the link: http://www.voxeu.org/index.php?q=node/6845
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