Wednesday, March 24, 2010

Final reflections ahead of tomorrow's EU summit [jp morgan] $EWG

Final reflections ahead of tomorrow's EU summit

Sometimes policymakers have to choose the lesser of the evils on offer; and sometimes they have to accept some near term pain in order to achieve a better long term outlook. Developments in the Euro area this week regarding financial support for Greece need to be viewed through these lenses.
The German position seems straightforward. There are clearly constitutional and domestic political issues regarding the provision of financial support to Greece. The debate around what does count as a bailout (apparently government guarantees and supranational borrowing do) and what doesn't (apparently bilateral loans don't) has been tortuous at best. And the upcoming regional election in North Rhine-Westphalia on May 9 adds further pressure on the German government given the unpopularity of financial support for Greece among the German population.
But, the Germans are also playing a longer game here. EMU is about stability as well as solidarity. The clear failure of fiscal discipline across the region in the first decade of EMU's existence suggests that there has been too much focus on solidarity and not enough on stability. The Germans want to redress that balance to ensure the prosperous survival of the region. Hence the focus of the German government on clear conditions for a near term package - a genuine liquidity crisis in the capital markets, co-funding with the IMF, and reforms of the stability pact - and on the idea of a European Monetary Fund for the medium term. Tough love never feels good at the time, but it may be best for the long run.
Given the German position, the rest of the region has come round to the idea that IMF involvement may be the least bad outcome. The main argument against IMF involvement comes from the embarrassment factor: it would suggest that the Euro area cannot solve its own problems. Well, in a sense that's true and it should be recognised. Everyone agrees that any financial support to Greece should come with strong conditionality. Given the abject failure of the "conditionality" of the stability pact over the past decade, what credibility would the conditionality of a purely intraregional support package have? Involving the IMF, an institution which has some credibility in this regard, seems like a sensible thing to do while the region decides what reforms need to take place over the medium term.
There is some uncertainty about whether we will get anything at all from the EU summit tomorrow. At best there will be a statement which effectively outlines the German position. The Greek threat of going to the IMF in order to gain concessions from the rest of the region appears not to have worked. Given developments this week, the Greek government is unlikely to go to the IMF unilaterally. Instead, it will focus on the consolidation effort and hope that spreads will narrow accordingly.

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