After two years of half-solutions, contagion risk from the Greek crisis is forcing euro area leaders to make a final decision on firewalls and on the most efficient trade-off between conditionality and effectiveness of the assistance programmes. FOMC: concerns over fiscal risks.....
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The political crisis in Greece is laying bare all the contradictions of the European crisismanagement strategy. The recent elections saw the success of political parties convinced that the euro area will not run the risk of suspending financial aid to Greece, out of concerns tied to a possible contagion. There are no certainties that the situation will be solved by the new election scheduled on 17 June. What are the possible scenarios?
The first scenario, the easiest to manage, implies the formation of a government that initially commits to respecting the terms of the bailout, in the meantime laying the grounds for a reformulation that would enhance its credibility. This would probably require an increase in financial aid, upturning the starkly unsuccessful logic adopted hitherto (at present, the target size of financial aid determines the intensity of fiscal correction).
The second scenario sees the new Greek government pushing for immediate and drastic renegotiation. This would pose a dilemma for the Eurogroup: defend the principle of conditionality, accepting to face contagion risk and the scenario of a political and social collapse in Greece, or accept a drastic easing of conditionality (with the risk of the new terms also being breached). The tone of official statements has changed dramatically in the corse of the week: initially, the threat to suspend aid and reassurances on the sustainability of the consequences prevailed; then a generic preference for Greece to stay in the monetary union was voiced by many. This change is due to a combination of factors: the perception of the risk that the liquidity position of Greek is becoming critical, resulting in forced exit from the euro even in the absence of explicit political choices, and signals of the contagion spreading to other peripheral markets. An additional factor could also be the desire not to fuel an estreme polarization of local public opinion positions.
If ultimately the decision is taken to abandon Greece to its fate, work should begin immediately on preparing a safety net capable of shielding Spain and Italy from contagion effects. Possibly, the declines observed in the share of Italian and Spanish debt held by nonresidents would already be enough to avoid catastrophic consequences. Also, as explained a few weeks ago in our analysis of financial support mechanisms, even for smaller financing needs the current architecture could only provide temporary assistance, but without being able to guarantee the liquidity of the two countries in any market condition; therefore, a confidence crisis would be hard to prevent. The only decisive measure would be a strong and determined intervention of the central bank, with an extensive purchase programme addressed to government bonds on the secondary market. This would imply the ECB taking back all the numerous statements made against the Securities Markets Programme. But would they prefer to face the risk of a disaggregation of the European Monetary Union?
The minutes of the FOMC meeting confirmed the “moderate” growth outlook, with a gradual acceleration. Although the monetary policy stance remains unchanged for the time being, “several” members indicated that “additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough “. The Committee believes fiscal policy will hinder growth in the coming quarters, and pose “considerable” risks in view of potentially drastic restriction at the beginning of 2013. Also, uncertainty over fiscal prospects could result in a slowdown in the spending of enterprises, even before the actual implementation of restrictive measures. Serious uncertainty emerges over the monetary policy strategy, although the existence is confirmed of a substantial group of members still willing to intervene in support of growth and employment, in a context of increasing risks tied to fiscal policy.
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