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<div style="margin-bottom: 11pt;"><b>Viv Davies</b>: &nbsp;Hello, and welcome to Vox Talks, a series of audio interviews with leading economists from around the world. I'm Viv Davies from the Center for Economic Policy Research. It's the 16th of August 2011, and I'm speaking to Professor Charles Wyplosz, Professor of International Economics at the Graduate Institute, Geneva, about his recent Vox article on the Eurozone crisis. We discussed the recent ECB intervention in the markets for Italian and Spanish bonds, the European Financial Stability Facility, Eurobonds and the possibility of further contagion. Professor Wyplosz presents his views of what must now be done in order to get ahead of the markets and resolve the crisis.</div>
<div style="margin-bottom: 11pt;">I began by asking Charles why he was of the opinion that it was a mistake to have bailed out Greece in May 2010.</div>
<div style="margin-bottom: 11pt;"><b>Charles Wyplosz</b>: &nbsp;Well, because bailing out Greece was making an open‑ended commitment, not just to Greece but to all the other Euro area countries, and you shouldn't make an open‑ended commitment unless you're sure you have the means and the will to do it. Had we just not bailed out Greece in May 2010, Greece would have had to go immediately to the IMF, and they would probably have organized with the IMF a debt default and that would be it. We wouldn't have the current burning issues about whether the Germans want or don't want to pay and in what form, et cetera.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;But if there was a default from Greece, wouldn't that have meant their exit from the Eurozone?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;No, I don't see the link. People make this link quite often, but I don't see the logic. We can have corporations that default within the Euro area and that doesn't mean anything. We can have a government that defaults within the Euro area and the government uses the currency. What is true is that, very often in history, countries that defaulted depreciated or devalued at the same time, and that gave them a boost. That's not available in the Euro area, and it's a cost of being the Euro area. But that's the accepted cost from day one or from day minus one, and there's no reason to wink when it happens.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;So what about the recent decision by the European Central Bank to intervene again in the markets for Italian and Spanish bonds? Was that also a mistake?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;No. Paradoxically, no. I thought it was a deep historical mistake for the ECB to go along with governments and bail out Greece in 2010, but now the situation has changed. The cardinal sin has been made, and the issue now is to go to the bitter end of this new logic and make sure that the crisis stops. And the decision by the ECB of 10 days ago is the right one, but it's not enough. Small installments here and there will not stop the crisis. What the ECB has to do now is to get ahead of the markets and provide a blanket quarantine.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;So what do the European leaders need to do to get ahead of the market or get ahead of the problem?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;Well, they have to convince the ECB to do what it has to do. The ECB is the only place that can do anything about it right now. The numbers are too big with Spain and Italy and, quite possibly, France coming on stream. This is not something that states can do. This is something that only a central bank can afford.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;What about the European Financial Stability Facility more generally? Is that the answer to Europe's long‑term solvency issues?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;No, that's another big mistake. If you just add up the public debts of the three countries currently under IMF program - Greece, Ireland and Portugal - and you add, say, Spain and Italy which are coming into serious trouble, you reach something that's about 35% of the Euro area GDP, or 130% of German GDP. If you start supporting that, you have to be willing and able to support all of the debts. There is no way European taxpayers and, therefore, the Stability Facility can guarantee 35% of Euro area GDP. That's just completely out of the picture. So, the current focus on the EFSF is simply completely misleading and completely overlooking the kind of money that needs to be put forward now.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;Germany and France are ruling out the Eurobonds as a solution to the Eurozone debt crisis. Do you think that's another mistake?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;No. Eurobonds are a fascinating topic, and I suspect that one day we'll have Eurobonds. I also suspect that if Eurobonds are well done, namely along the blue bond‑red bond proposal that has been put forward by economists, that would be a step forward, but that's not a solution of the crisis. It's for after the crisis to reduce the odds of another crisis of the kind we have right now. One more time, the amounts needed are much too big to be dealt with through taxpayers' money at this stage.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;How serious, still, is the issue of contagion? Is it still a possibility in the Eurozone?