European stock and bond markets are already treating that as an ever- more-realistic possibility, shunning even moderate levels of risk and pushing interest rates to unsustainable levels. As far as they can see, Mrs. Merkel and her fellow euro-zone leaders haven’t come up with an adequate plan, sufficient political will or sufficient cash to halt the contagion. As far as we can see, they are right.
The political changes at the top of Greece and Italy are promising. Greece’s new prime minister, Lucas Papademos, and Mario Monti of Italy are internationally credible economists, committed to making painful but much needed reforms, including liberalizing labor markets, shrinking overgrown bureaucracies, shedding state properties and rooting out corruption.
Given their training, they surely understand that their economies are not now strong enough to absorb more austerity, including broad new taxes or further sweeping service cuts. Mr. Papademos and Mr. Monti should press their fellow European leaders for a new and better deal. Even with the best leadership, neither Greece nor Italy will be able, on their own, to restore their fiscal health and help slow the spreading financial contagion. That will require substantial and immediate help from their euro-zone partners, starting with Mrs. Merkel.
An all-out effort by the European Central Bank to buy bonds, lower interest rates and inject new liquidity into the markets may still calm the contagion if it begins in the next few days. The bank’s new president, Mario Draghi, may be willing to play this role, if Germany stops standing in the way.
Mrs. Merkel must make clear that she will support the central bank taking on this expanded role. And now that new, credible leaders are in office in Athens and Rome, she and other euro-zone leaders need to meet with them and negotiate more growth-friendly reform packages. There is very little time left to avoid financial catastrophe.
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