Extend and pretend
So far, there are three key mechanisms the troika — the European Commission, International Monetary Fund (IMF) and ECB — has employed to buy time for the Eurozone’s weaker countries to regain competitiveness and return to growth. Each of these could fail over the next few years, prompting a renewed intensification of the crisis.
Source: EFSF, ESM, RGE estimates
* We assume that Italy and Spain will not be forced to request official financing before 2013
Making the most of borrowed time
Even if all of these efforts to buy time go off without a hitch, there is a significant risk that social and political factors will lead the weaker Eurozone countries to squander the time that has been bought for them, rather than implement the difficult reforms that are needed.
This crisis has legs
Even if the Eurozone survives the current crisis fully intact, there are reasons to worry about further crisis lying ahead. The cycle of boom and bust is such that at some point the euro area will hit another economic and/or financial shock. But the troika’s current crisis-resolution approach of extend and pretend will have done nothing to position the Eurozone to survive such shocks any better in the future. Ultimately, unless the fundamental structure of the Eurozone is reformed so that political union leads to fiscal transfers or joint and several liabilities, this crisis will inevitably rage on.