In a note out this morning, Goldman Sach’s Francisco Garzarelli writes that four things have him convinced that Europe will not fall back into the crisis environment it saw between August and December of last year:
- More credible structural adjustments are now being carried out in Italy and Spain, with all the qualifications on the contents and sequencing of policies. Over time, they should lift trend growth and thus improve debt sustainability (Lasse Nielsen, Andrew Benito and Kevin Daly review the tall challenges facing Southern Europe in a series of notes featuring in the last four issues of the European Economics Analysts). Meanwhile, Ireland, Portugal and Greece are also making progress, and their government bonds are gradually being replaced by official sector loans, reducing the systemic relevance of these countries.
- A more coherent (albeit imperfect) ‘policy governance’ framework is in place which should facilitate agreement on the fiscal stance in Euro area countries. This is embodied in the so-called ‘six-pack’ and in the ‘fiscal compact’ (with Hamiltonian echoes), which is in the process of being ratified in national parliaments (and through a referendum in Ireland).
- Despite all their limitations, financial backstops (the EFSF, and soon the ESM) have become operational and can be accessed through better designed ‘fast-track’ procedures. Interventions in both primary and secondary markets can accompany rather than substitute private intermediation. There is also the possibility of precautionary lines, and support for bank recapitalizations.
- The ECB has secured bank funding for financial institutions for three years through the LTROs has loosened the pernicious correlation between the cost of funds for banks and sovereigns (although one side effect of this has been a larger ‘home bias’). The central bank is also directly active in the debt markets through its Security Markets Program.
Even so, that does not mean Europe is out of the woods yet. Garzarelli said Goldman analysts are still concerned about the scarcity of adequately priced government bonds, lack of growth, and the fact the the European Central Bank has replaced markets rather than bolstering them in doling out cheap liquidity.
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