Greece fire (is that what we're calling it now?)

Europe's attempts to stem the Greek debt crisis haven't calmed interbank lending markets. The TED spread (LIBOR minus Treasury bill rate) has poked up above 30 - well below the crisis levels of 2008-09, but troubling nevertheless.

The NY Times assesses the danger this poses for the European and US banking systems. But the article's focus on the dangers of public debt is misguided:

The European rescue plan, totaling 750 billion euros, is intended to head off the risk of default but would vastly increase borrowing. That could hamstring Europe’s nascent recovery.

Indeed, it was too much debt that caused the problem in the first place: a new report by the International Monetary Fund warns that “high levels of public indebtedness could weigh on economic growth for years.”

The world’s budget deficit as a percentage of gross domestic product now stands at 6 percent, up from just 0.3 percent before the financial crisis. If public debt is not lowered back to precrisis levels, the I.M.F. report said, growth in advanced economies could decline by half a percentage point annually...

After borrowing trillions to stimulate their economies and ease credit concerns during the last wave of fear in late 2008 and early 2009, governments cannot borrow trillions more without risking higher inflation and shoving aside other borrowers like individuals and companies. Short-term interest rates, already near zero in the United States, cannot be lowered any further. And vital steps like raising taxes or cutting spending increases could snuff out the beginnings of a recovery in northern Europe and worsen the pain in recession-battered economies like Spain, where unemployment recently passed 20 percent.

With the exception of wartime, “the public finances in the majority of advanced industrial countries are in a worse state today than at any time since the industrial revolution,” Willem Buiter, Citigroup’s top economist, wrote in a recent report.

“Restoring fiscal balance will be a drag on growth for years to come.”

Though excessive public debt in Greece and possibly Portugal, Spain, and some other countries, is clearly the root cause of the problem, the high levels of debt in the US, Germany, France, UK and other large economies have little to do with it. As Paul Krugman notes, according to the IMF report cited in the article the reason debt has exploded in these countries is a decline in tax revenues due to the recession, not excessive government spending. (The report also makes the specious claim that the financial crisis has caused a permanent reduction in potential GDP.) Attacking deficits now would be the height of insanity: we need continued fiscal stimulus to maintain the recovery and put us in a position where we can begin to restore fiscal balance in a few years.

Near term, the ECB needs to learn a lesson from the Federal Reserve's success in the US and begin a program of quantitative easing focused on purchases of sovereign debt. Fears that this would be wildly inflationary are crazy - at any rate, Europe could use a dose of higher than normal inflation at this point in time to ease the adjustment of countries like Greece.