Friday, July 29, 2011

Europe Gets Debt Relief One-Third Right

by Harald Uhlig


July 29, 2011

On July 21, European leaders decided on a new plan for Greece and new rules for the European Financial Stability Facility. They also came up with two remarkable oxymorons: The private sector will voluntarily agree to losses and Greece won't default for now, but instead will selectively default on some of its obligations. President Nicolas Sarkozy of France and Angela Merkel, the German chancellor, seemed to be smiling.

Did they have reason to celebrate? While the leaders took a step in the right direction, I would argue that the glass is only one-third full. The euro zone still faces several thorny issues, but the proposals that were offered to resolve them are more in conflict than in harmony.

First is the question of Greece. It is suffering under its weak economy, out-of-balance government and enormous debt burden. Will it be able to repay? The European leaders have agreed to reduce that debt by about 20 percent to 30 percent of gross domestic product; some of the relief will be achieved via transfers, some of it through elective defaults. Yet many believe that won't be enough. Greece's debt accounts for less than 5 percent of all sovereign debt in the euro zone. If the goal was simply to bail out Greece, it would have been easy for other member countries to do so, and not particularly costly. Clearly, that wasn't the point.


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