EU’s Message to the PIS Nations: Go Hog Wild!
February 9th, 2010If the accounts I’ve been reading are true (see Growing Prospects for Bailout for Greece), Greece might be the beneficiary of an imminent bailout. As reported by Bloomberg:
Olli Rehn, who takes over as European Union economic affairs commissioner tomorrow, said support for Greece will be discussed in coming days. Michael Meister, a German legislator from Chancellor Angela Merkel’s Christian Democrats, said lawmakers in that country are considering financial assistance.
The EU (in particular France and Germany) ought to be very careful in how it approaches the bailout so as to prevent moral hazard. And in this case I am not referring to moral hazard in the sense that the bailout provides Greece an incentive to behave badly again in the future, but moral hazard in the sense that Portugal, Ireland (maybe Italy too), and Spain now have the incentive to continue to behave badly. After all, if France and Germany come to the rescue of Greece, it sends a signal to other fiscally troubled European nations that they are likely to receive similar treatment, …and especially for the more consequential economies of Spain and Italy (see Euro Perspective).
If the EU comes to the aid of Greece, what incentive does Spain, Portugal, Italy, or Ireland have to bring their fiscal house in order. In fact, what’s to prevent them from going on a bigger fiscal bender? For after all, although Greece represents only a small fraction of European GDP, allowing Spain and Italy to falter could be disastrous for the Union.
February 9th, 2010 at 5:59 pm
Could you clarify what you mean when you say “Spain now [has] the incentive to continue to behave badly”. Italy and Greece, with long-running structural deficits and high debts, I undertand. But your link makes the point about how their situations differ:
http://krugman.blogs.nytimes.com/2010/02/07/know-your-deficits
I wonder how, in your opinion, has Spain been behaving badly? And what would you propose they do to fix it?
February 9th, 2010 at 6:09 pm
CSpain, in the case of Spain, what I mean by behaving badly is that Spain has less of an incentive to take the tough decisions to address its deficit/debt problem. I agree that Spain’s problem was not entirely its own creation in the sense that it was not a repeat offender that had run structural deficits like Italy and Greece. But now that such deficits exist, it is unclear that Spain will have the incentive to address it.
February 9th, 2010 at 9:37 pm
Oops CSpain, I forgot to address your second question. In my opinion an IMF-supported solution that imposes some much needed fiscal discipline is a better route for Greece. This would serve as an example for the rest of the fiscally troubled European nations (including Spain), and provide the appropriate incentives to credibly commit to bringing their deficits down to 3% of GDP.
But make no mistake, increasing taxes and/or severely curtailing spending to bring deficits down will be a very painful process for the citizens of those countries.