Tuesday, 5 July 2011

Time-inconsistency in European policy

We must thank Mr. Sarkozy and Mrs. Merkel for today’s downgrade of Portugal’s debt rating by Moody’s. The main driver of Moody’s decision was “the growing risk that Portugal will require a second round of official financing before it can return to the private market, and the increasing possibility that private sector creditor participation will be required as a pre-condition”. Why? Because Moody’s believes that the EU’s decision to require private sector creditors to participate in the new financing package for Greece is the new official EU policy on financing programs. As such, private sector creditors will not be willing to provide financing to any country that may require official financing in the future, and Portugal will not be able to return to the markets when expected. Mr. Sarkozy and Mrs. Merkel have managed to transform the availability of official financing from a market confidence booster to a sign of future default. Someone needs to teach European politicians about time-inconsistent economic policy, before they completely destroy the euro and a few small countries with it…

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