That is the topic of my latest New York Times column, and I will start off by stating the case for optimism (if that is the right word):
On the bright side, the fact that markets haven’t ended the European mess by themselves — say, through a truly huge capital flight from the more troubled countries — suggests that a solution does exist in principle, and may even take hold. That isn’t much to cheer about, but, under the circumstances, even simple survival is positive news. One specific bright spot is that both Spain and Greece have been making some wage adjustments to restore longer-term competitiveness.
I grant there has not been comparable progress in reducing suffering. And here is the case for pessimism:
Imagine a situation where the sounder countries need to put up more money, or the troubled countries need to make bigger financial adjustments, or — most likely — both. Yet power vacuums on each side, or voter rebellions against cross-national agreements, could stop these responses from being applied in a timely way. Political paralysis could then become the harbinger of disaster.
The mess won’t be resolved until the various governments raise their hands and announce transparently just how much of the mess they will pay for — and how. Such announcements will then need to be validated by elections. That means sending a consistent message to other countries and to their own domestic electorates and interest groups. Until then, the game of chicken will continue, and the risks of financial catastrophe will remain high.
Overall I still do not think the current arrangement will work out. On the positive side, the political commitment in Greece has turned out to be stronger than I had thought, with the comparable judgment for Spain and Italy remaining up in the air. On the negative side, the broader eurozone recession has halted what was significant progress in Spanish exports.
Finally, I don’t think we will know “the answer” anytime soon:
…the euro zone’s mess could last for a long time, with neither solution nor dissolution.
When matters appear to improve, or when the troubled countries receive more aid, there is more slack in the system. The troubled countries respond by behaving less responsibly and, as a result, move the financial situation closer to the precipice again. For instance, when the European Central Bank announced its debt monetization plans, Spain’s government suddenly faced lower borrowing rates and then refused to apply for a politically costly bailout and austerity package.
When matters become worse, the fiscally healthier countries pony up more aid, as we have seen them do repeatedly for Greece.
It is thus a mistake to overreact to most of the headline events about the euro zone crisis. The good news is never quite as good as it looks, and the bad news often brings beneficial responses. It seems that for dozens of months now, we’ve been hearing that the fate of the euro zone will be decided “shortly,” yet somehow the drama continues.
In normative terms, I see debt forgiveness as essential to moving forward in Europe.