Blog Post

How to stop the European contagion

What’s at stake: This isn’t what was meant to happen. The Irish bailout was meant to stop and reverse the stress in European markets. Instead, the eurozone’s turmoil is spreading to Portugal and Spain, putting further pressure on policy makers as they grappled with decisions over emergency financial bailouts and the European Crisis Resolution Mechanism. […]

By: Date: November 26, 2010 Topic: European Macroeconomics & Governance

What’s at stake: This isn’t what was meant to happen. The Irish bailout was meant to stop and reverse the stress in European markets. Instead, the eurozone’s turmoil is spreading to Portugal and Spain, putting further pressure on policy makers as they grappled with decisions over emergency financial bailouts and the European Crisis Resolution Mechanism.

The market’s reaction to Ireland’s bailout

Mohamed El Erian
worries that the contagion is spreading fast and that the levees put around Ireland do not preclude speculation from spreading. He posits that the rescue will be of little use if it covers large scale exodus or depositors and creditors. In his view, the crisis is just at its inception and clearly flags the risk that markets turn to Spain.

Felix Salmon writes that what the CDS tell us is that any bailout now only serves to make a future default more likely. The contrast from just a few months ago is striking: while the 1-year CDS showed the highest default probability back then, today it’s the lowest. The EU bailout of Ireland confirms that Portugal will probably not be allowed to default any time soon. But markets now consider a default is more likely 3 years out, and on from there.

Michael Schuman writes that the hope was that backing up Ireland would quell the contagion spreading to other weak Eurozone members, especially Portugal and Spain. But the opposite has happened. The fact that Ireland, considered a paragon of reform, was forced into a bailout has only solidified fears in financial markets that the others could be doomed as well. The strategy so far has been simple: Put up rescue funds, demand reforms in the weak economies and hope those steps rebuild confidence in financial markets that the Eurozone’s struggling nations can pay back their giant debts. Europe’s bailout strategy has failed because investors don’t believe it is viable.

What to do now?

Paul Krugman
writes that the European bailout basically short-circuits the vicious circle induced by higher interest rates. But the bailout will only work if the vicious circle is at the heart of the story — as opposed to being a symptom of the fundamental unsustainability of the austerity-and-full-repayment strategy. That is, it will work only if Ireland is the fundamentally sound victim of a self-fulfilling panic. And that’s a hard claim to make. If the problem is not essentially one of confidence and liquidity, Ireland (and Greece, and Portugal, and …) would need actual debt relief. Yet that is not on the table. Ireland, like Greece, is now insulated from the need to go to the market. But it still faces an enormous debt load, made worse by deflation and stagnation.

Michael Schuman writes that the entire bailout mechanism forged by the EU isn’t tackling the roots of that crisis. What the Eurozone requires is a proactive effort to engage its problems in a more comprehensive way, helping the weaker members to resolve their debts and return to healthy growth, not just saddling them with further debt to prevent losses at European banks. In other post, Schuman argues that Germany and France can’t just put up some cash for a bailout and go about their business. Germany, for example, should show a stronger commitment to reducing its current account surplus by liberalizing its still highly regulated economy to spur more domestic demand and buy more from the rest of Europe.

Emma Saunders
argues that EU officials may have pressured Ireland to accept a bailout for nothing. High yields were surely not caused by Ireland’s lack of funds; otherwise we would have seen a big drop since Sunday. Yields spiked after Angela Merkel’s comments that bondholders might need to share the pain. Yields tempered after her comments were partly retracted. No other event – such as a bail-out agreement – has helped to calm the markets.

Jacob Funk Kirkegaard argues that what we are seeing with Spain is a largely speculative attack by the markets on the inability of current EU policy tools (EFSF/EFSM) to address Spain in the same way as Greece, Ireland and Portugal. Certainly, Spain faces serious economic growth and labour market challenges as it works its way through a devastating real estate collapse. But it has neither the debt stock of Greece, the bust banks of Ireland, nor the complacent government of Portugal. The case that economic fundamentals are behind the turmoil is missing. Instead, market concerns seem overwhelmingly speculative. Kirkegaard is confident that the EU can cope with such a threat as it functions best in crisis, and the political will to preserve the eurozone should not be underestimated.

Paul De Grauwe compares the possibility of debt restructuring to the possibility of devaluation during the Exchange Rate Mechanism (ERM) years. He argues that the proposed sovereign debt default mechanism for the eurozone introduces a similar incentive structure for speculators and national authorities as in the ERM. He concludes that a monetary union can only survive if there is a willingness to provide mutual financial assistance in times of crisis. The solution therefore is not to implement the sovereign debt default mechanism, which will lead to the demise of the eurozone, but to give a permanent character to the European Financial Stability Facility.

Bruegel Economic Blogs Review is an information service that surveys external blogs. It does not survey Bruegel’s own publications, nor does it include comments by Bruegel authors.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More by this author
 

Blog Post

It’s hard to live in the city: Berlin’s rent freeze and the economics of rent control

A proposal in Berlin to ban increases in rent for the next five years sparked intense debate in Germany. Similar policies to the Mietendeckel are currently being discussed in London and NYC. All three proposals reflect and raise similar concerns – the increase in per-capita incomes is not keeping pace with increases in rents, but will a cap do more harm than good? We review recent views on the matter.

