The ECB is the difference
The reason Greece (and Ireland, and Portugal, and to some extent Spain) are in so much trouble is that by adopting the euro they’ve left themselves with no good way out of the aftereffects of the pre-2008 bubble. To regain competitiveness, they need massive deflation; but that deflation, in addition to involving an extended period of very high unemployment, worsens the real burden of their outstanding debt. Countries that still have their own currencies don’t face the same problems.
–The Euro Straitjacket, Paul Krugman
The euro area has become the focus of the sovereign debt crisis, rather than the U.S., Britain or Japan – all of which have huge deficits of their own – because of the currency zone’s faulty design… While 17 countries share the common currency, there is no central fiscal authority or executive body capable of enforcing rules or addressing the vastly different levels of competitiveness within the region.
Here’s the thing though. The ECB does have the power to end this. They are not doing so for ideological reasons. Let me suggest two scenarios.
The ECB could do rate easing. Frankly, I am uncomfortable with any kind of easing but I certainly see some legitimacy in the ECB acting as a lender of last resort here. The ECB would ‘guarantee’ a rate for Italian bonds that is high enough to be a Bagehot penalty spread to Bunds but low enough that it effectively acts as a lower bound for a positive nominal GDP target. This would be liquidity at a penalty rate, say 200 bps to German Bunds, which would be 4.7% right now.
In practice the ECB would want to step in at unpredictable times and buy up sovereign issues below the guarantee rate to ‘punish’ speculators and police the guarantee this way.
you could have sovereigns conduct a ‘sovereign debt swap’ whereby the ECB buys an agreed-upon portion of the existing debt from the sovereigns and then uses these funds to back the [Eurobond] supranational debt. In future, the same agreed upon percentage of debt would be issued at the supranational level. Clearly, you have to have all euro zone members commit in equal measure or the benefits would not accrue to the periphery.
I reckon a proposal of this sort would be controversial. One should consider this a form of quantitative easing. This is the sort of structure which could only be set up over time – and may require amendments to existing treaties. Moreover, it should be viewed as a move toward the United States of Europe. I have said previously that the Germans would rather defect than allow this. So it will not be considered a legitimate political option until all other more superficial remedies have failed.