Europe’s endgame?

Vanderbilt economics and finance professor David Parsley discusses the European Debt Crisis as part of the Dean’s Book Club at the Owen Graduate School of Management.


In his bestselling book, Boomerang: Travels in the New Third World, author Michael Lewis presents a compelling, if unnerving, patchwork of narratives designed to shed light on the still-unfolding debt crises plaguing Europe and parts of the U.S.

The title was chosen for the Dean’s Book Club at Vanderbilt’s Owen Graduate School of Management this fall as a way to foster a broader discussion about the state of the global economy — and what can be done to solve some of these seemingly intractable problems.
David Parsley, E. Bronson Ingram Professor in Economics and Finance at Owen, helped lead the recent book-club discussion. Here is some of what he had to say:

How has the situation in Europe changed since the book’s publication?
Well, have you noticed that Iceland is doing pretty well lately? The book depicted Iceland as a basket case, but its unemployment rate is down to around 6%, inflation has moderated, and its debt-to-GDP level is expected to decline to around 82% by 2016 from its current level of 115%. That's in contrast to the U.S. debt-to-GDP level, which just climbed over 100% and is rising.

How did Iceland accomplish this?
They let their banks go belly-up and they depreciated their currency. It was similar to what happened in Argentina when the country repudiated its debt in 2005 and creditors were forced to take a 65% haircut. It’s not an easy solution, but it has worked in the past.

Could Greece do something similar?

It doesn’t look like it, mainly because of the way the European Central Bank is handling the situation. They’re asking private investors to take a 50% haircut on their Greek holdings, but the ECB is not willing to take any reduction on their Greek investments. That’s hypocritical.

What’s to prevent Greece from just reverting to the drachma and devaluing it?
I think there is an immediate reason that Europe would want to keep them from doing that, namely the pain that the ECB and private banks would suffer as a result. The ECB owns an enormous amount of Greek debt that it purchased as part of bringing Greece into the euro.

Could the ECB drop interest rates to near zero and institute a round of quantitative easing, as the U.S. has done?
I think that could help. But it will never happen. Germany would never allow it. They are still so haunted by the runaway inflation experienced during the Weimer Republic in the 1920s that they would block any significant moves towards adopting a looser monetary policy.

Going back to the 2008 financial crisis, what could the Federal Reserve, the SEC, or the ratings agencies have done to prevent this worldwide mess?
I go back to Alan Greenspan telling Congress, telling everyone, that there was nothing to worry about. He said the financial markets and the mortgage banking system were working normally. And then he came out and said he was wrong about all of it. But I think the Federal Reserve—as a function of government—fulfills the role that it’s meant to fulfill. I also happen to think that it’s working much better now because of Ben Bernanke.

Published Nov 15, 2011 in Vanderbilt Business Intelligence
Copyright 2011 Vanderbilt Owen Graduate School of Management