The risks facing the eurozone have been reduced since the summer, when a Greek exit looked imminent and borrowing costs for Spain and Italy reached new and unsustainable heights. But, while financial strains have since eased, economic conditions on the eurozone’s periphery remain shaky.
Several factors account for the reduction in risks. For starters, the European Central Bank’s “outright monetary transactions” program has been incredibly effective: interest-rate spreads for Spain and Italy have fallen by about 250 basis points, even before a single euro has been spent to purchase government bonds. The introduction of the European Stability Mechanism (ESM), which provides another €500 billion ($650 billion) to be used to backstop banks and sovereigns, has also helped, as has European leaders’ recognition that a monetary union alone is unstable and incomplete, requiring deeper banking, fiscal, economic, and political integration.
But, perhaps most important, Germany’s attitude toward the eurozone in general, and Greece in particular, has changed. German officials now understand that, given extensive trade and financial links, a disorderly eurozone hurts not just the periphery but the core. They have stopped making public statements about a possible Greek exit, and just supported a third bailout package for the country. As long as Spain and Italy remain vulnerable, a Greek blowup could spark severe contagion before Germany’s election next year, jeopardizing Chancellor Angela Merkel’s chances of winning another term. So Germany will continue to finance Greece for the time being.
Nonetheless, the eurozone periphery shows little sign of recovery: GDP continues to shrink, owing to ongoing fiscal austerity, the euro’s excessive strength, a severe credit crunch underpinned by banks’ shortage of capital, and depressed business and consumer confidence. Moreover, recession on the periphery is now spreading to the eurozone core, with French output contracting and even Germany stalling as growth in its two main export markets is either falling (the rest of the eurozone) or slowing (China and elsewhere in Asia).