NOW IS THE TIME FOR ALL ECONOMISTS TO SPEAK UP FOR NOMINAL GDP *LEVEL* TARGETING
Matthew Yglesias on the (Latest) Pinker Thesis

How Big Should the Eurozone's BIg Bazooka Be?

Gavyn Davies gives his view: $1.5T:

The size of the eurozone’s “big bazooka” The outline of a package to “save the eurozone” began to emerge at the G20 meeting last weekend…. The big questions surround Greek government solvency, the recapitalisation of the eurozone’s banking system and the leveraging of the resources of the EFSF. Expectations are now running high that Germany and France plan to deploy the “big bazooka”…. The more immediate market response is likely to hinge on whether the package is large enough to reverse the recent downward spiral in confidence. I would suggest using the following litmus tests in each of the key areas:

  1. Greece: The eurozone still seems reluctant to bite the bullet, and accept that an involuntary default on Greek debt is inevitable…. One litmus test for “credibility” would be that the package reduces the debt target to an ambitious 80 per cent of GDP by 2016. That requires the total package to amount to 82 per cent of Greece’s likely GDP in 2016, which is the equivalent of €200bn…. Currently, around €240bn of Greek government debt is in private hands. A 50 per cent haircut on this debt, as discussed in Germany recently, would thus raise €120 bn… it would still leave another €80bn to be found in order to hit the €200bn target, either from new official funding (i.e. from the EFSF and the IMF), or from write-downs on official debt….

  2. Bank recapitalisation: The amount that is needed to restore confidence in the banking system depends partly on the size of the Greek write-downs, and partly on the market’s expectations of possible future write-downs of other sovereign debt, especially in Italy and Spain…. Bank analysts’ estimates for the required amount of additional capital centre around €200bn… an announcement of €100bn new capital would be skimpy, while  €300bn would be impressive. Banks would be given time to raise this from private sources, but any shortfall would have to come from national exchequers or – once again – the EFSF.

  3. Leveraging the EFSF: This is perhaps the key component…. Theoretically, the EFSF has €440bn of equity capital which could be leveraged…. There are problems with this whole idea (see this earlier blog) but it has led to optimistic talk of leverageable capacity amounting to over  €2,000bn. This is probably far too high….

Overall, then, my litmus tests for the package are that it needs to reduce Greek debt by €200bn, that it needs to add €300bn to bank capital, and also add €1,000bn to the effective capacity of the EFSF. The first two components look difficult, but the third is critical, and it looks more probable that it can be achieved. There is no room for disappointment on that score.

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