Nouriel Roubini's Global EconoMonitor

Saving the Euro

From the FT:

The contagion from the Greek and Irish crises has spread to Portugal, Spain and possibly Italy. Unless the eurozone undertakes radical reform there is a risk of disorderly defaults by fiscally stressed member states and even – eventually – of a break-up of the monetary union.

The current muddle-through approach to the crisis is to “lend and pray”: ie, provide financing to member states in distress (conditional on such states implementing fiscal adjustment and structural reforms) in the hope that their problems are of liquidity rather than solvency. But this could lead to disorderly defaults and a break-up of the European Monetary Union (EMU), unless institutional reforms and other policies leading to closer integration and restoration of growth in the eurozone’s periphery are implemented soon.

The periphery members all suffer from a loss of competitiveness, low economic growth (Italy, Portugal) or contraction (Spain, Ireland, Greece), and large private and/or public debts. Spain’s and Ireland’s problems started with too much debt in the private sector (due to a debt-financed housing bubble) and morphed into a public debt problem once the losses from the housing bust were socialised. Greece had a reckless fiscal policy for more than a decade, which led to a public debt crisis. Portugal and Italy have lower levels of private debt but large stocks of public debt. Distressed sovereigns that have already lost market access (Greece and Ireland) were bailed out by the IMF and the EU, but no one will come from Mars to bail out these super-sovereigns if the sovereigns end up insolvent. Thus, a new plan is needed to save the eurozone.

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