Blog Post

The balance of financial terror

The relationship between Greece and the rest of the euro area are increasingly reminiscent of the Cold War’s balance of terror. We are speaking of financial terror only and Greece is no USSR, but the mechanics are strikingly similar. Start with the options for Athens. It is important to distinguish between budgetary and external aspects. […]

By: Date: May 22, 2012 Topic: Macroeconomic policy

The relationship between Greece and the rest of the euro area are increasingly reminiscent of the Cold War’s balance of terror. We are speaking of financial terror only and Greece is no USSR, but the mechanics are strikingly similar.

Start with the options for Athens. It is important to distinguish between budgetary and external aspects. Greece is forecasted to record a slight primary budget deficit in 2012, so should it default, forcing European partners to unplug assistance, it would have to tighten more (although only marginally). More importantly, the current account deficit is still expected to be close to 8 per cent of GDP this year. Without assistance and in the absence of significant private capital inflows, this deficit could only be financed by the ECB increasing its exposure even further. Should it refuse, as likely, Greece would be forced to close its external deficit precipitously – either within or outside the euro area.  If forced into an exit, what remains of the economy would instantaneously fall into chaos. Financial disruption would be massive, resulting in a chain of bankruptcies. Currency depreciation would substantially overshoot, especially as policy institutions have no credibility whatsoever. Foreign goods and equipment would become unaffordable. Eventually, but eventually only, depreciation would help rebuild competitiveness. In the meantime the damage would be massive. 

Turn now to the euro partners. A unilateral Greek default would undoubtedly be costly for them. Euro-area official exposure to Greece through assistance loans, ECB claims on the central bank and ECB holdings of government bonds amount to more than €250bn. To this sum must be added private sector exposure through bank loans and equity, roughly another €100bn. Additionally, a Greek exit would signal that there is nothing irrevocable with participation in the euro, turning the European currency into a sort of magnified fixed exchange-rates system; equally importantly, it would force to set rules for converting euro-denominated claims into the new currency, thereby indicating to every business or household what their assets and liabilities would become in the case of a euro break-up. No doubt this would trigger massive precautionary moves and undermine the rest of the euro area, starting with the weakest countries within it.

So each side can do major harm to the other one. The question is: will it happen?

Greek public opinion is adamantly in favour of remaining in the euro area while alleviating the austerity burden. But this is an inconsistent proposal. A Greek threat to default within the euro is not be credible if the ECB is ready to stop extending liquidity. The next government could wish to renegotiate some aspects of the programme or give priority to certain reforms. But it will still need a conditional assistance programme, until it completes the largest part of its adjustment.

The EU official line – no renegotiation of the programme, no exit at any price – is not credible either. First, it is hard to see how to object to changes in domestic priorities proposed by a newly elected government. For example, why should the EU rejects proposals to tax more and spend more, if this leaves the deficit unchanged?  Second and more importantly, the EU cannot deter Greece from making use of its leverage if the price it puts on exit is infinite. To strengthen its hand and make its tough line credible, it has to be ready to contemplate a forced exit. But the EU can only do that if equipping itself to limit potential damages. This means beefing-up firewalls and speeding-up preparations for further integration of the euro area through banking union and the issuance of common bonds. Here, it is Berlin that lacks consistency. Signals that it is close to reaching the limits to the price it is ready to pay to keep Greece within the euro are only credible if accompanied by willingness to consider bold moves to preserve the common currency. 

A lesson from the Cold War is that ultimately, rational behaviour proved to be the best insurance against disaster. Today also, both partners have a common interest in behaving in cool blood. They have to set red lines credibly and unambiguously, as well as to indicate where there is room for discussion. This can only happen after June 17, when a new coalition emerges from the election and forms a government in Athens. In the meantime, we are bound to live dangerously.


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 about event More on this topic
 

Past Event

Past Event

Fiscal policy and rules after the pandemic

What are the possibilities for shaping the new fiscal policy?

