A reader has pointed me towards this nice post by Michael Pettis, which strays from his usual Chinese turf to take a look at Europe. It makes the same points as the ones Martin Wolf has been making about the need for the large countries with ‘fiscal room’ in the Eurozone, particularly Germany, to do everything they can to maintain aggregate demand in the Eurozone.
This should be obvious to anyone with an understanding of intermediate macroeconomics, so I won’t comment on it. But Pettis also cites Barry Eichengreen’s classic Golden Fetters, which readers may not be familiar with, and in particular Barry’s views on the implications of democracy for the maintenance of the gold standard. That system required adjustment through deflation for countries suffering negative shocks. This was not necessarily a problem in the 19th century, when wages and prices were flexible, and universal suffrage was rare. By the 20th century, however, rigidities in the economy were such that deflation implied unemployment; and democracy meant that this economic cost translated into a direct political cost for policy makers. The gold standard, inevitably, broke down when confronted with the pressures of the Great Depression.
I don’t think it’s fair to compare the euro to the gold standard, as Pettis does. The ECB has lowered interest rates, not raised them, although not by as much as other central banks; and both the French and the Germans have applied fiscal stimulus to their economies. On the other hand, it is true that adjustment in the PIIGS now implies deflation there (unless, as the FT points out today, inflation in the Eurozone as a whole is increased). This is going to be both economically and politically costly, and will have unpredictable effects, especially if the Eurozone as a whole experiences a double dip recession.
I suspect that Ireland will find these adjustments easier to bear than most, since emigration gives us both an economic and a political safety valve. (That was a positive rather than a normative statement by the way.)
16 replies on “Pettis on Europe (and China)”
K O’R has previously linked to the very important Blanchard paper on macro policy in the new world. In that paper, Blanchard – Chief economist at the IMF, so presumably a high priest of orthodoxy – hints that central banks that currently have an inflation target of 2% should consider a 4% target. If nothing else, such a proposal has logic and does represent one route out. But, obviously, one with huge implications.
Reading this I’m curious about the details:
Should Germany lower taxes? For me, living & working in Germany it does have its appeal. More money for me to spend, still I’m not so sure how much would come Greece’s way. Still cheaper in other countries 🙂
Should Germany’s employers be forced to increase wages? Not so sure that could be pushed through and even if it would be pushed through, the spending would somehow still need to find its way to Greece. Still cheaper in other countries 🙂
Should the government in Germany keep the taxes at current levels but spend it in Greece? Central planning has benefits but allocating capital efficiently isn’t one of them. Still, if the German government paid for flights to Greece and accomodation for holidays there I would go. Sign me up 🙂
There is an imbalance for a reason. Greece found it easier to borrow against future earnings for current consumption than to compete in producing, value for money, goods or services. The future is now & now the borrowing is to be paid back. The lunch wasn’t free.
What is the theoretical micro-foundation for nominal wage rigidities?
I am not convinced by the idea of price stickiness in general or nominal wage rigidities. However for a firm it can be optimal to reduce head count rather than hours, as head count reductions can increase productivity.
I accept there are menu costs and possibly costly wage bargaining. However, annual bonuses are very flexible, and workers on sales commission see their pay fluctuate each week, as do people on piece-rates or waitresses that make money on tips.
While I have read a lot of such rigidities, I have yet to see either a convincing theoretical foundation or convincing econometric studies of their existence.
There is a fairy story that hag economists tell beautiful children: governments can create an economy and can create inflation out of deflation.
That is all it is, a fairy story.Economic activity depends on people, not governments. If governments could do this then Japan would have done this.
I am grateful for this post because it exposes this fallacy. Mummy can wipe tears away and destroy an economy, as in the US, by dropping interest rates and inflating, but it cannot create one! The world has symmetries, but time flows only in one direction. Fool me once….
Inflation is beloved of lazy, stupid, larcenous “economists”. Real economists realize it will not reverse the deflation of the bubble ……. Except by declaring Jubilee! That form of inflation would succeed. Declare all debts halved…….! Half the moral danger or whatever. Expect many to hang back, expecting a further jubilee! Moral Hazard…..
