Tumblr Icon RSS Icon

The Eurozone Needs Credibility, Not A Ton Of Money

By Matthew Yglesias  

"The Eurozone Needs Credibility, Not A Ton Of Money"

Share:

google plus icon

I have a mild dissent from Kevin Drum’s take on the European Financial Stability Fund issue. He says that “all the tricks in the financial rocket scientist’s toolkit can’t change” the “grim reality” that “Europe either ponies up eye-watering amounts of money for its teetering banks and teetering countries or faces financial catastrophe and the end of the eurozone.”

I think the real situation is both more and less dire than that. The real issue here is not so much a question of volume of expenditures as it is of credibility. If people really think that the EU will do what it takes to prevent bank failures, defaults, and euro exits then there’s no reason for firms or individuals to invest resources in trying to hedge against the risk of bank failure, default, or an exit from the euro. Some idiosyncratic speculators may want to bet on those outcomes, but other speculators will offset them. The total amount of spending that would be needed to back up a credible commitment might ultimately be quite small. Conversely, if you give people the impression that ultimately the EU will blink and the whole thing will go to shit then you’re going to see not just speculation but tons and tons of everyday firms and households trying to make financial moves to protect themselves. Efforts to counteract these moves by dribs-and-drabs can end up being very expensive, and likely doomed anyway.

That’s good news because it means that an institutionally and politically workable solution need not be very expensive. It’s bad news because levering up the EFSF appears to be the only institutionally and politically workable solution. And I don’t think any solution that involves a finite sum of money necessarily has the right kind of credibility. Instead, it sounds to me like basically a challenge for speculators to be daring enough to break the EFSF bank and then count on institutional gridlock to prevent a new solution from emerging. Not only does the EFSF have a quantitative limit, but the kludginess of the solution serves to highlight the extent to which institutional dysfunction makes a euro rescue difficult.

‹ The Preference For Killing Rather Than Capturing

Breakfast Links: October 4, 2011 ›

By clicking and submitting a comment I acknowledge the ThinkProgress Privacy Policy and agree to the ThinkProgress Terms of Use. I understand that my comments are also being governed by Facebook, Yahoo, AOL, or Hotmail’s Terms of Use and Privacy Policies as applicable, which can be found here.