Backing Spain to Save Italy

One of the possibilities that I left out of my last post concerning the Eurozone was a potential “pre-bailout” of Spain. The Free Exchange blog over at the Economist later posted about it, explaining why it could be a good idea. The rationale behind such a proposal is that it essentially stops the Italian domino from knocking down Spain, thereby saving Spain as well as the rest of the Eurozone while putting big pressure on those in trouble (Italy namely) to shore up their situations. Free Exchange sees it as a way to put more political pressure on Italy to pass the necessary reforms towards a more sound fiscal position. A more immediate effect might even be downward pressure on Italian yields simply due to reduced risk of a contagion that would end up partly spiraling back to Italy further pushing up yields.

While the positives might sound great, the reality likely is not. Backing Spain indefinitely could be a moral hazard even with stipulations on the aid and it once more sets a bad precedent. I also do not have as much faith in the political system of Italy as Free Exchange seems to, even in the face of such pressure. Even if the political system were sound and ready to act as needed, what to do to shore up the budget without destroying the economy (which would further hurt the budget) is arguable and not very clear-cut. Guaranteeing so much money while still keeping so much risk on the table and placing more responsibility in the hands of Italy right now just does not seem like a great option. I get the feeling that Germany agrees, hence the lack of movement on this potential front.

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