There are no easy lazy solutions! The ignorant pseudoeconomists who propose this should work it out in their “models” first. Every time they propose something like this as with any government act, someone must pay a price and lose value.
Please read anything by Austrian school economists. It will help the reader to understand that the inflation machine and the fractional reserve banking machine are very powerful for a very long time. Then they are a busted flush, as is the economy wherein they fluorished.
If I were to form a conspiracy of people to obtain a banking licence now, with a view to copying what has gone on, it would take decades before I could do it. Ponzi schemes require idiocy and mania. Most have now got hangovers and will not become manic again in their lifetime. Kondratieff winter!
Pettis, based on his post, suffers from Jet lag. A form of mental illness, hopefully temporary. As I hope mine is. He also thinks the euro will fail….. So he finds it easy to espouse that members will take the easy way, out of the EZ!
He is very astute as he notices inflation has been used in the weaker countries, to counter balance German over production and over investment. That is more or less how he puts it. He then seems not to know that Germany has had to subsidize the ossis at enormous cost. That would be a local version of a PIIGS! East Germany has been brought up to close to west German standards. He also does not appear to know that Germans are very well paid workers! He advocates increases! China and Germany in the same sentence…. wow!
But he is correct: “Asking the trade deficit countries to leverage up to stimulate demand is counterproductive and would ultimately just postpone the necessary adjustment. ”
He discusses the likely future in China well.
I suppose he is trying, as he says to make a fairer balance. It is easier for Germany to follow his advice that for PIIGS to suffer. It is just impractical and will not happen. Knowing that we are in a depression, the Germans are not going to inflate just for political ease. There are other ways to stablize across the EZ. Some of them involve strong arming individuals and governments. Via the EU or bankers.
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It’s standard to say Germany should spend more and then ignore the support provided by the ECB to banks in stretched Eurozone countries.
ECB loans to Irish banks peaked at over €130 billion in June 2009, up from €88 billion in December 2008. This was equivalent to over 21 per cent of total Euro system lending to institutions in the Eurozone, up significantly from an average of 6 per cent in 2007, according to the ESRI.
Other PIGS were likely to have been also deep in the trough.
“This was not necessarily a problem in the 19th century, when wages and prices were flexible, and universal suffrage was rare.”
On the contrary, it was a huge problem in the 19th century since deflation resulted in starvation which resulted in revolution. The long nineteenth centry (from the late 1780s to the first world war) is evidence enough of the increasing interconnectedness of economies, the decline of divine rights, and the rise of the ‘citizen’ with his ‘rights’ to health, wealth and happiness. Universal suffrage didn’t spring fully formed from the mind of philosophers in the twentieth century, it developed in fits and starts through the nineteenth…
I don’t know if anyone has previously mentioned the enthralling book by Liaquat Ahamed’s “Lords of Finance”. It is an account of the people and events behind the collapse of the gold standard in the inter-war period. It provides lots of material about the dangers of deflation following from trying to adhere to a strong exchange rate. Charles Rist (of Gide and Rist fame – to those of an older generation) wrote a book on the difficulties of deflation based on the impact of overvalued exchange rates on England, the US, France and Czechoslovakia in the 1920s.
I think that there is very little chance of any significant increase in demand or consumption in the German economy in the next couple of decades. The reasons are primarily demographic. It is far more fundamental than whether or not the BundesBank/ECB pumps money into the economy or not. Consumption in the Germany economy in 2009 was 2% less than in 2000. I think that they’ll be doing well to match that dismal growth in the next decade. The full extent of Germany’s disastrous demographics can be gleamed by comparing them with Ireland’s.
number of births in 2008:
—-Germany: 682,514 , Ireland: 75,065
number of deaths in 2008:
—-Germany: 844,439 , Ireland: 28,192
births as a percentage of deaths in 2008:
—-Germany: 80.8% , Ireland: 266.3%
percentage of population aged 65 plus in 2008:
—-Germany: 20.4% , Ireland in 2008: 11.0%
projected percentage of population aged 65 plus in 2026:
—-Germany: 30.8% , Ireland: 14.2%
projected change in population of working-age between 2008 and 2026:
—-Germany: -21.4% , Ireland: +25.3%
With such demographics, where on earth is growth in Germany going to come from? The answer is: it isn’t. Does it matter? Well, to some extent clearly. It would be much better for aggregate demand in the developed world if Germany’s population and economy were growing. But it is much more important for the developed world that the U. States’ population and economy be growing. Fortunately, that is happening and likely to continue
happening. The U. States’ demographics are far more similar to Ireland’s than they are to Germany’s. Not surprising, therefore, in 2009 Q4, the U. States economy grew at an annualised rate of 5.7%, while Germany managed 0.0%. That is going to be the pattern for decades to come.
