by Christophe Chamley and Laurence Kotlikoff
June 13, 2012
The eurozone’s sovereign debt crisis has become a full-fledged banking crisis, as more and more depositors of the sickest countries – Greece, Portugal, Spain, and Italy – withdraw their money from their broken banks.
The eurozone’s healthy members – essentially Germany – have tried to stop this downward spiral. They have lent money to sick members, helped fund the European Financial Stability Facility, forgiven debts, risked future inflation by letting the European Central Bank lend troubled banks tonnes of freshly printed euros, and allowed sick countries’ central banks to borrow huge sums from the Bundesbank.
But the Germans face the Samaritan’s dilemma: help fosters dependency and encourages requests for more assistance. To counter this moral hazard, each rescue comes with tougher strings attached. Both pride and politics are keeping Greece and the others from taking help on these toughening terms. Meanwhile, the situation worsens as people discover simple ways, such as remotely opening up mutual fund accounts in the US, to move their money abroad.
There is, however, a truly new way to cut Europe’s vicious cycle, which would fix the banks for good and allow countries choosing to default to do so without bringing down their banks or leaving the euro. It is called limited purpose banking.