The Choice: Save Europe Now or Later?
In every major crisis you have a choice. You cannot choose between inaction and action, because ultimately you will be forced to act. You do not really choose between bailout and no bailout, because very soon you find that all the reasonable options involve some sort of bailout for some people (and not for others). And, try as you might, there is no way to choose to let your neighbors fail completely—because that failure has such awful consequences for their citizens and, in all likelihood, for your banks, that you finally come across with the money.
But you do have a choice on when to come to help your neighbors and your friends, and you can definitely choose the form of this assistance. If you come in earlier and in a more systematic fashion, the cost for everyone is lower and the chances of a fast recovery are stronger.
The sensible decision might seem obvious from a distance or in retrospect, but it's this exact choice that the richer and more stable countries in Western Europe are now struggling with.
Back in October, we argued for a eurozone stabilization fund, as a means of mutual support and—most importantly—as a way to provide liquidity and buy time for euro sovereigns who need to make fiscal adjustments. Circumstances have changed, of course, but I would like to reiterate the following proposal:
Create a European Stability Fund with at least €2 trillion of credit lines guaranteed by all eurozone member nations and potentially other European countries with large financial systems such as Switzerland, Sweden, and the UK. This fund should provide alternative financing to member countries in case market rates on their government debt become too high. This will prevent a self-fulfilling cycle of rising interest rates. The fund should be large enough to have credibility; countries could access the fund automatically, but should then adopt a 5-year program for ensuring financial stability, subject to peer review within the Eurozone.
I should also clarify that we are not suggesting that countries leave the eurozone (this would be bad for everyone) or that this is likely (the adverse consequences are sufficiently obvious on all sides). In fact, my presentation in early January—which has circulated to some effect—very much emphasizes that eurozone fiscal austerity is our baseline expectation.
German Minister of Finance Peer Steinbrueck this week suggested that financial support within Western Europe is on the cards for the first—presumably, his mind is concentrated by potential developments for Austrian banks. At the same time, there are strong voices opposed to any kind of bailout, e.g., represented by Charles Wyplosz writing yesterday on VoxEU.org. Europe should really have had the full moral hazard theology debate back in the fall; better late than never, but it's awfully late.
Remember this. Eventually, you will go to help your neighbors (again, see Iceland for details). And the longer you delay, the more it will cost, in both monetary and human terms. And, for those of you still hung up on moral hazard, I can assure you that support provided today will not prevent middle class and poorer people from being hammered hard by the crisis—and I would suggest that they will sort out their rulers at a time and place of their choosing.
Provide generous support, come in early, and insist on a sensible macroeconomic framework—some fiscal adjustment is almost always needed. Do not require eurozone countries to go to the IMF.
Also posted on Simon Johnson's blog, Baseline Scenario.