By answering these obvious questions, we define the political narrative through which the increasingly euro-skeptic electorate should be addressed by their respective leaders, and the political framework within which economic proposals have a chance to survive the existing political resistance.
Based on these criteria, one politically feasible set of solutions is the following:
First, there is an immediate need to reduce contagion risks and restore overall credibility towards financial markets. Therefore the European banking system need to be recapitalized based on appropriate (politically non-biased) stress tests. A prudent solution for that is the transformation of EFSF/ESM into a European Monetary Fund, which is able to buy participations in systematically important financial institutions, which can leverage itself (via ECB or markets) and which, similar to the International Monetary Fund , has relatively strong independence from short-term political influence (and so it has credibility).
Second, guarantees against profligacy need to be established in the governance of the euro zone. Therefore, the already approved new economic governance toolkit (the six pack, euro plus pact) should be linked with a pre-agreed orderly, quick, and almost automatic exclusion mechanism from the euro zone as an ultimate sanction of notorious non-delivery by any country. This, combined with constitutional fiscal rules, independent monitoring, and stronger and permanent coordination of fiscal and competitiveness policies, should be the ultimate guarantee, that no one member state is allowed to put the others at risk. Medium-term recovery plans for countries at risk of contagion should be linked to this new regime to improve credibility.
Third, a socially and economically manageable perspective has to be offered to Greece, in exchange for continuous painful efforts by the Greek society and the political elite in the future. Greek sovereign debt should be restructured within the euro zone to reduce it to approximately half of the current level (to less than 80 percent of gross domestic product). This should be achieved through a partial, significant haircut to private investors, as well as a conditional cancellation of a portion of public debt. The conditions of public debt cancellation have to be strictly linked to the milestones and key steps of a 10-year realistic fiscal consolidation, and competitiveness enhancing program with the ultimate aim for Greece to return to proper debt service, sustainable growth, and market financing. The key targets of this program should be accepted by a supermajority of the Parliament of Greece.
In case of a breach of the key conditions later, Greece should be excluded from the euro zone based on the above mechanism and the conditionally cancelled (suspended) part of the public debt should also be reactivated.
The acceptance of such solutions in core European countries will require political courage from leaders of otherwise competing political parties in the center, often reaching through usual lines of fire. But even the most euro-skeptic voters of today will not be thankful when they experience the consequences of a possible euro zone collapse.
Even if Europe finds the right road forward, it will be a painful travel for a couple of years. And the ultimate responsibility of political leaders is to make the sacrifice worthwhile.
Gordon Bajnai is the Former Prime Minister of Hungary’s crisis management government (2009/10) and a Visiting Professor at Columbia University, SIPA and has joined the Johns Hopkins University Paul H. Nitze School of Advanced International Studies (SAIS) as a distinguished fellow.