In the periphery of the eurozone, the problem is the opposite: bond vigilantes are demanding that Greece, Ireland, Portugal, Spain, and Italy front-load fiscal consolidation or watch their borrowing costs go through the roof, risking them their market access and triggering a public-debt crisis. Markets don’t care that front-loaded fiscal consolidation is exacerbating recession and thus making the goal of reducing debt and deficits as a share of GDP near-impossible to achieve.
To avoid a persistent and destructive recession, the fiscal and structural reforms imposed by the bond vigilantes should be accompanied by other euro-zone policies that restore growth and prevent vicious debt dynamics. The European Central Bank should ease monetary policy in order to weaken the value of the euro and bootstrap the periphery’s growth. And Germany should cut taxes temporarily – rather than raising taxes, as planned – in order to increase disposable income and stimulate German demand for the periphery’s goods and services.
Alas, neither of the two biggest players in the euro zone is pursuing policies consistent with restoring sustained growth in the euro zone’s periphery. The ECB’s monetary policy is too tight; and Germany is front-loading fiscal austerity. Thus, the periphery is destined to a destructive deflationary and recessionary adjustment that will exacerbate the risks of recession, insolvency, eventual defaults and, possibly, exit from the euro.
Related: Telefonica S.A. (ADR) (NYSE:TEF), iShares MSCI Spain Index (ETF) (NYSE:EWP), Banco Santander, S.A. (ADR) (NYSE:STD), Banco Bilbao Vizcaya Argentaria SA (ADR) (NYSE:BBVA), Bank of Ireland (ADR) (NYSE:IRE) , Allied Irish Banks, plc. (ADR) (NYSE:AIB), National Bank of Greece (ADR) (NYSE:NBG), Portugal Telecom, SGPS (ADR) (NYSE:PT) , Banco Comercial Portugues SA (ELI:BCP)