′Alliance between banks and governments at the heart of eurozone crisis′ | Transatlantic Voices | DW | 16.12.2011
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Transatlantic Voices

'Alliance between banks and governments at the heart of eurozone crisis'

The 'monstrous irresponsibility' of European banks contributed to the current euro crisis, says Edmund Phelps. But at its core lies a fatal collusion between governments and banks, argues the Nobel Winner in Economics.

Edmund Phelps

Banks can't be allowed to calculate their own risks, says Phelps

Edmund S. Phelps is the 2006 winner of the Nobel Prize for Economics. Phelps is McVickar Professor of Political Economy at Columbia University in New York and Director of Columbia's Center on Capitalism and Society.  

Deutsche Welle: There has been criticism of last week's EU summit that it didn't address the immediate crisis enough. And that under the leadership of German Chancellor Merkel European leaders didn't allow the European Central Bank to act as a lender of last resort, didn't implement eurobonds or grant a banking license for the stability mechanism. Many say that the crisis can be only be solved by implementing some or all of those measures. Do you agree?

Edmund Phelps: I guess I was a little surprised that there wasn't more attention paid to the immediate crisis. But the explanation I suppose is that the leaders had not yet reached an adequate agreement as to how to proceed with the immediate crisis. And we are still wondering whether the European Central Bank (ECB) is going to be empowered to buy up a whole boatload of Greek debt and I suppose the willingness of the ECB to do so is another element in the equation. I think there is still some uncertainty about how much money the IMF would be able to bring to this task. 

It may take a month or even several months before a full agreement is reached how to deal with the Greek problem. Of course the problem is that meanwhile the clock is ticking and Italy is exposed to a speculative attack on Italian bonds. So Europe is in very dangerous territory at the present time.

With the clock ticking for Greece and Italy, but also for Spain and Portugal which are also seen as increasingly shaky creditors by the markets, how do you assess their ability to acquire loans at affordable rates going into 2012?

The Italians I talk to are very optimistic that this can be done. But of course if participants in the bond market decide that it can't be done then they are going to be unwilling to lend to Italy even at very elevated interest rates. The higher the interest rates the Italian government is willing to offer the more nervous the bond buyers will be. So it is a possibility that there could be breakdown of Italy's ability to roll over its public debt and move forward.

What is your sense then of the eurozone? Will it continue to exist in its current form with all 17 members or do expect that Greece or others might drop out?

I think we have to entertain the possibility that Greece will want to drop out and the possibility that the other members of the eurozone would push Greece out. That could help the euro as a currency. It wouldn't help the solvency of the European banks. I find it very hard to imagine that the eurozone as a monetary zone would close down. All the countries in the eurozone have benefitted from the arrangement, so I think there will be determined effort by all concerned to reach an agreement that will preserve the euro.

Britain has chosen to go it alone and not join the planned stability union. Is that smart move in your opinion?    

It's understandable that the British didn't want to put themselves in a position where they would be forced to hand out big bailouts to Greece, Italy and Spain and others.

But that decision is now being criticized by people who say that Britain now won't be part of the discussions about reforming the fiscal, monetary and financial system. And Britain is very dependent on the eurozone countries and the way the eurozone works. While it fled the scene because of the risks it saw, it may have jumped from the frying pan into the fire.

If Chancellor Merkel, widely regarded as the central figure in solving the euro crisis, were to ask you for your economic advice how to solve this crisis what would you tell her?

I think she is proceeding in a way that looks to be the right way for Germany. I think what she wants to do is nail down a reconstruction of the eurozone so that the Greek behavior can never be repeated. If she can get agreement on that then maybe she can get support of the German public for a bailout of Greece and everyone can understand as far as we can foresee that this bailout is the last in the eurozone.

But I don't think that right now there would be much support in Germany of jumping ahead in the next weeks and months with a bailout of Greece or even using the ECB for that purpose because there would be feeling that there would be a moral hazard in doing so, because that would only encourage countries to believe that if they are in fiscal difficulties they would be bailed out.

It looks like we are seeing the beginning of a second banking crisis in Europe. France's second-largest bank as well as four other European banks have just been downgraded. Does history repeat itself after all?

And so soon (laughing)? I think even two or three years ago a lot of economists were wondering about the solvency of the French banks. I have to say as an American I find it a little strange that whatever happens in Europe is a problem of the eurozone. What's happened to the national governments? Why isn't the French government ensuring that its banks have a very comfortable margin of solvency. And why didn't they do that two or three years ago?

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