11
May

Amid growing risk of a Greek exit, the euro zone has yet to face up to the task of saving the single currency itself

The respite in the euro crisis lasted a few short months. Now, despite a €130 billion ($169 billion) second bail-out for Greece, a fiscal compact agreed on by the euro-zone leaders in December, and €1 trillion of cheap long-term loans from the European Central Bank, the night terrors are back. How dispiriting that Europe is still so ill-prepared for the ordeal to come.

Time is short. In France voters have given their new president, François Hollande, a mandate to alter the “austere” course set by his ousted predecessor, Nicolas Sarkozy, and Angela Merkel, Germany’s chancellor, and to focus on growth. Mrs Merkel says she will not change the fiscal compact, but Mr Hollande needs something to show voters in legislative polls next month. More threatening is the second election looming in Greece, where parties are struggling to form a government. If a majority of Greeks again vote to reject the spending cuts and reforms that go with their country’s bail-out, then euro-zone governments—in particular, Germany’s—will face a drastic choice. Mrs Merkel will either accommodate Greece and swallow the moral hazard of rewarding defiance or, more likely, stand firm and cut the Greeks adrift (see article).

The idea of a chaotic Greek departure from the euro at a time of Franco-German disunion should terrify everyone it touches (the damage it would do the world economy may well be the biggest risk to Barack Obama’s chances of re-election, for instance). With so much at stake, the rest of the euro zone urgently needs to lower the risk that contagion from a Greek exit would infect Portugal, Ireland and even Spain and Italy. The worry is that, just at the moment when hardheaded realpolitik is needed, politics has fallen prey to self-delusion, with leaders in all the main countries peddling seductive half-truths that promise Europe’s citizens an easier way out.

Stories that people tell…

The euro zone needs to do a lot of hard things. Our list would include at the very least: in the short term, slower fiscal adjustment, more investment, looser monetary policy to promote growth and a thicker financial firewall to protect the weaklings on the periphery from contagion (all of which the Germans dislike); in the medium term, structural reforms to Europe’s rigid markets and outsize welfare states (not popular in southern Europe), coupled with a plan to mutualise at least some of the outstanding debt and to set up a Europe-wide bank-resolution mechanism (a tricky idea for everyone). It is an ambitious agenda, but earlier this year, with the Italians, Spanish and Greeks all making some hard choices and ECB money flushing through, the politics seemed possible.

As published in www.economist.com (from the print edition) on May 12, 2012.

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