B. Rates at which people and firms can borrow in some Euro periphery countries are still high. The rate set by the ECB is much lower. The high rates charged by banks reflect the mediocre health of the banking system. What can be done? Bank rates depend on sovereign bond rates, the rates at which governments can borrow. Here, the offer of OMT by the ECB, even if it has not been taken up, has had good effects, and sovereign bond rates have decreased since their peak last year. But, the solution lies mostly in a stronger banking system. Many banks still need to be better capitalized.

S. In your "multiplier" paper, you raised the question of the negative impact of fiscal consolidation on growth.
B. Fiscal consolidation is needed in nearly all advanced countries. There are too many risks to letting debt increase much further. The main reason is that, at high debt levels, things can get quickly out of control. Take an economy with debt at 120% of GDP. It doesn't take much of an increase in interest rates to make the interest rate bill very high, and debt totally unsustainable. So long as investors believe the country can adjust and ask for a low interest rate, things may be fine. But if they wake up one morning and decide the country is risky, they will ask for a high interest rate, the country will be unable to pay, and investors will thus trigger the very outcome they feared. So countries eventually have to get to much lower levels of debt than they have today.
The question is at what speed countries should reduce their deficit. Here one should be under no illusion: In the short term fiscal consolidation is contractionary on demand and output. If growth is already very low, non performing loans will pile up very quickly, the banks will get into trouble, credit will become tighter, and the risk is that growth goes much lower. This argues for going slow, especially if growth is very low already. At the same time, if you say "I'll start next year", this is not credible. So the answer is: If the markets leave you room, go at a steady, measured pace. No slower, no faster.

S. European authorities insist that fiscal consolidation will help growth through positive confidence effects.
B. At the start of the crisis, some argued that fiscal consolidation could increase confidence so much as to lead to ``expansionary fiscal consolidations''. This had indeed happened in the past, as documented in an important paper by Francesco Giavazzi and Marco Pagano, looking at Ireland and Denmark in the 1980s. But, after 4 years of data, the evidence is that these confidence effects have not played an important role. Fiscal consolidation has not been expansionary.

S. What about the composition of adjustment? In the past year, Italy, for instance, has chosen tax hikes above spending cuts.
B. Composition may be as important as speed. A basic question here is how large you want your public sector to be. The answer may well be different in the US and in Europe, and determines the choice between spending cuts and taxes. If you believe that the public sector is too large, then the focus should be on spending cuts. If not, the focus should be on tax increases.
There are other relevant dimensions here. Politically, programs which start with spending cuts are more credible, because revenue increases are easier to reverse. Empirically, there is some evidence that the adverse effect of spending cuts on output is lower than that of higher taxes, as Alberto Alesina and Silvia Ardagna have shown. They are not expansionary, but they appear to have less adverse impact on output than tax increases.

S. The fiscal problem cannot really be solved without growth, as the results of adjustment are wiped out by the contraction of the economy.
B. You can in principle have fiscal sustainability even without growth. Italy managed to do so for a long time until the crisis. But growth makes it much easier to solve the fiscal problem. And, to achieve higher growth, not only now, but in the medium term, you almost surely need structural reforms. In the case of Italy, we know what the options are: reforms of product markets, reforms of the labour market. It is really worrisome that Italy has had so little productivity growth for such a long time.

S. Cyprus has rekindled fears of contagion in the Eurozone and also raised concerns that the measures adopted there, including the bail-in of bank deposits (including insured deposits, although this was later taken off the table), could be imposed elsewhere.
B. Cyprus was a one-off situation: Two big banks in a small island. They needed to be reorganized and because of their funding structure there was no way of doing this without touching the uninsured depositors. The new structure should lead to a well capitalized bank.

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