WARSAW – The
seemingly never-ending debate over the eurozone’s fiscal problems has focused
excessively on official bailouts, in particular the proposed purchase of
government bonds on a massive scale by the European Central Bank. Indeed, we
are warned almost daily – by the International Monetary Fund and others – that
if bailout efforts are not greatly expanded, the euro will perish.
For some, this stance reflects the benefits that they would gain from such
purchases; for others, it reflects mistaken beliefs. Creditors obviously
support bailing out debtor countries to protect themselves. Many political
leaders also welcome official crisis lending, which can ease market pressure on
them. The media, meanwhile, always thrives on being the bearers of bad news.
Mistaken beliefs, on the other hand,
are reflected in metaphors like “contagion” and “domino effect,” which imply
that financial markets become blind, virulent, and indiscriminate when they are
disturbed. Such terms provoke fear that, once confidence in any one country is
lost, all others are in danger.
According to this logic, it follows
that only a formidable countervailing power – such as massive official
intervention – can halt the ravenous dynamics of financial markets. Widespread
use of expressions like “aim a bazooka at the eurozone,” and “it’s them or us,”
demonstrates a pervasive Manichean view of financial-market behavior vis-à-vis
governments.
But financial markets, even when
agitated, are not blind. They are capable of distinguishing, however
imperfectly and belatedly, between macroeconomic conditions in various
countries. This is why interest-rate spreads within the eurozone have been
widening, with Germany
and the Nordic countries benefiting from lower borrowing costs and the
“problem” countries being punished by a high-risk premium.
Another, related, fallacy is the
assumption that reforms can reap benefits only in the long run. This
misconception reduces the short-term solution to affected governments’ sharply
higher borrowing costs to bailouts. In fact, properly structured reforms have
both short- and long-term effects.
For example, one does not need to wait
for the completion of a pension reform to see reduced yields on government
bonds. Markets react to credible announcements of reforms, as well as to their
implementation.
The countries that have been severely
affected by the financial crisis illustrate the impact of reform. One group – Bulgaria,
Estonia, Latvia,
and Lithuania (BELL) – experienced a surge in yields on their government bonds
in 2009, followed by a sharp decline. Another group – Portugal,
Ireland, Italy,
Greece, and
Spain (PIIGS) – has had more mixed outcomes: yields have soared on Greek and
Portuguese bonds, while Ireland’s
were falling until recently.
These differences can be explained
largely by the variations in the extent and structure of these countries’
reforms. Proper reforms can produce confidence and growth. Official crisis
lending can buy time to prepare, and it can help to stop a banking-sector
crisis, but it cannot substitute for reform.
All bailouts can create moral hazard,
because they weaken the incentive to implement reforms that will avoid bad
outcomes in the future. To some extent, official crisis lending replaces the
pressure from financial markets with pressure from experts and creditor
countries’ politicians.
Among the proposed eurozone bailouts,
none has come under the spotlight as much as the idea that the ECB should
purchase massive quantities of the problem countries’ bonds. Advocates of this
approach stretch the concept of “lender of last resort” to suggest that
providing liquidity to commercial banks is the same as funding governments.
They also present the alternative to a bailout as a “catastrophe.” Finally,
they cite similar policies implemented by the United States Federal Reserve,
the Bank of England, and the Bank of Japan – as though merely mentioning past
examples is evidence that ECB lending will work.
These rhetorical devices must not
overshadow careful analysis of the various options. There has been surprisingly
little comparative analysis of the effects of quantitative easing (QE) in Japan,
the US, and Britain.
Yet the evidence indicates that QE is no free lunch. Although it may offer
potential benefits in the short run, costs and risks invariably emerge later.
In Japan,
QE may have contributed to delays in economic reform and restructuring, thereby
weakening longer-term economic growth and exacerbating fiscal distress. In the US,
it failed to avert the slowdown during 2008-2011, while America’s
2011 inflation figures may turn out to be higher than they were in 2007. In Britain,
economic growth is even slower, while inflation is much higher. And these
countries’ QE has also fueled asset bubbles in the world economy.
Massive purchases of government bonds
by the ECB would be the worst type of bailout. The fact that such purchases are
potentially unlimited would exacerbate the problem of moral hazard. It would
also increase the risk of inflation, along with other negative economic
consequences.
Moreover, such a bailout could
undermine the ECB’s trustworthiness as guardian of the euro’s stability,
particularly in light of the new political power that it would obtain. And it
would further undermine the rule of law in the EU at a time when confidence in
the Union’s governing treaties is already fragile.
The key to resolving the eurozone
crisis lies in properly structured reforms in the ailing countries. Indeed,
experience shows that there is no substitute.
Leszek Balcerowicz is a former Deputy Prime Minister and Finance
Minister of Poland
(1989-1991; 1997-2000) and a former President of the National Bank of Poland
(2001-2007).
