October 28, 2011
Markets loved the EZ rescue. This column argues that it was short-term good news in that it defused ‘the bomb’ – a catastrophe vortex of failing banks and defaulting sovereigns. The bad news is that the rescue will induce a recession. Banks will create a credit crunch in trying to meet capital adequacy ratios, and the renewed emphasis on austerity will create a fiscal contraction. The resulting recession will weaken banks, sovereigns, and Greece. We’ll be needing another crisis summit by Spring 2012.
Almost nothing decided at the latest Eurozone Summit was a surprise. For many months, economists on Vox have identified six elements that are essential to turning the Eurozone into a sustainable endeavour (see Wyplosz 2011, De Grauwe 2011, Baldwin and Gros 2010, etc).
Three measures were urgent and necessary to rule out the possibility of a catastrophic explosion of Europe’s banks and sovereign debt markets – or to put it colloquially – to defuse ‘the bomb’. These are:
- Fix Greece
- Backstop the banks
- Backstop the sovereigns