Even after European leaders appeared to have averted a chaotic default by Greece with an eleventh-hour deal for aid, worries persist that a debt disaster on the continent has merely been delayed.
The tortured process that culminated in that latest bailout has exposed the severe limitations of Europe’s approach to the crisis. Many fear that policy makers simply don’t have the right tools to deal with other troubled countries like Italy, Spain, Ireland and Portugal, a situation that could weigh on the markets and the broader economy.
“I don’t want to be a Cassandra, but the idea that it’s over is an illusion,” said Kenneth S Rogoff, a professor of economics at Harvard and co-author of “This Time Is Different: Eight Centuries of Financial Folly.” “I am amazed by the short-term psychology in the market.”
Throughout the crisis, the European Union’s favoured strategy has been to provide tightly controlled financial support to highly indebted countries, in the hope of buying them enough time to put in place policies aimed at cutting budget deficits. While such moves can deepen recessions, the goal is to eventually lower debt levels and win back the confidence of the bond markets.
On the margins, investors have become more optimistic. European stocks and government bonds have rallied sharply this year on the belief that Greece would avoid a disorderly exit from the euro. On Tuesday, United States equities rose slightly after the Greek deal, while European stocks fell modestly, giving up some of their gains from the previous day.
But Greece’s predicament highlights the weakness in the European response. Austerity policies imposed by the authorities contributed to a sharp contraction of the Greek economy last year. In 2010, the International Monetary Fund had forecast that the economy would shrink only 2.6% in 2011, but current estimates suggest a contraction of 6.8%.
Greece is also resorting to a move that European officials initially wanted to avoid at all costs. As part of the 130 billion euro aid package, the country is going to reduce its overall debt load by requiring some creditors to take losses on Greek bonds. In total, the restructuring will