Understading the Europe bailout

I am still trying to read up on the huge literature post Europe bailout. Here is a sort of primer on the events

Broadly there are two measures.

  • Economy and Finance Council of European Commission (Ecofin) decided to pass a bailout package of Euro 500 billion. And then IMF is supposed to give nearly half of the promised Ecofin amount. So the total bailout is about Eur 750 billion. And you also add Greece’s plan of Eur 110 billion. So in all about Eur 860 billion of bailout for Europe’s cause. Within Eur 500 bn you have 2 components:

The European stabilisation mechanism includes an aid facility to balance of payments to a value of 60 billion euros, with the Union’s own resources as guarantee, plus 440 billion in funds or guarantees supplied by the Eurozone member states, as well as a quantity from the International Monetary Fund (IMF) to the value of at least half of Europe’s contribution.

  • Second set of measures came from ECB. There were three broad measures:i) ECB agrees to “intervene in public and private debt markets to ensure depth and liquidity in those market segments which are dysfunctional.” I love the fancy language and play fo words. The pressure on ECB was building to buy government bonds. However, in the mon pol meet on 6 May 2010, Trichet said no such measure was discussed. So to have ECB agree to do this so quickly suggests two things- One, ECB did discuss these measures at the monetary policy. Two, things became so bad that ECB was pressurised to do this.

    ECB adds that it would sterilise the excess flows which result from these operations. What is the purpose of buying bonds then?

    ii) Providing liquidity at a fixed rate just like Fed’s Term Auction Facility.

    iii) Reintroducing Swap Lines with Fed. This was followed by 4 other central banks- BoE, BoJ, Swiss National Bank and Bank of Canada. This was started as banks again faced shortages in dollar funding. Just recently as crisis eased, these swap lines were withdrawn. Now again they have been started. Charles Plosser of Philadelphia Fed discusses the impact on Fed balance sheet. A primer on these swap lines is here.

As various economists and papers have been discussing, it is so much like Lehman days. Except that in Lehman’s case you could pinpoint the data and time to 15 Sep 2008. In this case it has been going on for a while now. Voxeu is recycling series of old articles which predicted this kind of scenario for Europe going ahead, but they were obviously ignored. See this from Paul De Grauwe and this from Willem Buiter for instance. Buiter is bang on target about ECB. So just like Lehman days you saw something coming all along and then Lehman collapsed leading to TARP, ARRA etc. Now, you have the same for Europe as well.

It is such a mixed feeling to see all this. I for one have been amazed by the massive EMU and Euro project. It looked quite good till the crisis. However, what stung them was not the monetary integration but fiscal disintegration. Fiscal policies were a mess and Stability and Growth Pact was just too weak to correct reckless countries. We may all be ridiculing Greece etc now but Germany and France also did not follow SGP in its true spirit. So, this crisis points to the importance of fiscal policy. It is not just useful in managing the crisis but very important before the crisis as well. EMU, ECB etc are paying a huge cost for very weak fiscal rectitude amongst countries. So just having a monetary union will not work, you need a fiscal union as well (as suggested by Krugman and others). In Europe’s case, there was never a case for fiscal union so there was a SGP which was too weak.

Another important thing is this discussion over whether Greece etc would have been better off with their own currency? Paul Krugman did suggest before the bailout (I don’t know what happens now after the bailout) that exiting from Euro was inevitable for Greece. He compared the situation to Argentina. In a very interesting article then Argentina’s finance minister Domingo Cavallo (with Joaquín Cottani) write that exiting will not work. They suggest the introduction of VAT in Greece et al as a reform measure.

There were some earlier suggestions (from Martin Feldstein I think) that Greece could exit Euro for sometime and rejoin later. This was trashed by Europe based economists (and others) that it will just lead to a complete crisis of sorts. If we just recall as the crisis started there was a suggestion that non-euro economies like UK, Dernamrk should join Euro. And now this opposite suggestion of exiting the Euro. It is quite a turnaround. More research is needed for sure.  

Another lesson is forgetting lessons of economic history. We have seen only recently what happens when policymakers ignore the build up of the crisis. So US policymakers ignored the lessons of build up of leverage in private sector. As times were good all was ok and the bust followed. The sheer volume shocked the policymakers. Now this Europe case. All along Europe policymakers kept blaming US for the crisis. They said European economies were impacted because of confidence channel etc. But there was a build up of leverage in both public and private sector. And they kept ignoring it. And now this bust followed.

Finally the role of financial firms and markets. How they always end up winning and forcing governments. Though economics would say this is a rational reaction to the situation, but it is too asymmetrical. First markets decline as they are in trouble and push government for supporting ther markets. As governments react and crisis eases, the markets again force the government to lower its deficit and debt levels. And I just did not understand the euphoria in markets after the Europe bailout. True they have been battered and deserved a break. But the reaction was just too much. It was actually time for introspection as markets are getting too dependent on government. Moreover, bailout money is not a freebie and has to come from somewhere.

Here are a few links of what other economists think about Europe bail out:

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2 Responses to “Understading the Europe bailout”

  1. A note on European Financial Stability Facility « Mostly Economics Says:

    […] is a very interesting topic and have missed writing on this despite the hype. I covered it in May 2010 but not after […]

  2. bail agents Says:

    bail agents…

    […]Understading the Europe bailout « Mostly Economics[…]…

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