Friday, July 16, 2010

Europe Is Doing Everything Wrong

That’s what Mario I. Blejer and Eduardo Levy Yeyati claim in a recent post on Project Syndicate.

First, European governments should relieve the pressure on peripheral countries (Greece, Portugal, Spain, Ireland, and perhaps some others) through a significant depreciation of the euro. Second, for these countries to regain competitiveness within the zone the inflation differential that built up during the pre-2008 capital-flow bonanza should be reduced. And third, last but not least, the debt/income adjustment problem should be helped by higher overall eurozone inflation and, at least in some cases (particularly Greece), by an ordered process of debt restructuring.

“So far, European policymakers have chosen to do precisely the opposite on each front. They have tried to talk up the value of the euro, though currency markets have dismissed this as mere political rhetoric, (…)”.

They also have tried to dispel doubts about the imminence of Greek and other sovereign-debt restructuring. But lenders understood the unfeasibility of the underlying fiscal cuts. “In a recent survey of global investors, 73% call a Greek default likely.”

And European governments seem to be competing to carry out the most drastic fiscal adjustment (leading, I would like to add, to additional local deflationary pressures to worldwide ones).

This is a self-defeating solution that can appeal only to the most myopic market analysts – and, curiously enough, to a bipolar International Monetary Fund that, less than a year ago, correctly advocated synchronized fiscal stimuli.

“In this context, Germany’s new austerity package is the latest and most striking element in a sequence of ill-advised responses. Fiscal austerity in Germany can only reduce demand for eurozone products, and result in lower German inflation. And lower inflation in Germany means that, to close the inflation differential, peripheral countries will need a bout of outright deflation.”

My comment: A reasonable diagnosis, at last. But even the first adjustment that the authors consider positive is not that convincing: the recent depreciation of the euro has benefitted the German economy most, without bringing real relief to the other Europeans still suffering from the intra eurozone inflation differentials (see my previous post on the advantage of a weak euro for German exports). It follows that the German government does see further stimulation of its economy as necessary,of course, even though the Obama administration would like to obtain some more stimulus on ts part in exchange for the added deflationary impact in the US of the dollar appreciation relative to the euro.

Diverging national macroeconomic interests and flawed macroeconomic analysis push together all the other European economies in the wrong direction. The more so since the depreciation of the euro, from 1.45 dollars to 1.20 or 1.22, has been reversed in the last few days, and partly compensated by a new rise to 1.30 dollars.

Something has got to give. And the always excellent “Lex Column” in the Financial Times (Thursday July 15) was titled “Dis-membering the euro”, echoing my own article of a few weeks ago in Le Figaro , precisely titled “Il faut démonter l’euro” (“The euro should be dis-membered”) (downloadable from my homepage at http://www. The conclusion? “the possibility of a (Greek) departure (from the euro) has been awakened. Policymakers should at least be ready for it.”

Blejer and Levy Yeyati punch line:

“ … Europe and the IMF, by endorsing unqualified fiscal restraint, fail to recognize that the European crisis calls for differentiated policies to achieve multiple and different objectives. Implementing today’s conventional un-wisdom promises only a deeper recession and the postponement of the inevitable day of reckoning.”

No comments: