The Living Room

By Kenneth Rogoff

Europe is in constitutional crisis. No one seems to have the power to impose a sensible resolution of its peripheral countries’ debt crisis. Instead of restructuring the manifestly unsustainable debt burdens of Portugal, Ireland, and Greece (the PIGs), politicians and policymakers are pushing for ever-larger bailout packages with ever-less realistic austerity conditions. Unfortunately, they are not just “kicking the can down the road”, but pushing a snowball down a mountain.

True, for the moment, the problem is still economically manageable. Eurozone growth is respectable, and the PIGs account for only 6 per cent of the eurozone’s GDP. But by stubbornly arguing that that these countries are facing a liquidity crisis, rather than a solvency problem, euro officials are putting the entire system at risk. Major eurozone economies like Spain and Italy have huge debt problems of their own, especially given anaemic growth and a manifest lack of competitiveness. The last thing they need is for people to be led to believe that an implicit transfer union is already in place, and that reform and economic restructuring can wait.

European Union officials argue that it would be catastrophic to restructure any member’s debts proactively. It is certainly the case that contagion will rage after any Greek restructuring. It will stop spreading only when Germany constructs a firm and credible firewall, presumably around Spanish and Italian central-government debt. This is exactly the kind of hard-headed solution that one would see in a truly integrated currency area. So, why do Europe’s leaders find this intermediate solution so unimaginable?

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