ECB preparation for Greek default
My colleague Shahin has just posted a blog entry in which he argues that the broad framework of European Financial safety nets is in place and will not improve very meaningfully after the ESM is ratified. Therefore, time may have come to let Greece default. However, he is concerned that the ECB will not agree […]
My colleague Shahin has just posted a blog entry in which he argues that the broad framework of European Financial safety nets is in place and will not improve very meaningfully after the ESM is ratified. Therefore, time may have come to let Greece default. However, he is concerned that the ECB will not agree to do so because of lack of preparation for what would be needed. In particular, he argues that to preserve the integrity of monetary union, the ECB will either have to expand the ELA and let Target 2 balances rise substantially more. Alternatively, if it refuses to do so, in anticipation or in response to a euro area exit, it may become necessary to impose capital controls to prevent capital flights from the other peripheral countries.
I disagree with both. First, the eurosystem is by now prepared for a Greek default. The December 8 decision of the ECB’s governing council has already lowered collateral standards (link to press release). In particular, "To increase collateral availability by (i) reducing the rating threshold for certain asset-backed securities (ABS) and (ii) allowing national central banks (NCBs), as a temporary solution, to accept as collateral additional performing credit claims (i.e. bank loans) that satisfy specific eligibility criteria. …" It seems that there is sufficient flexibility to provide additional liquidity to the banks in Greece if needed. Greek government bonds could largely become unnecessary for liquidity.
Suggesting capital controls is more worrying. Indeed, imposing capital controls would basically imply the end of monetary union. The slightest doubt that this is seriously contemplated would lead to an unprecedented panic. Overall, I agree with Muenchau’s recent post as regards Greece. A managed default inside the eurozone is possible. Claims of contagion effects of this appear to be largely exaggerated. Absolute exposures to Greece are minimal by now (France and Germany have around 7bn in their banking system of Greek debt). More importantly, yields of other countries have typically come down after every decision to involve private creditors in Greece during 2011 (see my column). During the last two months yields have come down even further despite the more and more imminent default of Greece. So why would the actual event make a difference now?
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