Drawing on a recent paper by Nouriel Roubini, Martin Wolf lays out the options facing the euro zone with depressing clarity. (The Roubini paper is accessible here after an easy sign up for a trial subscription.)
Mr Roubini discusses four options for addressing these stock and flow challenges simultaneously: first, restoration of growth and competitiveness through aggressive monetary easing, a weaker euro and stimulatory policies in the core, while the periphery undertakes austerity and reform; second, a deflationary adjustment in the periphery alone, together with structural reforms, to force down nominal wages; third, permanent financing by the core of an uncompetitive periphery; and, fourth, widespread debt restructuring and partial break-up of the eurozone. The first could achieve adjustment, without much default. The second would fail to achieve flow adjustment in time and so is likely to morph into the fourth. The third would avoid both stock and flow adjustment in the periphery, but threaten insolvency in the core. The fourth would simply be the end.
While each of the options brings horrendous challenges, I think that there is fairly widespread agreement among economists that the first offers the best route to save the euro zone. The problem, of course, is the stonger members are wary, fearing inflation, a large contingent liability from their support of weaker members and severe moral hazard.
A modest suggestion/question: Should the government reprioritise its diplomatic efforts away from debt relief to work with like-minded countries to offer the strong countries credible mechanisms for tighter controls over fiscal policy as a quid pro quo for the stimulus components of Option 1?
Of course, efforts to put in place such controls are well advanced through the Euro Pact Plus. But these controls are seen as something being imposed on weaker countries, undermining the belief in Germany and other stronger countries that they will actually be respected.
Might a more more active embrace of the controls — but also making clear that the current restrictive monetary and fiscal policies in the core put the survival of the euro zone at unnecessasry risk — pay greater dividends?
27 replies on “Wolf and Roubini (and a modest suggestion)”
Worry about inflation is like worrying about rust on the Titanic, it’s something we can deal with if we ever get back to port, but something which is completely irrelevant in the middle of the Atlantic.
Swift’s modest proposal may be more to the govt’s liking.
The question comes – how is stimulus to be funded? And how are wages to be raised?
(The shortest solution to the problems of excessive debt both for governments and the individuals are raised wages – inflation won’t do it without wage growth – it will simply be impoverishing. Wage growth is unlikely in the face of competitive pressures, even given a weakening of the euro internationally (ask the Swiss and the Japanese how you go about that one)).
I don’t see an outcome that doesn’t involve a return to protectionism in the form of import tariffs on finished goods at the edge of the EU used to finance stimulus programs within it. A financial transactions tax would also be part of this.
“Should the government reprioritise its diplomatic efforts away from debt relief to work with like-minded countries to offer the strong countries credible mechanisms for tighter controls over fiscal policy as a quid pro quo for the stimulus components of Option 1?”
I vote for chewing gum and walking at the same time.
Think I’d prefer a Rothman with Juncker followed by a stroll with Megan Greene. Great options – ain’t they.
Will get to Wolf later …. tmro.
If the gum chewing is: “[b]ut that still seems to leave the pace of repayment, and the funding of this repayment, as very much an open question” (from your post on ELA), I’m with you.
Thanks John. I’m certainly not going to let that particular bone drop!
@ John McHale,
What about democracy?
Since at least July I’ve been stridently arguing that the Irish government’s position is wholly wrong:
– 1: ask for lower interest/debt reduction for us
– 2: keep the head down
I’ve pointed out that this narrow self interest is useless if Merkozy kill the real economy. Their dithering has prevented either a natural, or governmental solution to the Eurocrisis – which now imperils the global economy.
Merkel in particular seems clueless about system financial (in)stability, and had the quaint now that the world would wait years whilst she squeezed say another 10% efficiency from Greece. The world cannot wait years, the uncertainty is toxic, and political interference has ruined everything. E.g. the sham EBA stress tests etc etc.
We are a small open economy, and rely on a healthy European and global economy. The extreme recklessness of Merkel and Sarkozy last week re Greece, has started a self fulfilling debt spiral in Italy – with the ECB(sorry Bundesbank), having already signalled it won’t really help.
Firefighting in a minion (Greece) nearly felling Italy is pure recklessness. It is clear that our demented cacophony of Ez leaders (the newly christened ‘Frankfurt group’) lack a plan. This situation is sufficiently complex to require the services of a multi disciplinary secretariat to plan out( economists, game theorists, finance professionals). Instead we’ve jingoism, posturing and sleep deprived fudges.
BRICs, USA , UK etc are watching and are both dismayed and furious. We need to reach out to them, and other bodies, to fashion a consensus , in this order of priority:
1) Admit the failure of Ez decision mechanisms +various fudges
2) Get a problem solving secretariat up and running pronto
3) Solution options
And yes, that will take time, but there are global design problems in:
Bank credit risk
Local currencies (e.g. Euro)
Global currency ‘system’ (i.e. the Dollar)
Opacity of capital markets (derivatives)
As well as instantiations of same problems.
Solution options could be trashed out in weeks, focusing on Ez firstly. But if we waste time appealing to Frankfurt or Paris…we’re barking up the wrong tree. Need to get BRICs + USA onboard.
