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Europe’s Short Vacation

NEW YORK – Since last November, the European Central Bank, under its new president, Mario Draghi, has reduced its policy rates and undertaken two injections of more than €1 trillion of liquidity into the eurozone banking system. This led to a temporary reduction in the financial strains confronting the debt endangered countries on the eurozone’s periphery (Greece, Spain, Portugal, Italy, and Ireland), sharply lowered the risk of a liquidity run in the eurozone banking system, and cut financing costs for Italy and Spain from their unsustainable levels of last fall.

At the same time, a technical default by Greece was avoided, and the country implemented a successful – if coercive – restructuring of its public debt. A new fiscal compact – and new governments in Greece, Italy, and Spain – spurred hope of credible commitment to austerity and structural reform. And the decision to combine the eurozone’s new bailout fund (the European Stability Mechanism) with the old one (the European Financial Stability Facility) significantly increased the size of the eurozone’s firewall.