Forex Flash: EU damage control highlights moral hazard – Goldman Sachs

FXstreet.com (Barcelona) - The fact that a national stabilization policy should be sufficient in ‘normal’ times does not mean the crisis has not exposed some missing pieces in the toolbox of Euro area policy makers. According to the Economics Research Team at Goldman Sachs, “The main challenge policy makers have faced has been the issue of how to prevent a liquidity crisis for a country that was about to lose market access. Through the creation of the EFSF/ESM and the ECB’s OMT programme, policy makers have provided enough financial firepower to credibly backstop the periphery, and even other countries, should that be needed.” Policymakers have therefore created an option through which countries can increase their fiscal capacity significantly.

However, the use of the EFSF/ESM and OMT can only buy time to adjust a country’s fiscal position. What it cannot do is directly address the “stock problem“, the problem of a sovereign debt level that has become unsustainable. Assessing whether a “stock problem” exists for Euro area countries is not straightforward. How a country’s debt level develops depends on several variables that, to some degree at least, can be influenced by policymakers. This implies that – if governments are granted enough time – a fiscal path that looks explosive can be brought back into a sustainable pattern. It is the purpose of the EFSF/ESM and OMT to provide this time.

Ultimately, this also highlights the implicit moral hazard risk in these operations. The conditionality of the financial support and supervision through the ‘troika’ are meant to counter this risk, although they cannot eliminate it completely.