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;You bet! We are now seeing the contagion hitting core countries like Spain and Italy. We see France vacillating. Belgium should not be far down the road. And if all of these countries go down the drain like Greece and Portugal, then one will start to question the ability of even the German government to deal with the problem, and we could have contagion all the way to Germany.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;And how easily do you think the crisis could also spread into the banking sector?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;Oh, this is the total disaster scenario and, fortunately, very unlikely. Let's take an example. Suppose that Italy has to default, which is a very plausible scenario, not necessarily happening but very plausible. Then it's almost certain that a number of banks, not just in Italy but also in France and maybe Germany, will be insolvent. The question then is: Who bails out this insolvent bank? It can't be the insolvent Italian government or the insolvent French government. It can only be the ECB, and that's stretching the ECB to enormous, enormous risks.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;You mention in your recent paper that, in short, this isn't a liquidity crisis but it's more a crisis of confidence. Could you expand a little on that?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;Yes, but I just want to preface by saying liquidity crises are very often crises of confidence. It's not a solvency crisis. Let's take again the example of Italy. Barely a month ago nobody was really saying that Italy is insolvent. But because there was this little conflict between the prime minister and the finance ministers, the financial markets panicked, and now Italy is about to be declared insolvent. As a result of that, the Italian government will find it increasingly difficult to raise funds on the market.</div>
<div style="margin-bottom: 11pt;">So yes, it's insolvency in the sense that that's what the markets now believe. Yes, it's illiquidity in the sense that nobody will lend to Italy sometime soon. But what I wanted to say is, because it happens this way, it's a self‑fulfilling situation where it happens because you believe that it will happen, and it's totally a confidence problem.</div>
<div style="margin-bottom: 11pt;">That's why I believe the solution is to get ahead of the markets and restore confidence. That's why I've been suggesting that the ECB should guarantee public debts. When public debts are guaranteed by the ECB, there will be confidence because the ECB has the means to guarantee everything it wishes. Then we will see, in a matter of a few weeks, that the situation is solved, confidence comes back, liquidity comes back.</div>
<div style="margin-bottom: 11pt;">Then we'll have to deal with the question of which countries can pay back their debts wholly and which ones cannot, in the sense that it would be too painful. For example, I don't think that it makes sense for Greece to attempt to pay back all of its debt. It just would be a drag on its growth rate for the next 10 years, and it doesn't really make sense. But that's for later, and at this stage, that's when we will start talking about Eurobonds and how to restart these countries.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;So in summary, Charles, what would be your strapline advice to the leaders of the Eurozone countries right now?</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;Ok. Number one, stop trying to solve long‑term problems in the middle of a catastrophic situation. Eurobonds, fiscal discipline, European governance, all of these things are crucial questions to be dealt with so we don't have a repeat of the current crisis, but these things cannot be done in the middle of turmoil. So, we'll have to have a proper assessment of what happened, and we'll have to draw all the conclusions of what happened, but not now. That's number one. Number two, don't push for immediate debt stabilization programs because that is cutting growth or introducing recessions, and countries cannot solve their deficit problem in the middle of a recession. So, ease up in the short run and aim at the long run, and that's number three.</div>
<div style="margin-bottom: 11pt;">My number three recommendation is we have to start putting in place institution that will guarantee long‑term fiscal discipline.</div>
<div style="margin-bottom: 11pt;">And finally, stop the rot right now, today. And that's a call to the divided ECB, because we know that there are some people who want to do what I suggest, others don't. It's a call to all ECB board members and governing council members. Think about history. If we let the Euro be broken up now, future historians will not be tender towards those who have been counting beans and asking for protections and discussing narrowly about the mandate of the ECB.</div>
<div style="margin-bottom: 11pt;">They just have a historical role to play, to come in, say &ldquo;we guarantee the debts&rdquo;. There are many ways of doing that; some are very smart and not costly at all. But they have to step in and say &ldquo;we have the Euros and we'll print whatever it takes to make sure that debts are not challenged any more by the markets&rdquo;, and the markets are just waiting for that to happen to come down.</div>
<div style="margin-bottom: 11pt;"><b>Viv</b>: &nbsp;Charles Wyplosz, thanks very much for taking the time to talk to us today.</div>
<div style="margin-bottom: 11pt;"><b>Charles</b>: &nbsp;My pleasure.</div>
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