While it may be true that we are not blessed with the finest crop of leaders in Europe, it has to be said that they all – especially Merkel face huge problems domestically, and in terms of getting a consensus amongst the governments of the Euro area.
Merkel in particular is vulnerable, and shold she slip you only have to look at the German press to imagine what kind of alternative we might face.
So Option 1 looks good, but can it be acheived? I said from a long way back that a solution would not be acheived until the crisis hit the core. ~It is hitting the core now and I’m afraid I don’t know that a solution will be acheived.
More and more the papers and the economic commentators are talking of the need for the ECB to print money and ease the debt problem, while seeing that this will require a much stronger fiscal union.
But how would this be acheived? Merkel had planned from the start to stall until after elections when she hoped to be in a stronger position. But events have moved too fast – as was always clearly going to be the case.
The question remains, though, how any coherent plan can emerge from core leaders in the North baited by hardliners in their parliaments and press – and populace – who must also convince leaders and peoples in peripheral countries who feel bullied and blamed by self-righteous demagogues in the north?
I suggested before that rather than declare how we were not Greece – or Portugal – that we should have been building diploma tic links with these countries because it was always going to come down to a negotiation between the core and the periphery and we are not core.
Do we even believe that the first option would work?
Lets say there was abit of quant easing by the ECB and a decent stimulus package in the few northern states not in trouble, would that help greece? Ireland? Portugal? Spain? Italy?
Has quant easing being much of a success? I mean if it does done without raising inflation target or expectations of inflation then will it make a difference?
f germany spends lets say 3-5% of gdp on a stimulus how much of that will trickle through in demand to other countries and will it cause any inflation in the core?
I mean, is the game already up even under number 1?
The government can continue its efforts on getting help with the promissorary notes etc from the EU partners.
Option 1 is decided by the ECB, not the strong countries. The government could work on reforming the decision making structure at the ECB where appiontments are based politically rather than on merit. Also they could work on changing the ECBs mission/charter to make growth at least as important as inflation – more like the US fed and other central banks. This inflation watching mission of the ECBs job was JCTs justification for not doing option 1 and may keep Draghi in a straight jacket on option 1 too if inflation starts to rise.
The government could offer the strong countries credible mechanisms for tighter controls over fiscal policy as a quid pro quo for the stimulus components of Option 3.
There is much negativity about the possibility of option 3. How many countries and which ones would have to have a referendum on option 3 which would include a common ‘treasury’ as proposed by many even by JCT. Does anyone know?
Stephen Kinsella posted a paper here saying that fiscal spillovers from a stimulus in the core are not significant at all for helping growth in the periphery.
Worry about inflation is like worrying about rust on the Titanic….
As the core countries show not even a hint of adopting monetary easing (option 1) or transfer union (option 3) and insist only on impoverishment of peripheries (option 3) as a solution then breakup (option4) is the only solution.
Indeed breakup is the only desirable solution faced with the failed idealogical internal devaluation option.
The sooner the better. Who the biggest beneficiaries of the euro were, will soon come out in the wash. Possibly a rather bloody wash.
The bond markets seem to have reacted modestly, so far, to the latest coup de marche. So, reading this in line with the McCarthy post one cannot but fear that the politicos will stuff it up again
I’m all in favour of doing what we can to invoke the Deus Ex Machina of Option 1, but should stop faffing around waiting for Woden to show up and make everything right. The deflationary adjustment and structural reforms of Option 2 are within our own control, and will work in our favour whatever the rest of the Eurozone does. We should go ahead and embrace them, despite the objections of economic insiders.
“But these controls are seen as something being imposed on weaker countries, undermining the belief in Germany and other stronger countries that they will actually be respected.
Might a more more active embrace of the controls — but also making clear that the current restrictive monetary and fiscal policies in the core put the survival of the euro zone at unnecessasry risk — pay greater dividends?”
This is, of course, the crux of the matter. But there is no need to re-invent the wheel. The Commission’s roadmap prior to the last European Council, or five-point plan, touches on all the main aspects of what needs to be done.
But no country is going to lead with its chin on the issue of controls because the division into white and black sheep does not hold water. France and Germany were the first to breach the SGP. The austerity measures recently announced by France are quite laughable against a background of a level of public expenditure matching that of Denmark but without the social and economic structure to go with it.
The issue is not one of “controls” but of “controls to ensure solvency” i.e. sound budgets to ensure that investors get their money back. This must be a collective effort and not one of the (French) pot calling the (peripheral) kettle black.
On the restrictive monetary and fiscal policies in the core, the only development that will bring about a change of policy is an economic recession, a spectre that is already knocking at the door. If there is no action, this threatens to turn into a full-blown European and global depression. But this debate is by now almost old-hat.
On fiscal spill-overs, the reality is as pointed out by Stephen Kinsella. An economic up-turn in the core will not be sufficient. There will have to be an active policy of economic growth promotion across the EU. Unfortunately, the larger net contributors to the budget of the EU wish to reduce its impact, not to increase it.