Speakers: Zsolt Darvas, Maria Demertzis, Michel Heijdra and Katja Lautar Topic: Macroeconomic policy Date: November 24, 2021
Read article
 

Blog Post

European governance

Including home-ownership costs in the inflation indicator is not just a technical issue

The European Central Bank is right to propose inclusion of owner-occupied housing services in the inflation indicator. But the ECB’s preferred method would involve an asset price in the consumer inflation indicator.

By: Zsolt Darvas and Catarina Martins Topic: European governance, Macroeconomic policy Date: November 18, 2021
Read article More by this author
 

Blog Post

Fiscal arithmetic and risk of sovereign insolvency

The record-high debt levels in advanced economies increase the risk of sovereign insolvency. Governments should start fiscal consolidation soon in an environment of low nominal and real interest rates and post-COVID growth.

By: Marek Dabrowski Topic: Global economy and trade, Macroeconomic policy Date: November 18, 2021
Read article More by this author
 

Opinion

European governance

Growth and inflation after the pandemic in the EU

Countries hit comparatively hard during the financial crisis, helped also by domestic and European policies, are bouncing back from the pandemic faster than their peers.

By: Maria Demertzis Topic: European governance, Macroeconomic policy Date: November 18, 2021
Read article Download PDF More by this author
 

Parliamentary Testimony

European governanceFrench Senate

European Union countries’ National Recovery and Resilience Plans: A cross-country comparison

Testimony before the Economic Affairs Committee of the French Senate.

By: Simone Tagliapietra Topic: European governance, French Senate, Macroeconomic policy Date: November 12, 2021
Read article Download PDF
 

Policy Contribution

European governance

Next Generation EU borrowing: a first assessment

The Next Generation EU programme is radically changing the way the EU finances itself and interacts with financial markets. This paper assesses the first design decisions made by the European Commission and the issuances that have taken place so far. It also outlines the potential risks and opportunities linked to this upgrading of the EU borrowing.

By: Rebecca Christie, Grégory Claeys and Pauline Weil Topic: Banking and capital markets, European governance, Macroeconomic policy Date: November 10, 2021
Read article Download PDF More by this author
 

Parliamentary Testimony

European governanceEuropean Parliament

The New Euro Area Inflation Indicator and Target: The Right Reset?

Testimony to the Monetary Dialogue Preparatory Meeting of the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Zsolt Darvas Topic: European governance, European Parliament, Macroeconomic policy Date: November 9, 2021
Read about event More on this topic
 

Past Event

Past Event

Phasing out COVID-19 emergency support programmes: effects on productivity and financial stability

How can European countries phase out the COVID-19 support measures without having a negative impact on productivity and financial stability?

Speakers: Eric Bartelsman, Maria Demertzis, Peter Grasmann and Laurie Mayers Topic: Macroeconomic policy Date: November 9, 2021
Read article
 

External Publication

European governanceEuropean Parliament

The new euro area inflation indicator and target: the right reset?

In-depth analysis on the European Central Bank's revised inflation target prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Zsolt Darvas and Catarina Martins Topic: European governance, European Parliament, Macroeconomic policy Date: November 4, 2021
Read about event More on this topic
 

Past Event

Past Event

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Petra Geraats, Wolfgang Lemke, Francesco Papadia and Massimo Rostagno Topic: Macroeconomic policy Date: November 4, 2021
Read article Download PDF
 

Policy Contribution

European governance

COVID-19 financial aid and productivity: has support been well spent?

While support schemes during the pandemic were not targeted at protecting ‘good’ firms, financial support mostly went to those with the capacity to survive and succeed. Labour schemes have been effective in protecting employment.

By: Carlo Altomonte, Maria Demertzis, Lionel Fontagné and Steffen Müller Topic: European governance, Macroeconomic policy Date: November 4, 2021
Read article Download PDF More on this topic
 

Working Paper

Does money growth tell us anything about inflation?

Attention should be paid to a possible sequence of negative events: if inflation would start to be volatile and money growth remains high, efforts to control inflation could be undermined.

By: Leonardo Cadamuro and Francesco Papadia Topic: Macroeconomic policy Date: November 4, 2021
Load more posts