Italy and Spain are at an increased risk of exiting the euro as European leaders grapple with how to contain the region’s sovereign debt crisis, Nobel economics laureate Paul Krugman said.
“There are the ones that can probably make it through, even though it will be very unpleasant, as long as there isn’t a panic, and those would be Spain and Italy,” he said today in an interview in Stockholm. “There are the ones that are probably fundamentally insolvent where there’s going to have to be a debt writedown and those would be Greece, Portugal, Ireland.”
European leaders are struggling to solve the debt crisis, after a July 21 accord to boost the region’s rescue fund failed to calm markets. German Chancellor Angela Merkel and French President Nicolas Sarkozy rejected on Aug. 16 an expansion of the 440 billion-euro ($630 billion) bailout fund as well as calls for common euro-area bonds, arguing for more economic integration first.
The European Central Bank this month ended a five-month hiatus to buy 22 billion euros of government bonds in the week through Aug. 12, and has bought more since. That helped push 10-year Spanish and Italian yields below 5 percent after they surged to euro-era records the previous week.
Spain’s 10-year yield advanced four basis points to 4.94 percent as of 4:35 p.m. London time. Italy’s 10-year yield rose three basis points to 4.93 percent. German benchmark notes with a similar maturity dropped 12 basis points. Yields move inversely to price.
Leaders need to make it clear that there will be funding available to prevent the crisis spreading to Italy and Spain, Krugman said.
“I still think that the odds that Italy will be forced out of the euro are fairly low but they are not zero, they may be 10 percent, so it’s a scary story,” Krugman said. In May, Krugman put the risk of Italy and Spain being forced to leave the common currency at 1 percent, calling it a “nightmare scenario.”
The chance of Greece exiting the euro is more than 50 percent, he said, adding that a partial default by the southern European nation probably won’t be enough to solve the bloc’s problems.
To make the euro “at least workable” policy makers should set up a “centralized operation” to deal with bank bailouts and put in place a common euro bond so that governments can “borrow without being as subject to speculative attacks,” Krugman said.
Krugman, a columnist for the New York Times, also said the ECB needs a “much more expansionary” monetary policy and to do more so-called quantitative easing. The risk for a global recession may be “a bit higher” than one-in-three, he said.
The ECB this month kept its benchmark interest rate unchanged at 1.5 percent. The bloc’s combined economy grew 0.2 percent in the second quarter, the worst performance since emerging from recession in 2009, data showed this week.
In the U.S., the policy-setting Federal Open Market Committee last week pledged to keep its benchmark rate near zero until at least mid-2013 to revive a recovery that’s “considerably slower” than anticipated.
Italian Prime Minister Silvio Berlusconi’s Cabinet approved 45.5 billion euros in deficit cuts to tame the euro region’s second-biggest debt burden. The deficit-reduction plan aims to balance the budget in 2013 by raising the capital-gains tax, increasing levies on the highest earners, cutting spending and reducing funding to regional administrations.
There’s “a pretty good case” that Italy doesn’t have fundamental solvency problems, Krugman said.