Immediate summit reaction
This week’s summit will do little to solve the fundamentals of this crisis. What has been agreed is definitely not a fiscal union, there is no agreement to close any of the institutional gaps in the eurozone, such as the lack of any real fiscal union or pan-eurozone backstop to the banking sector. Without these two things the crisis will continue to worsen. Market reaction – spreads have jumped sharply. Italian yields are back up to close to 7 per cent, up around two-thirds of a percentage point.
The package of measures is a ‘fiscal union’ in name only. There is no joint debt issuance, no shared budget, and no mechanism to transfer monies between the participating countries. It is little more than a Stability Pact with lipstick. Essentially, it hard-wires pro-cyclical fiscal austerity into the institutional framework of the eurozone, with no quid quo pro in terms of a commitment to move gradually to debt mutualisation.
However, fiscal austerity alone will not solve the crisis. Indeed it has become part of the crisis. Such a strategy has already failed in the periphery and threatens to make a bad situation in Spain and Italy even worse. What the eurozone needs is economic growth, and this agreement further worsens the outlook for that.
But does the agreement at least give the Germans cover to back more substantive solutions to the crisis, such as debt mutualisation? Similarly, does it provide sufficient cover for the ECB to step up its buying of struggling eurozone countries government bonds? This is little indication of any thaw in the German opposition to debt mutualisation. And the longer the crisis goes on, the riskier Eurobonds become for Germany economically and hence politically: the bigger the crisis, the larger the impact debt mutualisation would have on Germany’s own borrowing costs, and hence the political difficulty of taking the step.
Does the agreement open the way for greater ECB action to stem the crisis? The ECB has stepped up support for the eurozone’s struggling banking sector. For example, banks will be able to borrow from the ECB on longer maturities, but there is no indication that it will dramatically increase its bond buying or set targets for borrowing costs. Opposition on the ECB’s governing council to the provision of additional support to the banking sector was apparently strong. The idea that they can engage in the scale of bond-buying needed to dispel fears of default looks a little far-fetched at this juncture, but who knows. The ECB certainly couldn’t intervene indefinitely anyway. It would need to be accompanied by institutional reforms.