Bailout proponents continue to sing its praises. By forcing the troubled government to change its economic policy, it supposedly fosters growth and prevents further debt crises. By imposing the majority of the costs on the rescued countries, it purportedly stiffens their fiscal discipline. Finally, by preventing a sovereign default by a member of the eurozone, it allegedly stabilises debt and currency markets.
Upon closer inspection, however, none of these benefits materialise. In Greece and Ireland, bailouts did not stabilise markets, did not encourage economic growth, and did not inspire a change of heart about credit. If anything, these cases suggest that, within the straitjacket of a monetary union, the bailout mix does not work. It requires strict fiscal measures that discourage economic growth and make it impossible to lower the debt-to-GDP ratio.
On the contrary, the conditional bailouts imposed on Greece, Ireland, and, now, Portugal, lead to an insidious cycle of spending cuts and tax rises which produce economic stagnation, social unrest and political turmoil.
A sovereign default would also give markets a firm signal about the EU’s commitment to limit moral hazard. Whereas a bailout supposedly disciplines the demand side of credit markets, a default effectively disciplines both demand and supply, producing a long-term stabilising effect.
Pretending the default option does not exist violates fundamental economic principles that will eventually override any political preference. To avoid wasting a decade, the governments of Greece, Ireland and Portugal should force Europe to discuss a debt restructuring.