Economist Ricardo R. Reis expects “better policymaking from the European authorities now.” Originally from Portugal, Reis teaches at Columbia University, he is a former graduate from the London School of Economics and Harvard Ph.D and has worked extensively on inflation dynamics and monetary and fiscal policy, including evaluation of fiscal stimulus programs. He gives his take on the current economic turmoil for our readers in the first of a summer interviews’ series.
First of all, a pretty general question: is Europe ahead or behind the curve? European leaders and institutions have been behind the curve in this entire crisis, and things have not changed in the past month.
One only needs to look at the debate and statements when the problem emerged in Greece almost two years ago, and compare them to what we know now. At the core of the problem, there is an institutional failure in the design of the euro-area that does not allow it to deal with financial crises, and a very difficult political compromise that has not been reached on how to fix this gap.
Do you think the euro is here to stay? The euro was created as political project, not an economic one, and while the political will remain, so will the currency. But, certainly, much remains to be done to strengthen the institutions and foundations of the euro, and its disappearance will never be out of question.
Why is the ECB not acting? It bought southern european countries’ debt before, so it cannot claim that that’s not in its protocol… The ECB is acting by reducing interest rates, and massively expanding its liquidity facilities through which banks can borrow against different types of collateral, especially sovereign debt. It is very difficult for the ECB to buy a lot of sovereign debt. By buying debt, the ECB brings onto itself the risk that the debt will not be paid, which becomes higher the more debt the ECB buys and default becomes less complicated. Yet, the ECB has no guarantee from any fiscal authority in Europe that it will be recapitalized in case it suffers these losses. So, it is risking its own solvency, and its commitment to prevent hyperinflation when it does so.
Some people think there is actually a political intention of creating a two-speed Eurozone. What’s your take on that? I don’t think that political intention exists. But, it is the case that Europe is going through perhaps its main crisis ever. It is not hard to imagine that in 5 years we will have a very different Europe, but it is much harder to predict what it will look like.
SPAIN’S DIABOLIC LOOP
Why do you think the Spanish ten year bonds yield is so high? Everybody agrees it is not based in fundamentals. Fears about the solvency of Spanish banks feed fears about solvency of the Spanish state, which would have to come to the rescue of some banks. But in turn, as the price of Spanish bonds falls, the banks get in more trouble as they hold so many of them, and because there is growing anticipation that austerity will follow leading to low growth and further hurting banks’ balance sheets. Caught in this diabolic loop, there is great room for runs on the sovereign debt market.
It’s been said that we (southern european countries) are under speculative attacks. Can that be true? How can somebody increase the yield on Spanish debt if at all? It is hard to believe that anyone could by itself manipulate a market of the size of the Spanish bond market.
Geithner and Bernanke both said Europe together with the fiscal cliff are the biggest risks on US economy right now. On the other hand, US financial institutions already reduced drastically their exposure to southern countries debt. Why do they say that? Because Europe is still a source of massive exporter and importer of goods to the United States. So, a deep recession in Europe will inevitably affect economic growth in the US.
Please tell us one positive thing in the horizon for the sake of Europe, if you see any… Greece, Ireland and Portugal are small in the overall euro-zone, so it was possible to do some political posturing or take strong stands on principle regardless of the consequences. Spain is big, and with Italy, too big to fail without having a serious effect on financial institutions across Northern Europe, a recession euro-wide, and the credibility of the euro. So, I expect better policymaking from the European authorities now.