Euro Zone
Death Trip
NY Times,
September 25, 2011
By PAUL
KRUGMAN
Is it
possible to be both terrified and bored? That’s how I feel about the
negotiations now under way over how to respond to Europe’s economic crisis, and
I suspect other observers share the sentiment.
On one side,
Europe’s situation is really, really scary: with countries that account for a
third of the euro area’s economy now under speculative attack, the single
currency’s very existence is being threatened — and a euro collapse could inflict
vast damage on the world. (terrified)
On the other
side, European policy makers seem set to deliver more of the same. (bored)
They’ll probably find a way to provide more credit to countries in
trouble, which may or may not stave off imminent disaster. But they don’t seem
at all ready to acknowledge a crucial fact — namely, that without
more expansionary fiscal and monetary policies in Europe’s stronger economies,
all
of their rescue attempts will fail.
The story so far:
- The introduction of the euro in 1999 led to a
vast boom in lending to Europe’s peripheral economies, because
investors believed (wrongly) that the shared currency made Greek or
Spanish debt just as safe as German debt.
- Contrary to what you often hear, this
lending boom wasn’t mostly financing profligate government spending —
Spain and Ireland actually ran budget surpluses on the eve of the crisis,
and had low levels of debt. Instead, the inflows of money mainly fueled
huge booms in private spending, especially on housing. (not
government spending)
- But when the lending boom abruptly ended,
the result was both an economic and a fiscal crisis. Savage
recessions drove down tax receipts, pushing budgets deep into the
red; meanwhile, the cost of bank bailouts led to a sudden increase in
public debt. And one result was a collapse of investor confidence
in the peripheral nations’ bonds.
So now what? Europe’s
answer has been to demand harsh fiscal austerity, especially sharp cuts
in public spending, from troubled debtors, meanwhile providing stopgap
financing until private-investor confidence returns. Can this strategy work?
Not for Greece,
which actually was fiscally profligate during the good years, and owes more
than it can plausibly repay.
Probably not
for Ireland
and Portugal, which for different reasons also have heavy debt burdens.
But given a favorable external environment — specifically, a strong overall
European economy with moderate inflation —
Spain, which even
now has relatively low debt, and
Italy, which has a
high level of debt but surprisingly small deficits, could possibly pull it off.
Unfortunately,
European policy makers seem determined to deny those debtors
the environment they need.
Think of it
this way:
·
private demand
in the debtor countries has plunged with the end of the debt-financed boom.
·
Meanwhile,
public-sector spending is also being sharply
reduced by austerity programs.
·
So where are jobs and growth supposed
to come from? The answer has to be exports, mainly to other European countries.
But exports
can’t boom if creditor countries are also implementing austerity
policies, quite possibly pushing Europe as a whole back into recession.
Also, the
debtor nations need to cut prices and costs relative to creditor countries like
Germany, which wouldn’t be too hard if Germany had 3 or 4 percent inflation,
allowing the debtors to gain ground simply by having low or zero inflation. But
the European Central Bank has a deflationary bias — it made a terrible mistake
by raising interest rates in 2008 just as the financial crisis was gathering
strength, and showed that it has learned nothing by repeating that mistake this
year.
As a result,
the market now expects very low inflation in Germany — around 1 percent over
the next five years — which implies significant deflation in the debtor
nations. This will both deepen their slumps and increase the real burden of
their debts, more or less ensuring that all rescue efforts will fail.
And I see no
sign at all that European policy elites are ready to rethink their hard-money-and-austerity
dogma.
Part of the
problem may be that those policy elites have a selective historical memory. They love to talk about the German
inflation of the early 1920s — a story that, as it happens, has no bearing on
our current situation. Yet they almost never talk about a much more relevant
example: the policies of Heinrich Brüning, Germany’s chancellor from 1930 to
1932, whose insistence on balancing budgets and preserving the gold standard
made the Great Depression even worse in Germany than in the rest of Europe —
setting the stage for you-know-what.
Now, I don’t
expect anything that bad to happen in 21st-century Europe. But there is a very
wide gap between what the euro needs to survive and what European leaders are
willing to do, or even talk about doing. And given that gap, it’s hard to find
reasons for optimism.
