Can you see the Euro surviving beyond this crisis?
A year ago I was saying the Euro might not survive but I thought it was very, very likely that it would. The debate has changed now. Partly, Eurozone leaders have broken a taboo by suggesting that Greece might leave. Partly there is the sense that voters in places such as Germany simply won’t back governments who do what it takes to keep the Euro together. I still expect the Euro to survive but it’s easier and easier to imagine that it will not.
What would be the consequences of Greece being forced to leave the Eurozone?
Some years ago we economists might have been quite sanguine about the idea: it would mean a Greek devaluation, which would make Greek exports more competitive and discourage imports, and so create room for the Greek economy to grow – a kind of cut-price sale for all Greek goods and services. The recent history of Argentina points to this kind of experience. But now we’ve learned the hard way how much the details of the banking system matter. The threat of Greek exit is already crippling Greek banks. The reason is that nobody wants to hold euros inside Greece – with the threat of devaluation – when they could be holding them in Germany instead. A Greek Eurozone exit would be extremely painful for Greece and for the broader Eurozone as a whole.
How likely is that to happen?
It’s clearly quite possible now. This is less about the debt – Greece’s debt cannot be repaid and a Eurozone exit could not change that – and more about Greece’s lack of competitiveness without a devaluation. Ireland has managed to cut wages and prices without a devaluation, but it’s tough to do so, as anyone in Ireland will tell you.
Are any other countries likely to be forced to leave the Eurozone?
You’re asking an economist to make a forecast! History should tell you we’re pretty bad at that. Each exit makes a subsequent exit easier to imagine, which adds to these silent bank runs away from periphery banks. It could all become self-fulfilling.
Why do people talk about a ‘tipping point’ in the sovereign debt crisis?
When a country such as Italy wants to borrow money it does so by issuing bonds, which are a tradable IOU, a promise to pay a certain sum of money on a certain date. The price of those bonds, obviously, will depend on how likely investors feel they are to be paid. If Italy seems like a risky prospect then the price of its bonds will fall and the implicit interest rate charged when it issues new bonds will rise. But here’s the tricky thing: the risk that investors will not be repaid is intimately bound up with the price of those bonds, and therefore the interest rate. It’s perfectly possible that there are two equilibria: one in which interest rates are low, and rightly so because the money can be repaid; a second one in which bond prices fall (and so interest rates are very high), and rightly so because investors are unlikely to be properly repaid. Both equilibria are internally consistent, but one’s good news and one is a disaster. The tipping point is about moving from the good equilibrium to the bad one, as Italy seems to have done.
Tim Harford writes the “Undercover Economist” column for the Financial Times and presents BBC Radio 4’s More or Less. His latest book is Adapt: Why Success Always Starts with Failure.
