The disagreements concern whether the analogies are the relevant ones.

There are important differences between the 1980s in Latin America and Europe today. The most important is that this will be a repeated game. No one expected the US government to bail out the Brazilians in 1999 or the Argentines in 2001. The current situation is more analogous to the founding of the US. The Federal government initially consolidated both state and national debt under Hamilton. The states naturally expected future bailouts. Congress did manage to say no in the 1840s, which led to several defaults, but this is a precedent no northern European wants to repeat.

The situation in Europe is also more complex than the US prior to Lehmann. As you indicate, two countries within the Euro had property bubbles (as did one European country outside the euro–the UK).  These states, however, are probably going to be fine–Ireland is now ahead of schedule on its consolidation, and Spain’s debt to GDP ratio is 20 points lower than the German one. There are of course risks, but the real problem cases are the states that have had chronic public debt problems. Greece was on the way to default prior to euro entry; the only question was at what level of debt-to-GDP would markets pull the plug. Italy has managed to stabilize its debt at a high level the past fifteen years, but it has not taken any steps to build it down. But one needs to look at why this has been the case to proscribe solutions. Clearly, structural reforms that increase potential growth top the list.

Finally, I am nervous about the “Lehmann” precedent being used every time someone–be it a country or firm–needs a bailout. I would like to see the counter-factual even in the Lehmann case. 

But you are absolutely right that both creditors and debtors need to pay, and will pay. Some delay is warranted–the EFSF needs to pass in the eurozone countries, and before that happens markets will remain nervous. After that, I hope they reach a consensus on a rescheduling of Greek and maybe Portuguese debt. They also need to signal that the EU will not simply bail out states in the future to avoid Lehmann moments–that is textbook moral hazard. Put another way, they need to get from the equilibrium that emerged under Hamilton to the equilibrium today at the American state level (the federal level is another ballgame). This is going to be really tricky, and how to do it would be another response.  But they do need to settle on who bears the costs when as you wrote.

Thanks for your post! –Mark Hallerberg, Hertie School of Governance, Berlin

Also, if the point of intervention by the ECB is to save the northern European banks, why don’t they just do that directly? Let Greece (and the others) default and recapitalize the banks. Isn’t that the simplest solution?

I am nor sure how likely it is that politicians or governmental policy-setters in Europe or in the USA or elsewhere for that matter will pay attention to what Profs. Chinn and Frieden write, but perhaps relevant individuals will read the book and act on the basis of its analysis. One can always hope for a modicum of intelligence, competent action and non-ideologically-determined perspective on the part of nation-level politicians or policy-makers.

But much as at least USA policy-setters and politicians have almost entirely ignored the facts and competent analyses offered by the likes of such academic luminaries as Profs. Krugman, Stiglitz and Sachs concerning current macro-economic and political-economic issues, I suspect much of this analysis will fall on intentionally deaf ears.

Prof. Andrew Moravcsik, Princeton University