Mohamed El-Arian in the FT:
Buoyed by a cyclical recovery, markets around the world have yet to recognise the complexity of this situation. When they do, it will also become apparent that Greece is part of a wider, and historically unfamiliar phenomenon – that of a simultaneous and large disruption to the balance sheet of many industrial countries. Tighten your seat belts.
One way or another, this spiralling crisis will force weak countries to balance their budgets, either in response to the risk of loss of market access or default. That means that much of Europe will face a Great Depression scenario: deflationary fiscal policy in the face of economic recession.
As Krugman pointed out in today's NYT, fiscal contraction in the face of deflationary monetary policy can only lead to disaster. Will the ECB cushion this blow, or will it do what the Fed did in the early thirties? And if it does pursue deflation, can it survive as an independent institution?
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