The Problems In Europe May Be Due To Misdiagnosis Of The Illness

This article in The Economist raises the question that the medicine prescribed in the euro zone may be killing the patient. The diagnosis of the problem was that government profligacy in the periphery was the problem. The medicine prescribed for profligacy has been austerity. It appears that the medicine is making the problem worse, so what should a good doctor do? This article describes another diagnosis. It has the advantage of being a more accurate diagnosis, but the disadvantage of placing the fault on those who made the first diagnosis.

According to this analysis, the problem in the euro zone is the loss of confidence in the bond market about sovereign debt. Prior to the Greek crisis, investors assumed that there was an implicit guarantee that sovereign bonds would be supported by the ECB. The low risk of default led to euro zone wide convergence of bond yields at low rates. Now that investors have lost confidence that the ECB will stand behind sovereign debt, yields have risen to the point that countries at risk may not be able to service their debt. Given this diagnosis, the medicine needed is the restoration of confidence. The article describes some of the ways in which confidence might be restored as long as the doctors who made the first diagnosis are willing to recognize their mistakes.