DW interview with Marcel Fratzscher

Deutsche Welle: Can you imagine Greece not extending its bailout? Has saving face politically become more important for Syriza than keeping Greece in the euro?

Marcel Fratzscher: Well, I can imagine them not extending the bailout program. To be quite honest, either the current Greek government of the finance minister and the prime minister are either very inexperienced and bad in negotiating or they're incredibly clever.

I think the odds are still good that we'll reach an agreement. I think we need to reach it by the end of the week. What I can see from what came out yesterday, basically the different positions are not that far apart. I think there's a willingness on both sides and the differences are not so big, whether we are talking about four months or six months and whether we call it a bridge or an extension of the program is really secondary.

I think on the key features - no debt restructuring, continuation of reforms - there is a broad agreement. The odds are not bad. But at the same time, I think if we cannot get a decision by the end of the week it doesn't look good for Greece to actually avoid a banking crisis.

You said the two positions are not that far apart, so what could a compromise look like?

I think a lot has to do with the language and symbolism. Certainly the Greek government would not want to hear that the current program is successful and will be continued as is. They want to have a clear language that there are changes to the program so that they basically can claim they succeeded in changing something.

At the same time, the Europeans certainly don't want to hear that there will be a debt restructuring. The troika doesn't have to be mentioned but certainly there will be something about IMF involvement and EU involvement, so I could imagine that also there they will use different wording to say "technical systems" or "help" so it doesn't sound like "control" and it doesn't sound like "troika." Also that is more about symbolism.

Essentially now it's about both sides saving face and basically coming back to their electorates and saying, "Look, we got what we wanted."

We must not forget that also for Germany and the other European partners, a failure could have a high political cost. It would be very difficult if there's no agreement. I think a default by the Greek government would ultimately be very likely via a collapse of the banking system. But I think it would not be very easy for the German government to explain to the German electorate, "Look, we promised there wouldn't be a haircut and we wouldn't lose any money on giving loans to Greece. Sorry, we were wrong about that and now we have a different reality." Everyone knows that.

Cleary the costs for Greece are much, much higher - certainly economically. Politically, the cost for other European countries is equally high. So, that means we have also something to lose.

What would be the economic consequences for Germany and other European countries?

I think the first thing we would see in Greece is a banking collapse, which would be followed by a sovereign default, which would be followed by deep economic collapse in the corporate sector and the economy as a whole.

We would likely see spillovers in financial markets, probably first affecting southern Europe - the other countries in trouble - with rising interest rates followed by capital flights, which makes it much harder for companies to invest.

We would see an economic slowdown and that would ultimately also spill over to Germany, meaning we could export less and we would have less demand. There would be more uncertainly in the euro area as a whole. It would depress German investment even further and German consumption. So that would be a likely mechanism how I see this could play out.

Is the current impasse an indication that austerity has failed?

First, there is no austerity. Greece still has deficits. Greece is still building up more debt. I think what has failed is not austerity, but first of all the Greek government, or the past few Greek governments, implementing their reforms fully. I think the second failure is we were probably too ambitious in the reform program. And the third failure is clearly a political one to find an agreement in Europe.

Marcel Fratzscher is president of the German Institute for Economic Research (DIW). He also spoke to DW's Made in Germany program. You can watch that interview on their website.