Peterson Institute for International Economics
March 15, 2011
The outcome of the euro area meeting last week was far more substantive than expected, even if one takes into account that the expectations had been at rock bottom. Not only did European Union (EU) leaders demonstrate how they intend to prevent peripheral defaults, they also gave us an idea of their longer-term solutions for Europe’s economic problems and future integration1.
Despite the talk by European federalists of their higher driving purpose toward an “ever closer union,” the EU and its institutions have always been a very pragmatic entity, built principally in times of crisis with the aim to avoid specific undesired outcomes, whether war among its members or excessive exchange rate volatility. Since you rarely get political benefits merely avoiding really bad outcomes, the EU project has persistently lacked popular appeal among Europeans.
Last week the EU returned to this time-tested style of “avoiding catastrophe and muddling though.” The solutions embraced by EU leaders avoided the undesired outcome of the current crisis, namely the destruction of the risk-free status of euro-zone sovereign debt, by barring haircuts to private creditors of Greek and possibly other debt, averting the spread of bond-market contagion. As predicted on this blog since late 20102, EU leaders did so by giving themselves the ability to grant fiscal transfers in another name to members facing acute financial stress.
The EU declared that while “taking into account the debt sustainability of the recipient countries,” lending rates imposed by the European Financial Stabilization Fund or its successor, the European Stabilization Mechanism, can be lowered to a level just above these facilities’ funding costs. Such a step puts them in line with International Monetary Fund (IMF) pricing principles and interest rates. Compared to the current “financing fee” of 300 basis points, this discount amounts to potentially large de facto fiscal transfers to countries like Greece, Ireland and soon Portugal.
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