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.
On the other side, European policy makers seem set to
deliver more of the same. 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.
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.