Once again, the decision to boost a firewall that would protect the euro zone has been delayed. Following the latest meeting of European finance ministers on Monday, the head of the Eurogroup, Jean Claude Juncker, announced that the topic would be taken up later in the month. The German government has yet to commit to increasing the size of the rescue fund. But for those observers (including me) who take it for granted that Berlin will eventually agree to such a move – most likely before the month draws to a close – time is slowly running out. While it is still realistic to expect the German Chancellor Angela Merkel to fund a stronger rescue fund, it is also clear that she is not yet ready to break the news to German taxpayers.
However, what if her reluctance to commit more money is rooted in more fundamental concerns that go well beyond purely domestic political calculations? Perhaps Merkel still doubts that there are any real benefits of a stronger firewall. If that is the case, these concerns might still win over the pressure being exerted by the rest of Europe, Washington, and by emerging economies. Is there a scenario under which changing circumstances would actually allow her to resist boosting the rescue fund and at the same time avoid an open confrontation with the rest of the world? Despite the private assurances that Merkel has given her euro zone partners, her government might still be tempted to let the clock run out on this phase of the crisis. Most partners would probably not dare to complain too vociferously for fear of rattling the markets.
Under this scenario, Merkel could point to the Greek example and argue that if that country can be stabilized, the worst is effectively over. Of course, she could point out that other countries, such as Italy and Spain, need to continue to do their “homework”, but that markets have now shown they are able to distinguish between different countries and different situations.
After all, the worst phase of the crisis, which occurred last fall, was triggered by overwhelming pressure on the banking system. If that was indeed the main cause of the fire sale of sovereign bonds, the problem has been effectively addressed by the European Central Bank (ECB). In fact, since the ECB’s massive intervention with its cheap loan program for banks, interest rates for Italian and Spanish government bonds have continued to fall. Perhaps, the argument goes, there is no need for a bigger firewall after all.
There is one more potent argument in Germany’s arsenal: moral hazard. Announcing a bigger rescue fund too soon could tempt southern European governments to water down their plans to reform their economies. In the German view, firewalls amount to bailouts, and the German public has had enough of bailouts. German officials have often pointed out that, even among economists, there is no consensus on an exact size of a powerful firewall. Some experts say one trillion euros would be needed, some say more than two trillion. Germany could ask for a longer pause to reflect on the situation. Furthermore, Germany could argue that Europe first needs to see the results of the French elections, as well as for the ratification process of the fiscal compact to be completed before committing new money. However, that would push the process well past the deadline of the spring meetings of the International Monetary Fund (IMF), when emerging economies were to decide whether or not to contribute more money to the IMF.
Last but not least, Germany might try to point out that not everything the media asks for makes sense. The sovereign bond-buying program of the ECB is a case in point. For months, public opinion described the program as the last line of defense against an impending euro zone collapse. But now, even the ECB has realized that the impact of the securities markets program (SMP) was limited. In fact, the ECB has stopped buying sovereign bonds on the secondary market. The German Bundesbank, which never liked the bond-buying program in the first place, must feel vindicated.
It should not come as a surprise then that the German government is still in a holding pattern. It is buying time on a decision that it does not want to take, while closely monitoring both financial markets and decisions taken in Madrid and Rome. As long as interest rates for Spain and Italy continue to fall, all is well. But if these countries come under renewed pressure, there is no firewall capable of mitigating negative effects. That too is something that Berlin must be acutely aware of.