A simple public choice theory of the Ireland bailout

In a very good piece, Barry Eichengreen writes:

One can interpret the intransigence of the German government and its EU allies in two ways.

  • First, they understand neither economics nor politics. As Tallyrand said of the Bourbons, “They have learned nothing, and they have forgotten nothing.”
  • Second, policymakers in Germany – and in France and Britain – are scared to death over what Ireland restructuring its bank debt would do to their own banking systems.

My model here is simple.  The Germans fear that if Ireland pulls the plug on the bailout deal, some of the other PBIIGS will meet immediate financial crises, and that spills over onto both German lending banks and Germany as the country holding the eurozone together.  Ireland feels that if it pulls the plug on the bailout deal, the Germans don't lend enough support and a) they lose what's left of their banking system, and b) their next government bond auction goes very, very badly.

I agree with the critics of the current arrangement, but I don't think they're facing up to how bad the alternatives will be (see also Megan).  Predictively speaking, I am betting on Irish electoral resentment to carry the day.  But in the meantime, EU bond purchases are kicking the can down the road.


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