Must-read: Barry Eichengreen and Charles Wyplosz: “How the Euro Crisis Was Successfully Resolved”
Must-Read: When people ask me if Barry Eichengreen is in, I sometimes say: No, he is in the 1920s. But he will be coming back via time machine and in his office this afternoon.
Now I learn that I was wrong: that he has been visiting Charles Wyplosz, whose home base is a parallel universe in which the Euro crisis was successfully resolved in 2010:
How the Euro Crisis Was Successfully Resolved: “When the newly elected Greek government of George Papandreou…:
…revealed that its predecessor had doctored the books, financial markets reacted violently. This column discusses the steps implemented by policymakers following this episode, which were essential in resolving the Crisis. What is remarkable, in hindsight, is the combination of pragmatism and reasoning based on sound economic principles displayed by European leaders. Instead of finger pointing, they acknowledged that they were collectively responsible for the Crisis….
A miracle [was] made possible by a combination of steely resolve and economic common sense. In their historic 11 February 2010 statement, European heads of state and government acknowledged that the Greek government’s debt was unsustainable. Rather than ‘extend and pretend’, they faced reality…. Greece, European leaders insisted, had to restructure its debt as a condition of external assistance…. Trichet, rather than opposing debt restructuring, opposed the Emergency Liquidity Assistance, noting that the ECB’s mandate limited it to lending against good collateral. German Chancellor Angela Merkel and French President Nicolas Sarkozy, not happy that their banks had recklessly taken positions in Greek bonds, agreed that those banks should now bear the consequences. If banks failed, then the German and French governments would resolve them, bailing in stakeholders while preserving small depositors. Chancellor Merkel was adamant: asking Greek taxpayers to effectively bail out foreign banks was not only unjust but would aggravate moral hazard….
[The] IMF staff’s debt-sustainability analysis showed that Greece’s debt was already too high for [any] large loan to be paid back…. The managing director quickly concluded that the expedient path was to ally with European leaders and embrace the priority they attached to debt restructuring. At the landmark meeting of the IMF Executive Board on Sunday 10 May, European directors overrode the objections of the US Executive Director. The Board agreed on a programme assuming a 50% haircut on Greek public debt…. Fiscal consolidation was still required but for the moment would be limited to 5% of GDP, which was just possible for Greece’s new national union government to swallow.
In return for this help, Greece was asked to prepare a programme of structural reforms, starting with product market reform… [which] lowered prices and increased households’ spending power, thereby not worsening the recession…. Programme documents gave the Greek authorities considerable leeway in the design of these measures and acknowledged the reality that they would take time to implement. The Greek government having been reassured of IMF support commenced negotiations with its creditors. A market-based debt exchange, in which investors were offered a menu of bonds with a present value of 50 cents on the euro, was completed by the end of the year…