The approach of eurozone leaders to the crisis in their region has so far been a piecemeal, sticking plaster approach. But this morning, calls are growing for big and effective bandages to bind up the wounds before it is too late.
Late last night, ratings agency Moody’s warned that the size of those bandages was so big that containing the shock of a Greek exit from the euro would come ‘at a very high cost’, and that ‘greater collective support’ for Spain and Italy would place a heavy burden on those eurozone members with higher credit ratings.
Hence the downgrades from the agency for Germany, Luxembourg and the Netherlands, while Finland retained its Aaa stable rating. Moody’s gave these two reasons for the rating changes:
1. The rising uncertainty regarding the outcome of the euro area debt crisis given the current policy framework, and the increased susceptibility to event risk stemming from the increased likelihood of Greece’s exit from the euro area, including the broader impact that such an event would have on euro area members, particularly Spain and Italy.
2. Even if such an event is avoided, there is an increasing likelihood that greater collective support for other euro area sovereigns, most notably Spain and Italy, will be required. Given the greater ability to absorb the costs associated with this support, this burden will likely fall most heavily on more highly-rated member states if the euro area is to be preserved in its current form.
On a possible Grexit, the agency later adds that ‘the risk of an exit by Greece from the euro area has increased relative to the rating agency’s expectations earlier this year… Although Moody’s would expect a strong policy response from the euro area in such an event, it old still set off a chain of financial-sector shocks and associated liquidity pressures for sovereigns and banks that policymakers could only contain at a very high cost’. Troika officials have arrived in Greece to assess how well the country is reducing its debts before releasing the final €31.5 billion installment of the country’s €130bn bailout package. Greece must pay €3.1 billion to the European Central Bank next month, but as the New York Times reports, it’s uncertain what will happen after that payment is reached.
So what are the ‘strong policy response’ bandages for the eurozone? Jim O’Neill, chairman of Goldman Sachs Asset Management, painted his nightmare scenario for the Today programme, arguing that ‘the policymakers need to try yet more initiatives to try to calm things down’. He explained that the central banks in the UK, the US and Japan ‘tend to be a lot more active in trying to help their situation’, and that ‘the ECB has to somehow do something a lot more dramatic and probably more radical’, suggesting ‘all sorts of things including monetary expansion’.
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