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A spiral for Europe?
Quelling the European debt crisis will take more than just a bailout package for Greece, says one expert in financial contagion. Other countries with shaky fiscal profiles need to get their finances in order–and fast.
Lasse Pedersen, a professor of finance at New York University’s Stern School of Business, has made a close study of liquidity spirals in financial markets, and he sees parallels between his work and the European crisis.
“Here the spiral is that the more concerned people will be about whether Greece can pay back its debts the higher the interest rate they will demand, and the higher the interest rate they demand the harder it will be. For instance, if the interest rate payments increase two or three times or more, it can become difficult to meet these payments even with a sound economic policy,” Pedersen said in an interview.
The danger that the feedback between investor anxiety and higher rates could appear in other European countries is real and needs some proactive attention, he added.
“I do think that the contagion risk is very real and perhaps the way to stop it is for the International Monetary Fund or the European Union to already now think about making a deal with other countries like Portugal that aren’t in immediate trouble now.”
The other countries where high debt-to-GDP ratios have already attracted concern also need to move more quickly with reforms, Pedersen said.
”These countries have to realize that the main party that has to save them is themselves–they have to have a responsible fiscal policy that means they can pay back whatever debt they have.”
If they don’t act decisively to show they can repay their loans, no amount of outside aid will help, Pedersen added.
“Bridge loans, if they are a bridge to nowhere, won’t help.”