Sunday 18 March 2018

No road map as we accelerate towards a multi-speed Europe

Last week, Ireland watched the euro crisis zoom past on a new Spanish and Italian fast lane. The market focus shifted quickly as yields on Irish debt continued to fall and our credit rating was confirmed as stable.

Meanwhile, Germany trudged along on an inside lane, refusing to panic and only doing the minimum to contemplate the future. An American speed bump added to the danger.

But where are we headed?

It is tempting to see such crises as the route toward some inevitable outcome but, of course, they are not. The journey itself will largely determine where we end up and there is even now some confusion as to where we started. So any definitive forecasts or prognostications should be treated with care.

For example, one cannot yet say with certainty whether Ireland will be able to repay its debts. This depends-- among other factors -- on the interest rate payable on debt and on our prospects for growth and both of these elements are hugely dependent on our programme creditors.

Certainly, the recent lowering of interest rates and extension of maturity on our credits has improved our chances but Irish banks have still not been given the medium-term support that they need to re-establish credit and underpin growth.

In addition, serious doubts about global prospects for growth have emerged in the past few weeks and the US Federal Reserve now expects another two years of torpor. Official interest rates will be kept low there for the foreseeable future.

But the eurozone does not seem to have any map and that is what makes the prospective outcome so scary.

The journey has not been planned and the danger is that Europe will, through a series of short-term actions and reactions, both waste the scarce resources that could be expended on a medium-term solution and establish precedents that will undermine credibility when it will be needed most.

Look at the record to date.

First, the ECB was reluctant to buy Greek and Irish bonds after May 2010 but finally undertook a series of purchases in an attempt to keep yields down.

This half-hearted attempt failed and required that recovery programmes be assembled instead. But Greek and Irish bonds are still on the ECB's books in testimony to the resources wasted in this effort.

Second, punitive interest rates on the crisis countries were totally counterproductive and have finally been reduced.

But not before yields on Greek and Irish bonds spent a further eight months on the rise and totally undermined credibility in the recovery programmes -- leading to a second instalment for Greece.

Yields are now falling for both countries but have a long way to go before credible levels are restored.

Third, deposits have continued to flow out of Greek and Irish banks and the ECB has continued to replace them with liquidity credits.


But the ECB refuses to put these credits on a medium-term footing, which would help restore credibility in the banks, with the result that more deposits flow out and more credits are needed.

The policy is counterproductive and, again, is a waste of valuable resources.

Now, and fourth, the ECB is again in the business of buying government bonds -- Italian and Spanish -- but is again doing so reluctantly and without the support of the Bundesbank.

The policy may work in the short-term, and yields have retreated below 6pc, but markets know it is only a short-term measure and expect the EFSF -- the European bailout fund -- to assume this responsibility in late September.

But if the EFSF does not credibly and quickly swing into action, the ECB's resources will again have been wasted on a failed short-term effort. And the EFSF has not yet been cleared to act.

Meanwhile, the EFSF is generally regarded as being too small to handle a recovery programme for either Spain or Italy but a decision to increase the fund is not even planned. And the likely need for recovery programmes has increased significantly because of lower global growth prospects and because there is no credible safety net in place to catch them if they fall.

The constant mantra from European policymakers that economic fundamentals are strong and markets are unreasonable only serves as a reminder of these repeated errors.

And when one European leader --President Barroso -- finally recognised last week that there is "a growing scepticism among investors about the systemic capacity of the euro area to respond to the evolving crisis", he was told to shut up.

So we are at the stage when a lack of confidence in policymakers is itself driving the crisis. This is not the fiscal crisis that hit Greece or the banking crisis that hit Ireland or the crisis in growth that hit Portugal.

If Italy and Spain succumb to market pressure and need a bailout, it will be largely because other crises were not handled convincingly by policymakers.

Both Italy and Spain could be solvent under a number of plausible scenarios, but they will crumble if the markets are spooked and there is no credible and comprehensive response forthcoming from Europe.

This crisis has gone into overdrive.

Gary O'Callaghan is Professor of Economics at Dubrovnik International University. He was a member of the staff of the IMF and has advised numerous governments on macroeconomic policies.

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