© Bernd Hayo
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If Greece leaves the Eurozone, then most of the consequences are likely going to happen to the country itself. As far as I can see, the only serious issue for the Eurozone might be related to setting a clear signal to the financial markets that the Euro adoption does not necessarily imply permanence. In the short run, this might lead to speculations about Portugal and perhaps Spain as future members and could exacerbate their current situation. In the longer run, markets may charge a higher interest rate premium for at least some euro area countries.
However, there might also be a positive aspect, as the Eurozone will become more balanced; economically, Greece's membership was always somewhat problematic. To my mind, an important issue caused by the recent crisis is the breakdown of the Euro area's foundation. Notwithstanding the creation of the Stability and Growth pact, it was planned as a monetary union characterised by member countries responsible for their own fiscal affairs and maintained by no-bail-out clauses encompassing the ECB and member countries. However, both the ECB and member countries have violated that principle, which means that the founding institutions do no longer apply in practice. Thus, it is important for the survival of the Euro area that a new institutional framework is implemented as a substitute. The idea put forward by the Germans of implementing debt brakes in all countries could work in principle. One problem is again related to weak institutions in Europe, as it is not clear what will happen if these debt brakes are violated.
Another problem is that national stabilisation policy becomes now even more difficult. With the ECB focusing, at least in principle, on the Eurozone's average business cycle and fiscal policy constraint by the debt brake, there is very little leeway for countering country-specific shocks.
What measures should the ECB undertake in order to combat the Europe's sovereign debt crisis?
The ECB was in a difficult situation, which, at least in my view, it was not responsible for. It were the governments that failed in their responsibility to keep the level of public debt sustainable. In the Southern European countries in particular, this can be understood as a failure of institutions, the remedy of which is difficult and long time.
At the early crisis period, the ECB had to decide on what to do: on the one hand, bailing out sovereign debtors was a decision that reduces its factual independence and creates moral hazard. On the other hand, not bailing out governments would have made the situation in the debtor countries much more difficult.
Today, this option no longer exists. The ECB has bought a huge amount of debt and thus shown that it is willing to sacrifice its prime objective in times of crisis. On top of that come the implicit guarantees given as part of the TARGET system. Thus, the ECB has become so entangled in the debt crisis itself that it has run out of options and consequently developed a great interest in preventing that a default will ever occur. This of course exacerbates the debtor countries' moral hazard problem.
Do you think Long Term Refinancing Operation conducted by the ECB is an effective measure in crisis times? What negative impacts it may have?
I think this is useful, as it helps financial institutions to plan ahead and anchor expectations that long-term liquidity is ensured. The disadvantage is that the ECB cannot extract excess liquidity from the markets, which increases the inflation potential. However, with the Eurozone facing little economic activity that may be a risk worth taking. Another issue is that apparently a number of financial institutions are using this money to buy government bonds from Southern European countries, which help alleviate the pressure on this front. However, at the same time, with banks' balance sheets now showing more potentially risky bonds, there is even more pressure on the ECB to avoid a default at all costs.
What are the main differences between LTRO and Quantitative Easing? What do you consider is more effective?
I think the main difference lies in the relevant time horizon, which is longer in the case of the former than in the case of the latter. Curiously enough, we have very little hard evidence about the efficacy of these instruments in the first place. Empirical evidence on quantitative easing in Japan suggests that there is a stimulating effect, the size of which is rather modest, though. I am not aware of any empirical results referring to LTRO. I believe that LTROs are both more effective and more risky than common instruments of QE.