Eurozone leaders must stop trying to “muddle through” the crisis
October 10, 2011
Less than three weeks before the next G20 meeting in France, the eyes of the world are firmly fixed on Europe. President Nicolas Sarkozy seems to share the desire of many of his predecessors for grand global meetings. Well, this one is going to be just as, if not more, important than many such meetings of the past. The power of the G20 meetings in the spring of 2009 in London, the success of the Plaza September 1985 gathering and the Louvre Accord 1987 will need to be matched, if not exceeded, if we are to get past the current eurozone crisis.
A number of key policymakers from outside of the eurozone, including Tim Geithner and George Osborne, have highlighted the November 3 meetings as critical in setting global financial markets on a better footing. On Sunday UK prime minister David Cameron urged European leaders to take a “big bazooka” approach to resolving the crisis, warning they have just a matter of weeks to avert economic disaster. Unsurprisingly, expectations have been raised. The credibility of the Europeans’ stance will be crucial, possibly in a way that it hasn’t been at any global leaders’ gathering yet.
Unfortunately, eurozone’s policymakers seem to be fond of the “muddle through” approach to policymaking. This has been a feature of European solutions to issues arising from the European Monetary Union since its creation in 1999, through dealing with challenges such as the adjustment of the Growth and Stability Pact and, of course, repeatedly since the Greek debt crisis exploded last spring. Yet it seems as though muddling through is no longer enough to keep financial markets at bay. If no credible “big bang” is unveiled next month to convince the markets, consequences are likely to be severe.
Firstly, given hardly anyone still believes Greece can avoid a major debt restructuring, it would be better to get it over and done with. The country appears to have neither the aptitude or flexibility to cope with the repayments it faces, and it clearly can’t grow its way out of such debts. By offering a decisive restructuring, agreed and recognised by key European and G20 policymakers, this would show eurozone leaders were finally facing up to reality.
Secondly, policymakers need to agree to a framework for the adequate recapitalisation of Europe’s banking system. If there is going to be a successful debt restructuring for Greece, with minimum adverse contagion effects, this will be vital. President Sarkozy and Chancellor Angela Merkel appear to have agreed in Berlin this weekend that they will have a comprehensive package by the end of the month. Taking guidance from the successful US stress tests of early 2009, it is time for them to take the lead, and put an end to the constant second guessing by the financial markets about the capital adequacy of Europe’s banks.
Thirdly, leaders must make clear that while Greece has a solvency challenge, the bigger economies of Italy and Spain only have problems with liquidity. In order to convince the markets of the distinction, both Italy and Spain need to demonstrate that their medium to long term fiscal paths are credible and improving. Adopting Germany’s constitutional budget stability model could be a major feature.
Lastly, and perhaps most importantly, all the key eurozone policymakers have to show that they are on the same page. This is true with respect to Germany and France, as well as the European Union itself and the European Central Bank. While it is important that the ECB’s cherished independence be respected, events have demonstrated throughout the past troubled 18 months, that the bank has been forced to undertake a number of policies it had not planned to do. It needs to embrace a different spirit if agreements made by Europe’s leaders and the G20 are to be successful. Many other independent central banks have considerable flexibility without abandoning their prime goals. Just look at the Federal Reserve Board, the Reserve Bank of New Zealand, which pioneered inflation targetting and, most recently, the Swiss National Bank.
By using the phrase “unlimited” in describing their how far they would go to intervene to support a lower limit for the Swiss Franc’s value, the SNB has not had to spend much at all to achieve these goals (so far at least). By adopting the same bold approach to direct liquidity-provision for the European bond markets, or possibly through leverage for the expanded European financial stability facility, the ECB could turn the current situation around. Longer term, steps towards genuine fiscal union including the development of a true euro-denominated bond market seem sensible goals. But unless Europe’s policymakers stop trying to “muddle through”, all these goals will be pointless.
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The writer is chairman of the asset management division of Goldman Sachs and former chief economist at the investment bank.
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