“With such demographics, where on earth is growth in Germany going to come from? ”
Reducing structural unemployment?
Extending working life?
Gastarbeiters from Ireland?
I would turn the question on its head – Germany is going to be an attractive place for emigrants from other EU countries. What is going to stop the talent from flocking there?
One possibility would be fore Germany to create a national minimum wage.
Exactly – as I said in the other thread, we must destroy German efficiency to wring out their intra-eurozone competitive advantage, then we must destroy the euro so that German exports don’t suffer and they don’t reduce their transfer payements to the rest of the eurozone. Maybe we could put Kinky Friedman in charge of the ECB? Only then can pain be avoided for the GIPIS…
“With such demographics, where on earth is growth in Germany going to come from? ”
The reality is if Germany’s population is declining it doesn’t really need to grow. It has a mature economy with great infrastructure, public transport and the 2 most recent cities I have been in (Cologne and Nurnberg) were clean and very attractive.
As Jto points out, not good for the developed world but for now we can rely on the US. It’s a bit rich that we should be asking the prudent Germans to bail out the rest of us. I understand their irritation, I am a bit Germanic in my approach to saving and spending money. During the boom while much of the population bought houses they couldn’t afford and everything else on credit cards and personal loans we as a family continued to only buy things when we had the money to do so. It meant on the face of it we had a lower standard of living than the Jones but I’m pretty glad we did it now. It doesn’t make me want to bail out the spenders.
Wonderful stuff as usual on this blog. Those ‘papers’ by Pettis and Blanchard: poor quality. Both have a Permagrowth economic Model-in-Use (though both authors utterly fail to acknowledge this). This is really dreadful.
Pettis, who says he is a China ‘expert’ – and I’ll accept his word on it, does not criticize the appalling behaviour of corrupt producers and politicians in China as they pay subsistence wages, steal patents, cheat on copyright, subsidize energy costs and exports and dump their s*** into their environment. If we did this in Europe we would be ‘competitive’.
The Blanchard paper is a tad worse. This guy is well regarded, so he is likely to be heeded. If this was an undergraduate term paper I would give it a D-. Someone above accused him of being a High Priest of something or other. How about the country parson of Ballygobackwards?
If you have access to a spreadsheet plot a couple of graphs. Aggregate economic output at x% pa. for 69/x = 20, or whatever. You need to borrow money (Permagrowth economic Model-in-Use) to ‘grow’ your economy. Now overlay a plot of Debt (Principal + interest) that has to be generated in order that your ‘growing’ economy can pay back. You set the initial values for Y and P to be the same. You can mess about with the value for r. Watch the divergence!
Now please explain to me how we are going to be able to generate the surplus to pay back our debts – absent inflation, Jubilee or default. We cannot! Its physically impossible.
Modern economic theories are a set of – somewhat elegant? – logical arguments, which are accused of being ‘Laws’. Now we know these logical arguments do indeed work in theory. But, and this is the rub: do they work in practice? I reckon not.
You CANNOT continue to expand exponentially in a finite field. You may in theory; but I should not like to try it in practice. You will get a most disagreeable surprise. We need a replacement economic Model-in-Use, (Annual Aggregate Declension) – but who in the economic community has the intellectual testicles to compose and promote this?
John the Optimist argues that German demographics mean it is unlikely to be driving EZ growth in the years to come. Whatever the truth of this it is different from the issue of current account imbalances. It is arguable that demographics also play a role here (by promoting a high savings rate) but as Charlie Fell points out in his column today Germany only went into current account surplus in 2002 – that doesn’t sound like a demographically driven development.