Greece’s elections and the future of the Eurozone

Summary

If, as seems likely, the Syriza party wins the Greek election on 25 January, what will be the impact on the Eurozone? This column summarises the views of 40 UK-based experts polled by the Centre for Macroeconomics (CFM). A 60% majority of survey respondents do not think that a Syriza victory will cause interest-rate spreads for other countries in the Eurozone periphery to increase significantly or for a sustained period. But opinion is more evenly divided on whether core Eurozone countries and the EU should be open to renegotiating the Greek debt and the conditions of the Greek bailout.

Potential spillovers of a Syriza victory

This month's survey looks at the implications for the rest of the Eurozone of the upcoming Greek elections. On 25 January, Greece will elect a new government. Current opinion polls show a lead for the anti-establishment party Syriza – which is associated with virulent criticism of EU policies towards Greece. One of the main planks of Syriza’s campaign is that existing agreements between Greece and ‘the troika’ (the European Commission, the European Central Bank and the International Monetary Fund) need to be renegotiated, with a view to further write-offs of Greece’s outstanding sovereign debt and a reduction in the scale of fiscal adjustment under the support programmes. 

The first of this month’s survey questions is about the potential spillovers of a possible Syriza victory to other ‘peripheral’ Eurozone members. One line of reasoning is that sovereign interest rate spreads will escalate, not only in Greece but also in some other countries that have experienced severe sovereign debt stress in recent years. This is because financial markets would interpret the failure of Greece to meet its agreed fiscal plans and any further negotiations over a reduction in debt as precedents, which others might be tempted to follow.

The alternative line of reasoning is that financial markets have effectively ‘decoupled’ Greece from the other peripheral countries, and hence little or no contagion is likely.

Q1: Do you agree that a Syriza victory on 25 January would lead to a significant or sustained escalation in spreads for other peripheral Eurozone countries?

|Summary of responses

A majority of respondents disagree with this question: 56% disagree and a further 3% strongly disagree, 18% neither agree nor disagree, and 23% agree or strongly agree – although when weighting by the degree of confidence held by respondents, the balance of the poll becomes slightly less uneven.

When motivating their answers, many of the respondents agree with the thesis that other Eurozone peripheral countries have decoupled from Greece. One reason is that these countries tend to have ‘relatively lower public and foreign debt burdens’ (Jim Malley, University of Glasgow). Another reason is that ‘today, there is very little exposure of banks to Greek debt’ (Costas Milas, University of Liverpool).

Others think that the extent of decoupling varies among peripheral countries. Sir Christopher Pissarides (LSE) thinks that contagion will happen ‘mainly in Spain, because of the close relation between Podemos and Syriza, and the forthcoming election in Spain.’ John Driffill (Birkbeck College, University of London) singles out Cyprus as ‘the only Eurozone member which is likely to suffer a contagious reaction.’

In general, respondents who don’t accept the decoupling argument stress that a Syriza victory is a harbinger of victories by similarly minded parties in other countries.

Respondents who do not think that a Syriza victory would cause problems for other countries in the periphery also note that polls have been predicting such an outcome for many weeks, so that ‘a Syriza victory should already have been priced in by the market’ (Martin Ellison, University of Oxford). According to Wouter den Haan (LSE), this argument is reinforced by the fact that ‘another round of Greek restructuring or even default is likely [even] without a Syriza win.’ Kate Barker (Credit Suisse) takes a similar view.

But Christopher Martin (University of Bath) reminds us that ‘financial markets are not objective and are often irrational.’ Several other respondents highlight the enormous difficulty of predicting financial market responses. Ethan Ilzetzki (LSE), for example, says that ‘forecasting spillovers of sovereign spreads is a nearly impossible task.’

Several respondents highlight the impact that ECB actions will have on the behaviour of spreads in the wake of the election. Gianluca Benigno (LSE) points out that ‘An aggressive QE programme could limit the escalation of spreads.’ Richard Portes (London Business School) opines that ‘new firewalls against contagion are some comfort, and the ECB will have announced some version of QE by then.’

Renegotiating Greece’s debt and bailout agreements

The second question in this month’s survey concerns the appropriate response by the EU and the core EU countries to a possible Syriza bid to renegotiate its debt and its bailout agreements. Advocates of the status quo argue that acquiescing to Greek demands would only encourage other peripheral countries to reduce their commitment to agreed fiscal plans. These commentators also think that Greece has a weak hand, as its outside option is unilateral default and likely exit from the Eurozone, both of which would be economically and politically too costly. In any case, they further argue, thanks to ‘decoupling’, the Eurozone can withstand ‘Grexit’.

Advocates of a more flexible position believe that a Syriza victory would give the EU a chance to recognise that Greece cannot possibly repay its debt in its entirety, and that the fiscal programmes may have been too draconian and unrealistic. They also discount the extent of decoupling and hence fear that Grexit would open the way to a wider Eurozone break-up.

Q2: Do you agree that refusal of the core EU countries to a renegotiation of the Greek bailout agreements would carry serious risks for the economic well-being of the Eurozone?

Summary of responses

On this question, there is an almost even split: 50% of respondents agree or strongly agree, while 43% disagree (nobody strongly disagrees). When answers are weighted by confidence, the ‘dovish’ position becomes stronger: 55% versus 35%.

David Cobham (Heriot-Watt University) captures a widely held sentiment among those who agree that ‘whatever the answer to the great puzzle “why is German macroeconomics so different from everyone else’s?”, EU leaders should understand that it is now time for compromises.’ Sir Christopher Pissarides predicts that ‘refusal of the “core” to listen to the “periphery” will sooner or later lead to… disintegration.’

Simon Wren-Lewis (University of Oxford) goes as far as to say that ‘A Syriza victory would be the best thing to happen in the Eurozone for some time,’ as it gives the EU a ‘chance to partly undo [the] mistakes’ it made in 2010-12. There is concern with moral hazard (the argument that other countries will want to renegotiate), but Angus Armstrong (NIESR) concludes that ‘after a certain point the trade-off is likely to show that the cost of the moral hazard is less than the consequences of denying the size of the problem.’

Many highlight the likelihood of Grexit in case of EU intransigence. Interestingly, this is cited both by those who agree and those who disagree. Among the former, Richard Portes thinks that ‘Grexit would be a disaster for Greece as well as a major risk for the continued existence of the Eurozone.’ Patrick Minford (Cardiff University) who also agrees with the question, writes the following: ‘This refusal makes Grexit far more likely. Effectively Greece can leave the euro and stay in the EU; any attempt to force it out of the EU for leaving the euro would create severe division between north and south Europe, since other southern countries may be forced to leave the euro too. The dangers of leaving are greatly exaggerated by euro-zone leaders; the benefits of an economic “reset” and debt write-off are substantial.’

Among those who disagree, the view is that Grexit would be ‘a much better outcome for Greece than continuing with current policies’ (Nicholas Oulton, LSE), and that ‘Greek exit from the Euro Area may strengthen the Area as it would become clear that the fiscal rules are binding’ (Ray Barrell, Brunel University).

On a related note, Jagjit Chadha (University of Kent) worries that ‘the re-opening of the Greek settlement… would threaten an early agreement on euro-wide unconventional [monetary] policy.