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Economics & Finance - BLOG

Not the Debt, But the Future: The Crux of the Eurozone Crisis

Antonio Fatás, INSEAD Professor of Economics  |

Now that the Syriza party has won the Greek election, what comes next will not be easy.

The momentous victory for anti-austerity party Syriza signals some tough negotiations on the horizon for the Eurozone. It’s not that the policies proposed by the leftist party are particularly radical or unreasonable – Greece has faced worse since the crisis started. The real issue is that this election result is a wake-up call for the euro area (and possibly the EU); an admonition that without a consensus as to the purpose and processes of a monetary union, this will be a failed project.

The reality is that so far the Economic and Monetary Union (set up to converge the economies of the EU’s member states) has been built in an asymmetric way. The European Central Bank (ECB) was designed as a strong anti-inflation central bank, with the Bundesbank in mind, and that served a purpose, for everyone including Greece. The strict criteria to enter into the EMU (low inflation, low budget deficits) were a great excuse for politicians in some countries to introduce internal policies that otherwise they could not have done.

There was no doubt who was in charge and the prevailing ideology when it came to defining policies.

That model worked well in times of economic growth when everyone, including Greece, enjoyed the benefits of stability and growth. Since the economic crisis, it’s been obvious the model was far from perfect: there was no consensus around economic policy and, more fundamentally, a certain amount of risk sharing was needed for monetary policy to function properly - something that no one had been willing to discuss before.
How to move on?

The elections in Greece over the weekend have made it clear, the consensus is now gone. And without a minimum level of consensus, EMU cannot work.

The problem is not that some countries may bring a halt to their anti-austerity policies. In fact, this is likely to benefit everyone in the short run including Germany. Nor is it the possibility that Greek debt would, once again, need to be restructured, (this too is feasible from an economic and political point of view).

The real issue is how to move forward from here. How will the European Commission deal with future budgetary plans of euro members? How will the ECB treat sovereign debt in the future? And, how will markets perceive the risk of future default.

From the perspective of Germany (and countries that share the same view and economic situation) any agreement with Greece that suggests to the market a debt restructure would be the preferred solution in any future crisis, would be a disaster. Germany needs a strong commitment from Greece and others that this would be the last time this happens. This is unlikely, and even if promises were made, I cannot imagine how to make them credible.

Crunch time: who leaves the euro?

So either Germany gives up and runs the risk of having similar negotiations later in the year with Ireland, Portugal, Cyprus, Spain and Italy, starting a new cycle of accumulation of government debt until the next crisis. Or it throws in the towel. I see this happening in two ways, either it refuses to be flexible in the negotiations with Greece and the ECB holds its promises that liquidity will stop unless there is an agreement, which will push Greece out of the euro. Or Germany decides to leave the euro and leaves the other countries to manage what is left.

Both of these scenarios are likely to cause a crisis. The first one could potentially be more contained assuming the other euro countries support Germany. The second one would be a major economic disaster for Europe and the world.

No, Syriza's policies are not that radical, crazy or absurd but the negotiations taking place are between parties that are either scared by what has happened so far, or unwilling to be members of a club that cannot commit to not doing this again. That said, I still do not see how they will agree on a model to move ahead.

Antonio Fatas is a Professor of Economics at INSEAD. You can follow him on Twitter at @AntonioFatas, and read his blog.

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