Last week my SAIS colleague Filippo Taddei gave an interview to a Bloomberg journalist about the Greek crisis where he argued that there is no necessary link between a Greek government default and the exit of Greece from the euro area. The reason, Taddei explained, is that a government default is only relevant to Greece’s euro membership insofar as such a default would wipe out many of the assets — and essentially all of the collateral — of the Greek banking system. If that were to happen, then the Greek central bank would have no choice but to give loans to the country’s commercial banks against little or no collateral in order to maintain the liquidity of the Greek financial system. Moreover, everyone is aware of this fact. You only have to look at what happened during the second Greek bailout in March 2012 to see the connection. Hence it is only reasonable to assume that the European Central Bank (ECB) would either accept the extraordinary measures of the Bank of Greece to keep the Greek banking system afloat or come up with some arrangement of its own to restock the collateral of the Greek banking system and restore its liquidity during the process of resolving the Greek government’s default. Indeed, Taddei suggested, people active in European economic policy circles are already planning along those lines.
The suggestion that people are planning to support Greek banks with central banking liquidity during a Greek government default is the reason that Taddei’s interview has been widely cited in financial circles. Here I should explain that in addition to being my colleague at SAIS, Taddei is also chief economist in the party secretariat of the Italian Democratic Party. That makes Taddei one of the main economic advisors to Italian Prime Minister Matteo Renzi and — as the Bloomberg journalist was quick to point out — the highest ranking European policymaker to go on record as suggesting that there are concrete plans for keeping Greece inside the single currency in the event of a government default. If such plans do exist, and if it is reasonable to assume that European policymakers will use them, then the Greek government can default without necessarily leaving the euro area.
It is probably safe to assume that such plans exist. Indeed, the need to replace the collateral of the Greek banking system and to support the liquidity of the banks while they repair their balance sheets after a Greek government default is so obvious, it would be hard to imagine that the Governing Council of the ECB has not discussed the matter at length. Moreover, the policy action required needs relatively little planning. The injection of liquidity into banks is familiar territory for members of the central banking community. There are technical details to resolve that will have implications for who wins and who loses from this extraordinary intervention into the Greek financial system and these are sure to be contentious. But the basic outline of what needs to be done and how is easy to envisage and to convert into a concrete ‘plan’.
The real issue that connects or disconnects a Greek government default and the exit of Greece from the single currency is not the existence of a plan of action; it is the ‘reasonableness’ of European policymakers and politicians to do whatever it takes to keep Greece inside the euro. This is not a straightforward matter; the technical requirements for the liquidity and solvency of the Greek banking system are only one consideration among many. If we could ignore the rest, the only reasonable course of action would be to prop up the Greek banks. Unfortunately, the other considerations are not so easily ignored.
To begin with, the act of propping up the Greek banking system could be seen as beyond the competence of the ECB. Bundesbank President Jens Weidmann made this point explicitly in an interview with Handelsblatt last week — claiming that Greece’s future within the monetary union is ‘undoubtably’ a political decision and also that central banks cannot be held responsible either for the composition of Europe’s monetary union or for giving out financial assistance. This is hardly the first time Weidmann has made such an argument. He criticized Mario Draghi’s policy to buy unlimited amounts of distressed sovereign debt through ‘outright monetary transactions’ along similar lines and he has remained a persistent critic of the ECB’s outright asset purchases for quantitative easing. Weidmann does not deny that these policies have been instrumental in holding the single currency together; rather he insists that they are beyond the ECB’s policy mandate and so should not have been used no matter what their benefits.
At a deeper level, there is also a sense of inequity and frustration. Many members of the Governing Council have had to wind up politically sensitive banks while at the same time pressuring their home country governments to enact painful austerity measures. For the central bank governors — all of whom are recognizable public figures in their home countries — it has been a searing and deeply personal experience. Hence they have little patience for what they perceive as gamesmanship (or worse, technical incompetence) on the part of the current Greek government and even less tolerance for the perceived ill treatment given by the Greek government to the Greek central bank governor Yannis Stournaras. From this perspective, any ‘reasonableness’ should come in the form of Greek government concessions and not central bank bailouts. Indeed, by tightening up liquidity conditions within the Greek banking system through restrictions on emergency liquidity assistance or by raising the haircuts on existing collateral these central bank governors hope to make Greek politicians come to their senses.
Any objective ‘reasonableness’ is lost in this contrast in perspectives. Whatever may make sense in technical terms is either unjustified in institutional terms or just plain unjust. Moreover, this is not the first time we have been in this situation. If anything, it is a defining characteristic of Europe’s sovereign debt crisis. And Europe’s political leaders have a long track record of embracing policy solutions that have more political than technical merits. If that trend continues, it would be unreasonable to assume that the majority of Europe’s politicians will support doing ‘whatever it takes’ to keep Greece within the euro. This will not stop the ECB from propping up the Greek banking system. The technical arguments Taddei sketches remain compelling. Nevertheless, Europe’s central bankers will have to face the political consequences of their actions. What is unclear is whether those political consequences will do more damage to the single currency than the exit of Greece from the euro.Follow @Erik_Jones_SAIS