Eventually their electorates would force a change in policy.
Two factors are exacerbating the problem and lengthening the list of countries being drawn into the maelstrom. The first is European policymakers’ failure to agree on the extent and terms of any rescue. The second is that although austerity might be required, without economic growth efforts to improve budget deficits will be negated by recessionary effects on tax revenues and government welfare spending.
Squeezing deficits in uncompetitive economies needs an offsetting growth boost. In the case of the UK, devaluation provides a remedy but this is denied the struggling eurozone economies. If the euro were competitive, laggards within Europe might just be able to hold their own in global markets, but the opposite has occurred. Tough talk on inflation has pushed the euro higher over the past year.
And tough action…
Having ignored the structural problems in the economies of Greece, Ireland and Portugal, Europe has allowed a difficult situation to grow much worse. Weakening confidence and a drying up of liquidity has resulted in Italy seeing its debt costs rocket since early July. This has dramatically raised the stakes, while making the choice of policy more clear-cut, even for European policymakers.
It is virtually inconceivable for Europe to countenance a default by Italy. Even Europe should now realise that the choice it faces has become unambiguous – put a cordon sanitaire around the default zone and adopt looser monetary policies or face a break-up of the eurozone, with its concomitant severe economic, banking and political implications.
There now seems to be a willingness to countenance a de facto Greek default; however, a default in present conditions would have to be accompanied by measures to reverse the current contagion.
If Europe does not rapidly restore confidence, it would represent a policy failure of epic proportions. It seems likely though that policy measures previously ruled out – that is rate cuts, a weaker euro, official purchases of problem debt, un-sterilised liquidity provision (QE) and loans at below market rates – will now have to be ruled in. For the eurozone to accept this and its political implications for economic governance may prove as uncomfortable as a hen laying an ostrich egg, though interesting to watch.
