WITH yields on Italian debt rising the euro problem is not getting better. It might be time for the ECB to make a bold move that even the Germans may approve of, albeit grudgingly.

Any solution to the euro crisis has to accomplish two goals: prevent a big country like Italy from failing because of illiquidity-turned-insolvency, and maintain the political pressure to reform and adjust so that this big country really is solvent in the future (see also Nick Rowe on this). Any commitment to support a country will be tested by markets and the more debt the ECB owns, the less negotiating power it has over the large country that will in this case be reluctant to continue its reform efforts.

In the case of Italy, there hasn't been much in the way of reform during the nearly 2 years of crisis. Spain on the other hand has shown quite a bit of resolve and is likely to elect another reform-minded government in the next election with an absolute majority.

Imagine the ECB were to announce publicly that if the Spanish government continued its reform efforts according to an independent IMF supervision, it would back Spanish debt in full from a certain point in time on (for instance a year from now depending on the IMF-approved reform plan) and will not tolerate yields above, say, 4% at that point. This target could be lowered to 3.5% after another year if the Spanish progress continues further, or increased if it doesn’t.

What would the consequences be? The Spanish people will realise that the ECB and Europe stand behind them as long as Spain keeps up the reform efforts. The new Spanish government in turn will continue its reform agenda in order to be rewarded by the ECB. Markets, anticipating this, will let yields drop to slightly above 4% immediately without any actual purchases by the ECB.

What about Italy? The ECB would have shown that it is willing to reward reform efforts with unlimited backing. Will Italy get back on track? The beauty of this plan is that the dynamic shifts such that all pressure rests on the Italian political system, which is exactly what is needed.

One objection is that the ECB cannot wait for reforms in countries like Italy to materialise. But this is ignoring the forward-looking nature of markets. With such an ECB/IMF policy in place, the only variable that the markets need to determine is the willingness to reform now and in the medium-term future. And the ECB does not need to take bonds on its books before the reforms have been implemented properly. If the reforms have been implemented, the ECB might not have to buy any bonds.

Italy might fail to deliver and a reasonable concern is: then what?! It is important, though, that in this case Italy would have jeopardised its entire political credibility because it would be almost solely responsible for wrecking the euro zone. Would Italy really risk that? I doubt it. My expectation is that Italy's yields would come down immediately after the plan for Spain is announced and would react significantly to reform efforts by the Italian government—precisely what markets should do: send signals and discipline governments.

Rewarding Spain might therefore be a strategically clever way to bring Italy's yields under control while sparing German taxpayer money as much as possible (and definitely more so than any limited bond insurance ever will). It could thereby represent a feasible step towards a solution—which unlimited lending by the ECB probably isn't, in part for good reasons. It would require a bold move by the ECB and Chancellor Merkel, though. Will they dare?

A side note: reform need not mean austerity, as in the demand-constrained environment that the ECB has created and is likely to maintain (God knows why), further austerity has a rather high multiplier. Reform can simply mean removing obstacles to economic growth, what ever they may be. Depending on your past inflation dynamics, a nationwide wage cut might be a difficult but necessary step. Or a restructuring of private debt or banks. Or freeing up professions currently closed to competition and innovation, and removing harmful regulation.

A side note: reform need not mean austerity, as in the demand-constrained environment that the ECB has created and is likely to maintain (God knows why), further austerity has a rather high multiplier. Reform can simply mean removing obstacles to economic growth, what ever they may be. Depending on your past inflation dynamics, a nationwide wage cut might be a difficult but necessary step. Or a restructuring of private debt or banks. Or freeing up professions currently closed to competition and innovation, and removing harmful regulation.

Iniciado por a la ruina

A Rajoy le han dicho bajando impuestos las pymes van a contratar y crear empleos y generar recaudación.

En el apartado militar, ya ha dicho que ahora está en mínimos y no se puede recortar.
En Sanidad y Educación, son las comunidades autónomas. No creo que les recorte de aqui, porque tendría que tocar la lofca.
Puede recortar en la ayuda exterior, pero eso es calderilla comparado con el déficit.
Puede recortar en infraestructuras, mandando al hoyo a las grandes constructoras.
...
Realmente Rajoy lo va a tener muy dificil para cumplir sus promesas de no recortes. Sólo se me ocurre a medio plazo ir subiendo los impuestos a los combustibles y dejarlos parejos a Francia o Alemania, pero es un arma de doble filo, debido a que casi toda nuestra mercancía se mueve por camión. El transporte por tren a Europa, tiene que potenciarse y para ello, es necesario invertir en el cambio de ancho de los corredores más importantes de la red.