Tuesday, October 20, 2009

Common Sense from a European Economist (at last)

It comes from Willem Buiter, a professor at the London School of Economics, who writes in the Financial Times here that “the euro has become a currency on steroids. (…) The strength of the currency is hurting the exporting and import-competing sectors of the Euro Area. Unemployment and excess capacity continue to rise.”

And he then adds: “any disinterested observer would be hard-pushed to avoid the conclusion that the Eurozone is paying the price for the ECB’s excessively tight monetary policy.” Moreover “The ECB is violating its price stability mandate by tolerating, aiding and abetting deflation in the Euro Area.”

The conclusion: “If the ECB persists in acting in a willfully asymmetric manner, its cherished independence will be taken from it. The letter of the Treaty will provide no protection against popular anger and political opportunism.”

Fair enough. But two observations are in order: first, this analysis points in the right direction but covers only half of the problem. As explained in my previous post, most of the foreign trade of the Eurozone countries is intra-zone. It follows that adjusting – at last – the euro exchange rate vis-à-vis the other major currencies (dollar, yen or yuan) will not solve the basic intra-zone imbalance of implicit (or shadow) exchange rates, for instance between Germany and Italy. This is a source of permanent real disequilibrium, mostly in Italy since Germans have a very low tolerance for inflation and much higher acceptance of deflation and wage moderation, or even of wage cuts. It is a good recipe for Germany but not so for France, Spain or Italy.

And second, where were you professor Buiter when the battle for and against the creation of the euro was raging, and when the euroskeptics were precisely warning in advance against the dangers that have become so real, alas, today? It would have been much better for Europeans if this dramatic mistake had been avoided from the start.

So let’s repeat the basic warning: a euro depreciation (did someone say “competitive devaluation”?)is necessary. But it will NOT solve the long term problem of inadequate and disequilibrium intra zone implicit exchange rates.

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