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A Standby Program for the Eurozone

CHICAGO – How will the eurozone crisis play out in the next few weeks? With luck, Italy may soon get a credible government of national unity, Spain will obtain a new government in November with a mandate for change, and Greece will do enough to avoid roiling the markets. But none of this can be relied upon.

So, what needs to be done? First, eurozone banks have to be recapitalized. Second, enough funding must be available to meet Italy’s and Spain’s needs over the next year or so if their market access dries up. And, third, Greece, now the sickest man of Europe, must be treated in a way that does not spread the infection to the other countries on the eurozone’s periphery.

All of this requires financing – bank recapitalization alone could require hundreds of billions of euros (though these needs would be mitigated somewhat if the sovereign debt of large eurozone countries looked healthier).

In the short run, it is unlikely that Germany (and Northern Europe more generally) will put up more money for the others. Germans are upset at being asked to support countries that do not seem to want to adjust – unlike Germany, which is competitive because it endured years of pain: low wage increases to absorb the former East Germany’s workers and deep labor-market and pension reforms. The unwillingness of the Greek rich to pay taxes, or of Italian parliamentarians to cut their own perks, confirms Germans’ fears. At the same time, German politicians have done a poor job explaining to their people how much they have gained from the euro.