Europeans are saying that the members of the eurozone or the EU have to bail out Greece, that this is better than having the IMF do it. Senior figures in Brussels apparently feel that the latter alternative is unthinkable. I am a little confused about why. Martin Wolf writes in the Financial Times this week that to bring in the Fund “would demonstrate that this is not a true union at all.” But the EU and EMU and not true fiscal unions. If the citizens of Germany and other more successful countries were willing to bail out the Greeks, then fine; the EMU would be ready to be a fiscal union. But they are not; so it is not.
The Maastricht treaty and the Stability and Growth Pact put fiscal constraints front and center on the list of country requirements for euro membership. Why? The same reason that the European Union has an explicit “no bailout” clause. Precisely to avoid the situation that seems to be facing German taxpayers today. What has changed since the euro’s birth? Only one (predictable) development: the realization that huffing and puffing from Brussels and Frankfurt are wholly inadequate to prevent members large and small from breaching the 3% deficit rule. Greece leads the pack, with a deficit last year of 12.7% of GDP. The fears of German taxpayers are more well-grounded today than they were at Maastricht, not less. (And disguising these transfers as loan guarantees is only a futile effort to perpetuate the denial.)
I am not even sure why it is considered anathema to run up default risk a little more, to help force Greek citizens to see the need for painful reform, including fiscal retrenchment at least as severe as what Ireland has recently done. If a presumption is now established that default risk is not to be allowed, moral hazard will wipe out all pressure on future eurozone governments to keep their finances in order. Indeed, some of us were puzzled why, for most of the years since 1999, the financial markets had failed to distinguish among euro members by creditworthiness: until recently the spreads of the Mediterranean countries over the German bond rate had been close to zero. This began to change in late 2008. Then, in 2009, the sovereign spreads in Ireland and Greece shot up, reflecting investor perceptions of these countries’ debt problems. This put pressure on them to adjust. The Irish responded like adults, undertaking stronger budget measures than Greece. Partly as a result, Irish government bond rates have declined over the last year and are now substantially below Greek rates, which have now risen almost to 400 basis points. Is Greece now to be rewarded?
Things aren’t yet bad enough to require a Greek default. Quite likely, by now, they are bad enough to require outside intervention. But shouldn’t Greece have to draw on the IMF first, rather than drawing on Germany and France? The IMF could impose conditionality, thereby helping the current Greek government make the necessary measures stick. There is no use in pretending that any promises that the government makes to Frankfurt or Brussels as conditions for a loan would credibly be enforced in the future, given the politics and given what was come before. But conditionality is what the IMF does for a living, and for all the criticism it sustains, it is better at it than any other institution.
Perhaps it is easier for an American, on the other side of the Atlantic, to discount glibly the financial strains that Greece is placing on Europe, including contagion to other countries such as Portugal, Spain and Italy, loss of prestige of European institutions, and the decline of the euro. But in fact it is the northern Europeans who should be most anxious for the IMF to come in, and who should be most worried what they are going to say to Portugal, Spain, Italy and Ireland if they have just bailed out Greece. It is generally good policy in such episodes to let at least one debtor fail, preferably the one most deserving of such a fate, thereby preserving a foothold in the long-term fight against moral hazard. That guideline may sound cavalier and arbitrary, but better that than letting everyone fail (as the noisy moral hazard police on the right would have it) or to let nobody fail (as the equally noisy social workers on the left would have it). Even if it proves necessary for the northern Europeans to rescue the next-worst debtors in line, after a Greek failure, I don’t see that they would be better off by starting now with Greece.