The new aid program represents both Greece’s final and best opportunity for a prosperous future in the euro area. The country’s early elections, announced last Thursday, are not likely to change this outlook.
The program, under the ESM bailout fund, includes fiscal targets appropriate for the domestic economic situation, the prospects for significant imminent monetary easing and a strong focus on front-loaded, deep structural reform and banking sector restructuring. The chances are therefore good that, with Greece finally on a credible reform and growth track, the euro area can now put the crisis behind it and again look to the future.
It is clear that recent events surrounding Greece will have a lasting impact on the character of the euro. For the first time, Germany and its numerous euro-area allies -- seizing on the negative public verdict in Greece’s referendum on July 5 -- explicitly put the option of a member’s exit from the euro area on the table.
Doing so proved to be an extraordinarily effective negotiating technique, compelling Greek Prime Minister Alexis Tsipras to recognize the dangers of his country going off the cliff with his excessive demands.
At the same time, the politically acknowledged possibility of a Greek exit – which, given its catastrophic domestic consequences in Greece, could not possibly have been merely temporary – will have undermined the sense of irreversibility in the euro area. The famous 2012 claims of Mario Draghi, president of the European Central Bank, to do “whatever it takes” to keep the euro together are undermined when top elected leaders threaten the opposite.
The German government and Finance Minister Wolfgang Schäuble in particular must presumably have calculated that the political gains to be had from coercing Mr. Tsipras toward the political center by talking openly about a “Grexit” exceed the potential future complications for monetary policy and the European Central Bank’s planned exit from its €1.1-trillion asset purchasing program in September 2016.
Financial markets may well, when the ECB is no longer intervening in the markets, reintroduce some degree of re-denomination risk – the risk that a euro zone member might be forced out of the currency bloc – onto the financial instruments of countries going through economic and political turmoil.
More broadly, the danger of a member state exiting the common currency’s institutions could lead to financial markets more actively pricing in the tail-end political risk associated with electing parties with political platforms similar to Syriza’s. Bank depositors in other euro-area countries, having witnessed European authorities shut down the Greek banks in reaction to Syriza’s policies, are also likely to respond to similar political developments in their own countries, precipitating bank runs ahead of future elections if Syriza-like parties lead in the polls.
All told therefore, German government negotiating strategies have helped engineer an outcome to the Greek debacle that will make it harder for populist and extremist parties to gain power inside the euro area in the future. The negative implications of Syriza’s fate on the political prospects of Spain’s Podemos are already becoming clear.
But this has come at the price of creating an even more potentially unstable and volatile euro area, where more economic crises are likely in the future before the bloc’s ultimate political stability is finally secured.
Any back door toward a more unconditional transfer union has been shut.
Germany, at least partly responsible for this and as the political leader of the euro area today, now has a particular responsibility to help avoid this outcome. For future crises in the euro area to instead be preempted, Germany must now take the lead in the next required phase of integration.
Fortunately, the July 12 agreement that secured Greece’s third bailout illustrates several issues that should make it easier for Germany to move this process forward. It highlighted how the euro area is first and foremost a rules-based club, where the costs of persistently breaking the rules in the end fall overwhelmingly on the wayward member state.
Current euro-area institutions have made it clear that they will ensure an appropriately asymmetric adjustment path following the kind of self-inflicted, prolonged crisis seen in Greece. This was to a large extent due to the demands of Germany and its allies.
This decision – a reflection of German political influence – successfully contained the risks of moral hazard inside the euro area, as any back door toward a more unconditional transfer union has been shut. A member state cannot, through confrontation and the willingness to destroy its own economy in the process, secure more lenient support from the rest of the euro area.
Those concerned about the latent threat of moral hazard, in what remains a collaboration of at least partially independent member states, should sleep more easily after what happened to Greece.
Knowing that the euro area has a set of institutions that can compel cooperation from even the most recalcitrant member, it is now time for Germany to tell the rest of the euro area in what direction it believes future integration should go.
The Five Presidents’ Report on the next integration steps can only be the low-hanging fruit. It is time to think creatively about what new political institutions the euro area will need in order to oversee the additional fiscal integration that preempting future economic crises in the euro area will require.
With its pivotal political position in the euro area and domestic federal governmental structure, no country is better positioned to start this necessary debate than Germany.
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