Another point that must not be lost sight of is the fact that core and periphery are relative concepts. Northern Italy is not Southern Italy. And there are 12 new member states which seem to be increasingly overlooked.
Finally, the risk of offering an inch and a mile being grabbed is evident from (i) Ireland’s own experience with corporation tax and (ii) from some of the proposals being put forward for purely domestic gain, notably the proposals being pushed by France and Germany for a financial transactions tax which the Commission has agreed to run with. This is an entirely divisive issue and not conducive to a smooth process of negotiation. No doubt, that is the intention.
I think this is a good suggestion, but I fear that it will ultimately come to nought.
The German adversion to monetary loosening is idealogical. The whole German establishment, including most of their economists and political advisors, seem to have been brought up to see inflation as an ever present threat, about to destroy their country (again). A CDU Chancellor agreeing to a dovish ECB would be like a Brian Cowan swearing allegiance to the Queen.
Besides, from a purely German perspective, I’m not sure that it would make a lot of sense. Monetary loosening and stimulus leading to a reduction of the trade imbalances within the EZ, would surely lead to a loss of competitiveness in Germany. If Germany becomes uncompetitive within the Euro, it will probably decide that it prefers to be uncompetitive outside the Euro, where it can keep its economic ideology intact.
The problem with the Roubini article is that it does not put the crisis in a historical context. It can be traced to the inherent and conflictual demands of a democratic-capitalist political economy. After the slow down of unprecedented growth in Europe from 1950-1970 democratic governments (in the interest of full employment) allowed inflation to rise. This was eventually brought down through increasing interest rates and constraining wages. The following increase in unemployment from the 1980-1990s generated large public debt – to pay for democratic welfare citizenship. This was brought down through fiscal consolidation bit governments still faced the problem of how to increase growth and employment. In response, and most aggressively pursued in the US was active de-regulation of finance markets. Credit cards rather than real wages ensured domestic consumption and growth. Financial liberalisation compensated for public austerity. Citizens rather than the state took on debt – a form of privatised Keynesianism. This has collapsed. So, governments across Europe are once again faced with the problem of how to reconcile the tension between capitalism and democracy that underpins every market economy. Europe is in a tug of war between the private vested interests of financial investors and democratic sovereign-states. It is not a crisis that can be solved with a once off technocratic fix because it reflects the systemic contradiction between two competing principles of allocation under democratic capitalism; marginal productivity in the market and social rights in the democratic-polity.
@ Aidan R
Well put! But this is a cycle which has been repeated many times – even before the invention of credit cards – ending occasionally in revolution. Efforts to find something better have not succeeded.
At this stage, it is impossible to forecast what will happen. However, I think that a likely scenario is that both the Greek and Italian crime scenes will be cleaned up rapidly – unceremonious ejection of both Papandreou and Berlsuconi – and some form of back-stop will be provided by the ECB to the EFSF with the implicit acquiescence of the German government (which is, after all, the body elected to represent the German people).
Indeed, it is impossible to forecast what will happen. All social scientists can claim to do (including economists) is identify the historical continuities and causal chains that brought us to the crisis. The only forecast or prediction any humble person can make is that finance capitalism is out of control and becoming increasingly impossible to manage. People will not tolerate market dictatorship of the democratic-sovereign for long, and nor should they. Economists will eventually realise that an obsession with budget-deficits is part of the problem (i.e. the state-public is not crowding out the private but the money masters are), the ECB will become a lender of last resort and the debt will be written or inflated away. The political realm will eventually have to confront the holders of financial assets either through inflation or default. In the meantime a generation will be lost and Wall street will continue to party.
Right on cue!
One wonders what Merkel will do now!
How would the economists with the fairly wide-spread belief in the first option reconcile the large differences in economic culture and competitiveness between e.g. the northen and southern countries. This isn’t going to go away in a less than a generation, if it ever will. This solution also doesn’t seem to take in the fact that growth and economic development in the competitive coutries is not going to remain static. The southern countries have quite a curve to catch up with if the eurozone will exist as it is.
Hasn’t the problem always been that there is something inherently “inorganic” about the euro project. A currency is a mean, not a dictat.
A departure of the northern countries from the eurozone, with a perhaps (temporary?) existance of a southern euro (to buffer the smaller economies), as suggested by many, seems to me the best long-term solution
The wisemen have evidently devoted a good deal of thought to their proposal and Merkel’s dismissal of it was to be expected but her only defence, that treaty amendments would be required, is weak and, indeed, disputed by the experts in question, who indicate that the matter could be put before the German constitutional court.
If I would the Prime Minister of Ireland/Greece/Portugal/Italy/etc, I would order a new set of bank notes to be designed and printed. Just in case …
Do not advertise that decision publicly, but give the printing order to several EZ central banks including the Bundesbank. And then just wait and see what happens.
All this discussion will be academic if backstop isn’t found before Mon’s Italian debt auction:
1) Banks don the blue jersey with yellow stars
Only question is who intervenes to buy some/all the issue. If that doesn’t happen…bank runs will intensify