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July 12, 2012 at 04:57 AM
The eurozone is trying to combine rewards with punishments as it seeks to thwart a stubborn debt crisis that has embroiled the region for the past few years. In their approach to Spain, political leaders offered Madrid an extra year to get its budget under control provided it enacted additional budget cuts—which Prime Minister Mariano Rajoy has already begun to do. And the European Central Bank (ECB) has seen overnight deposits plummet after a decision to slash interest rates to zero—forcing banks to at least consider lending to one another if they want to make any money on stashed cash.
Bloomberg reported Thursday that leaders’ approach to a bailout of Spain’s banking sector included not just the longer grace period but also Rajoy’s response, which included unpopular cuts to budgets and higher taxes. Other conditions attached to the deal, which offers the possibility that Spanish bonds will be bought up to keep yields down, include the transfer of powers from the Economy Ministry to the Bank of Spain and boosting the central bank’s independence.
The plan has come in for criticism as well as praise even as it makes Ireland and Greece hopeful that they might also be able to win a loosening of the terms of their own bailouts. Christian Schultz, a senior economist at Berenberg Bank in London and a former ECB official, said in the report of the relaxed deadline, “Europeans are learning from past mistakes. The stick is necessary but the carrot is also good.”
However, “Just when you think reason and pragmatism are returning, European policymakers resort to type,” Dario Perkins, an economist at Lombard Street Research in London, commented in a research note. “Significant fiscal tightening was the last thing the economy needed.” New budget cuts added to those already pushed through could cause Spain to fall deeper into recession—like Greece.
As eurozone countries combat the crisis in various ways, the ECB has seen an immediate effect from its action of dropping its benchmark interest rate for overnight deposits to zero. Reuters reported Thursday that the previous day had been the first day for the new policy to take effect, and the response was dramatic. Overnight deposits tumbled by more than half, and one ECB official said that he was hopeful banks would turn to lending instead of simply parking the money.
