Europe's $955 billion rescue package, Greek austerity, and moral hazard
Markets across the world soared after the European Central Bank promised the creation of a $955 billion rescue fund for eurozone countries with debt problems. But some economists are worried about moral hazard – bailouts leading to reckless spending.
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The reason is that the money comes with stringent demands for cutting spending and reducing deficits, something that Greece is finding out.Skip to next paragraph
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On May 2, European finance ministers endorsed a €110 billion bailout ($142 billion) for Greece, of which €80 billion will come from fellow eurozone members. The rest will come from the IMF
Greece has promised government pay freezes, pension cuts, and a higher retirement age in the middle of a deep and painful recession. Massive protests against the austerity measures in early May saw protesters repelled from the gates of parliament with tear gas, rock throwing, and the firebombing of a bank branch that killed three employees.
Greece is already grappling with 12 percent unemployment at the outset of austerity measures that are certain to drive unemployment higher. Greece is the recipient of the first-ever financial rescue of a member of Europe's 16-state eurozone currency area. Austerity's aim is to cut Greece's annual government deficit from 13.6 percent of gross domestic product to less than 3 percent of GDP by 2014.
To receive the loan, the Greek government agreed to freeze public-sector salaries until 2014, cut state pensions, and raise the average retirement age from 61 to 63. Laws limiting layoffs in the private sector to 2 percent of the workforce are also being scrapped.
Struggling to service a ballooning national debt, Greece has been locked out of the normal source for government borrowing, the bond market. Investors have been demanding high interest rates that Athens can't afford to pay.
Other countries with debt problems are taking steps to avoid Greece's predicament. Ireland raised taxes, slashed government spending, and imposed public-sector pay cuts of between 5 and 15 percent last year. At a press conference in Brussels after the bailout fund was announced early Monday, Portuguese Finance Minister Fernando Teixeira dos Santos said his country will sharply reduce its deficit in the next fiscal year and said the government is considering raising taxes.
Lessons from England?
But even here, the rigidity of the austerity plan now being imposed on Greece has sent a chill.
"What Mrs. Thatcher did was divisive – but it came in stages," says Kevin Featherstone, a professor at the London School of Economics. "There wasn't this preplanned awareness about what was coming next, and of course in Britain there were choices that could be made."
Thatcher's Conservative administration came to power in 1979, three years after a Labour government was forced to go to the International Monetary Fund for $3.9 billion – the largest amount ever requested of the IMF at that time.
Yield is effectively the price investors demand to hold a government or corporation's debt. The more likely default seems to investors, the higher the price they demand.
Investors had been deeply afraid in recent weeks that Greece would default on its debt, pushing yields past 12 percent on Friday. But those fears appeared to calm Monday, with yield on the Greek government's 10-year bond plunging down to 8 percent.
To be sure, investors still see Greek debt as risky and at 8 percent are demanding more than 5 percentage points in additional yield to own it than to own the European benchmark German 10-year, which was priced to yield about 2.8 percent on Monday.
German debt yields rose slightly on Monday, since the country will lead the way in paying for the debt of any European country's that seek help. The ECB has effectively signaled that it will spread the cost of the borrowing taken on by its heavily indebted members to the financially stronger European states and their taxpayers, something that alarms some economists.