Greece Wins Stay of Execution

Posted by Diane Swonk on June 17, 2012

The center-right, New Democracy Party won the election in Greece, gaining 50 bonus seats in the new government. Altogether, this will give it somewhere between 127 and 130 seats of the 300 in the new Parliament. A coalition government will need to be formed quickly – in the next two to three days – most likely with the center-left, Pasok party to secure the 151-seat majority required to rule. There is also speculation that additional support from other more left-leaning parties could help to counter the still-vocal, anti-bailout, Syriza party.

That said, Greece still faces substantial hurdles to staying in the euro area, and will remain a threat to the region for some time to come. The next step is for Europe to come up with a more credible plan to unify the region. This will require:

*A unification of the European banking system, with some form of deposit insurance to prevent runs on European banks. Greece has already seen a mass exodus of deposits, with Greeks withdrawing close to a billion euros a day (about 125 billion dollars).

*A larger fund to bail out and recapitalize insolvent banks.

*And, last but most important, a better way to fund troubled countries so that they can break the vicious cycle of recession, declining revenue and persistently large deficits that have emerged from austerity programs. Germany, in particular, needs to bite the bullet and sign off on euro bonds, which could be issued at much lower rates than the peripheral countries are currently paying.

Europe will also need to lengthen the time frame required for high-deficit countries to meet deficit targets.

The Group of 20 (G-20) meets this week in Mexico. Markets will be looking for reassurance that Europe is moving more rapidly to devise a plan which includes the above-mentioned criteria.

Europe remains the greatest near-term threat to global growth; we are still a long way from being out of the woods. As an economist, I believe in incentives, and Europeans do seem to understand that they have more to lose by scrapping the euro. The euro was a political decision; its fate will be determined by politics. Buckle your seat belts; it will be another anxiety-ridden summer, even without discussing our own impotence over dealing with the “fiscal cliff” prior to U.S. elections.

Bottom Line: The Greeks bought Europe a few weeks, but not much more. Central bankers around the world get to sleep tonight. The Federal Reserve, for its part, is likely to extend its “Operation Twist” on Wednesday and reaffirm its willingness to act further to expand its balance sheet if necessary. The Fed is likely to keep its powder dry on “QE3,” however, as it may very well need it later in the year. The Fed could also move its expectations on tightening from late 2014 into 2015, but it is unclear how much credibility such a move would have. Chairman Ben Bernanke’s term is up in early 2014, and some of those most likely to replace him have argued against his policies.

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