By: Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: July 8, 2019
Read article More on this topic
 

Blog Post

The breakdown of the covered interest rate parity condition

A textbook condition of international finance breaks down. Economic research identifies the interplay between divergent monetary policies and new financial regulation as the source of the puzzle, and generates concerns about unintended consequences for financing conditions and financial stability.

By: Konstantinos Efstathiou and Bruegel Topic: Finance & Financial Regulation Date: July 1, 2019
Read article More on this topic
 

Blog Post

The June Eurogroup meeting: Reflections on BICC

The Eurogroup met on June 13th to discuss the deepening of the economic and monetary union (EMU) and prepare the discussions for the Euro Summit. From the meeting came two main deliverables: an agreement over a budgetary instrument for competitiveness and convergence and the reform of the European Stability Mechanism (ESM) treaty texts. We review economists’ first impressions.

By: Bruegel and Inês Goncalves Raposo Topic: European Macroeconomics & Governance Date: June 24, 2019
Read article More on this topic
 

Blog Post

The campaign against ‘nonsense’ output gaps

A campaign against “nonsense” consensus output gaps has been launched on social media. It has triggered responses focusing on the implications of output gaps for fiscal policy under EU rules, especially for Italy. But the debate about the reliability of output-gap estimates is more wide-ranging.

By: Konstantinos Efstathiou and Bruegel Topic: European Macroeconomics & Governance Date: June 17, 2019
Read article More on this topic
 

Blog Post

The inverted yield curve

Longer-term yields falling below shorter-term yields have historically preceded recessions. Last week, the US 10-year yield was 21 basis points below the 3-month yield, a feat last seen during the summer of 2007. Is the current yield curve a trustworthy barometer for future growth?

By: Inês Goncalves Raposo and Bruegel Topic: Global Economics & Governance Date: June 11, 2019
Read article More on this topic
 

Blog Post

The 'seven' ceiling: China's yuan in trade talks

Investors and the public have been looking at the renminbi with caution after the Trump administration threatened to increase duties on countries that intervene in the markets to devalue/undervalue their currency relative to the dollar. The fear is that China could weaponise its currency following the further increase in tariffs imposed by the United States in early May. What is the likelihood of this happening and what would be the consequences for the existing tensions with the United States, as well as for the global economy?

By: Inês Goncalves Raposo and Bruegel Topic: Global Economics & Governance Date: June 3, 2019
Read article More on this topic
 

Blog Post

The next ECB president

On May 28th, EU heads of state and government will start the nomination process for the next ECB president. Leaving names of possible candidates aside, this review tries to isolate the arguments about what qualifications the new president should have and what challenges he or she is likely to face.

By: Bruegel and Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 27, 2019
Read article More on this topic More by this author
 

Blog Post

The latest European growth-rate estimates

The quarterly growth rate of the euro area in Q1 2019 was 0.4% (1.5% annualized), considerably higher than the low growth rates of the previous two quarters. This blog reviews the reaction to the release of these numbers and the discussion they have triggered about the euro area’s economic challenges.

By: Konstantinos Efstathiou Topic: European Macroeconomics & Governance Date: May 20, 2019
Read article More by this author
 

Blog Post

Is an electric car a cleaner car?

An article published by the Ifo Institute in Germany compares the carbon footprint of a battery-electric car to that of a diesel car, and argues a higher share of electric cars will not contribute to reducing German carbon dioxide emissions. Respondents rejected the authors’ calculations as unrealistic and biased, and pointed to a series of studies that conclude the opposite. We summarise the article and responses to it.

By: Michael Baltensperger Topic: Energy & Climate, Innovation & Competition Policy Date: May 13, 2019
Read article More on this topic More by this author
 

Blog Post

All eyes on the Fed

Last week the US Federal Reserve left the federal funds rate unchanged and lowered the interest rate on excess reserves. We review economists’ recent views on the monetary policy conduct and priorities of the United States’ central bank system.

By: Inês Goncalves Raposo Topic: Global Economics & Governance Date: May 6, 2019
Read article More on this topic More by this author
 

Blog Post

Is this blog post legal (under new EU copyright law)?

How new EU rules on using snippets from news publishers and on copyright infringement liability might affect circulation of information, revenue distribution, market power and EU business competitiveness.

By: Catarina Midões Topic: European Macroeconomics & Governance Date: April 8, 2019
Read article More on this topic
 

Blog Post

Secular stagnation and the future of economic stabilisation

Larry Summers’ and Łukasz Rachel’s most recent study documents a secular fall in neutral real rates in advanced economies. According to the authors, this fall would be even more marked in the absence of offsetting fiscal policies. Policymaking in a world of permanently low interest rates may be hard to navigate, especially in troubled waters. We review economists’ views on the matter

By: Inês Goncalves Raposo and Bruegel Topic: European Macroeconomics & Governance Date: April 1, 2019
Load more posts