Financial markets are overreacting, says EU president Van Rompuy
Assume that markets are overreacting.
That doesn\’t in fact mean that you can ignore them. Markets are reality: whether markets are right to think that European Governments are run by a bunch of spendthrift drunken sailors who can never repay their debts or not, interest rates on a number of bond issuers are rising to the extent that they will never be able to repay their debts.
Whether markets are being rational or not doesn\’t in fact matter.
Having got that out of the way, if the markets are being irrational then all you\’ve got to do is shock and awe them back into rationality. This, essentially, means getting the ECB to buy a few hundred billion € worth of secondary market debt from Spain and Italy and monetising said debt. Just print the money to buy it.
Interest rates on such bonds will decline and they won\’t be driven into the insolvency spiral.
If the markets are not being irrational then all you\’ve got to do is to monetise the Spanish and Italian debt: get the ECB to print a few hundred billion € and purchase Spanish and Italian debt with it. This will stop them falling into that insolvency spiral.
See? It doesn\’t actually matter whether the markets are being irrational or not. Your actions, your policy options, are the same in either case.
This is because, irrational or not, markets are reality.