Category: Fiscal policy

Eurodepression

This is a gloomy start of the week for the Eurozone, with spreads rising again in the usual suspects (Spain, 4.412, and Italy, 3.997) and not so usual suspect such as France (1.334). International investors are turning away from the Euro bond market, Euro is now at 1.302 dollars, and Asian stocks falling as a result of worries over the Eurozone… 
The adverse developments in the Eurozone are not the results of insufficient fiscal austerity but rather of too much austerity. As should by now be clear, and as Krugman notes in his Insane in Spain post, the crisis in Spain is not one of fiscal irresponsibility, but is better understood as resulting from a housing bubble

Why the ECB independence is detrimental in times of crisis

“the purposedly low level of direct political oversight in the area of central banking means that it is highly likely that independent central banks will have an intentionally high degree of agency slack [i.e.: in the form of slippage or shirking procedural problems identified in the Principal agent literature]
[…]
“such delegation may produce monetary authorities who pursue the goal of low inflation with too much zeal and thus have the potential to stave off needed growth and employment in the economy, without much leeway for the principals (i.e.: the governments) to correct this policy drift” (Mc Namara, 2002)
Precisely what’s happening now with the ECB… the benefits of conservative central bank independence do not seem to have taken into account the risk of the concurrence of stable low inflation but falling output…

Who will foot the bill? Distribution of EFSF commitments

The KPI library collected various data from Eurostat, OECD, IMF, Worldbank and plugged it into a cool visualizer. Germany is by far the main contributor, followed by France, Italy and Spain. 
Per capita contributions though look a bit different with Luxembourg, Netherlands and Finland coming first (3855, 2,677 and 2,599, respectively). Germany still comes fourth and France fifth.
As a % of national GDP, the first three biggest contributors are… Estonia, Slovakia and Malta (13.9, 11.7 and 11.4%, respectively). Germany only comes in 8th position.
German solidarity should therefore be put into perspective… In any case, the consensus seems increasingly to be that the EFSF won’t cut it… To the extent that there will not be any major overhaul of the degree of EU integration or the introduction of a system of fiscal insurance, only the ECB can save us now…

Germany and the Eurozone

Is Germany becoming part of the Eurozone periphery? Not quite but as Andrew Watt reports, the recent weak Bond Auction (35% of its 10 years bonds failed to get bids) is worrying on a number of counts.
An optimistic perspective would suggest that this may lead to the realisation that some structural changes are required thereby giving the impetus to long awaited regulatory changes and necessary reflationary policies.
Current austerity policies have been severely misguided not only because of their regressive impacts but also because of their self-defeating logic.

Periphery countries have in any case few tools at their disposal to address the crisis. The difficulties this entails is nothing new as Germany faced similar problems in 1931.
Of course there is a more fundamental problem a common monetary union which is that the Eurozone wide nominal interest rate will have different real values in differet Eurozone members (Hancke and Rhodes, 2005). Where inflation is high (e.g.: Greece) the real rate of interest rate will be comparatively lower than where inflation is low (e.g.: Germany).
Faced with different real interest rates, these countries will further deviate. Even with the heroic assumption that the Periphery would become as productive as the core of EMU, divergence in inflationary dynamics would ensure that competitiveness is not forthcoming in the Periphery. In other words, the institutional set up of the European Monetary Union is systemically unstable and this has nothing to do with the presumed inability of the Periphery to sort out their budget (on this point, note that whether Greece has taken some liberty with its statistics has recently been contested).

De Grauwe "Who cares about the survival of the eurozone?"

“CEPS Senior Fellow Paul De Grauwe expresses astonishment in this new Commentary at the continued insistence in both Brussels and Frankfurt on budgetary austerity as the necessary and sufficient response to stop the government debt crisis in the eurozone. In his view, the austerity programmes should be softened and spread over a longer period of time, allowing the automatic stabilisers in the national budgets to prevent the economies from spiralling downwards. Furthermore, he reiterates his argument that the ECB should take up its role of lender of last resort in the government bond markets of illiquid but solvent member countries of the eurozone.”