Ball in the court of the ECB, but not only them..
1) To contain the public finance situation, the following would help:
- Austerity measures (public sector cuts, tax hikes)
- Economic growth (boosts revenues and lessens outlays automatically and boost the GDP, debt and deficits are expressed as a ratio of GDP..)
- Inflation: reduces the real value of the outstanding debt
- Currency devaluation: softens the impact of the austerity measures
- Structural reform to make economies more productive and competitive (long-term)
) European governments need to embark on a considerable austerity program
- To keep public finances from spiralling out of control.
- Too much front-loaded austerity will be self defeating though, it will sink the economy which could create vicious cycles (lower GDP, higher deficits and debts, more austerity, etc.).
- The best would be to provide long-term plans for credible reductions in deficits and debts.
) The ECB (European Central Bank) needs to:
- Buy government debt. The Treaty of Maastricht says they cannot do that directly, but they can do it indirectly. This keeps interest rates and confidence from spiralling out of control and keeps the interbank market afloat.
- It would also lead to money creation (wholly absent at present in Europe), which would manage the euro lower, which is necessary to soften the impact of the austerity and keep Europe from having a double dip recession that would worsen its public finance situation
- Get creative, for instance, they could issue credit default swaps (CDS’s) on European debt themselves. This would get the price of these down, wrongfoot speculators, and drive interest rates on government debt down. At present, the thinly traded CDS markets are the main driver of these interest rates, which is self-defeating.
) Greece debt should be restructured and it should consider leaving the euro
- It’s situation is beyond help. The austerity (13% of GDP) will sink the economy, so the necessary economic growth nor inflation will be forthcoming to ease the public finance situation. In fact, it will make it worse, much worse.
- Greece should seriously consider leaving the euro. This much austerity without an offsetting devaluation just can’t work. But only Greece can decide this (there is no mechanism for other countries to kick them out of the euro)
- They could rejoin after they’ve sorted out their mess. Leaving the euro is no substitute for addressing their structural problems in the economy or their public finance mess.
) All this should happen orderly, to keep contagion at bay
- This is why the ECB action set out above is so important, they need to keep banks and the interbank market afloat and interest rates on debt reasonable. Without this, the markets will be in the driving seat and force the issues, and the problems will spread to other countries.
- Being within the euro still comes with large benefits, but if the outcome of this all is a smaller, but more cohesive euro area, it isn’t all that bad (it’s actually what Germany and a few other countries, like the Netherlands, wanted all along).