Friday, December 2, 2011

Evans-Pritchard Is Right: Eurozone Monetary Expansion Is Required

The eurozone badly needs monetary expansion and some inflation, that is, a depreciation of the euro as I advocated in my recent book. It is the first step to get out of the crisis.

Evans-Pritchard writes in The Telegraph:

“A near universal view has emerged that Europe’s crisis can only be solved by governments and fiscal policy, with varying views over the proper dosage of pain.
I beg to differ. This is a monetary crisis, caused by a jejune central bank that aborted a fragile recovery by raising rates earlier this year, allowed the money supply to collapse at vertiginous rates in southern Europe, and caused a completely unnecessary recession – and a deep one judging by the collapse in the PMI new manufacturing orders in November.
Needless to say, drastic fiscal austerity is making matters a lot worse. You cannot push two-thirds of the eurozone into synchronized fiscal and monetary contraction without consequences.
Note that five-years break-even spreads have dropped below zero for Italy, meaning that markets are now pricing in outright deflation. For a country with public debt stock of 120pc of GDP, that is a death sentence.
The eurozone economy is in imminent danger of crashing into deflation, bringing down the whole interlocking edifice of sovereign debt and distressed lenders.
This crisis can be stopped very easily by monetary policy, working through the old-fashion Fisher-Hawtrey-Friedman method of open-market operations to expand the quantity of money, ideally to keep nominal GDP growth on an even keel.
This does not solve the 30pc intra-EMU currency misalignment between North and South, of course, but it  quite literally “solves” the solvency crisis for Italy and Spain. They would not be insolvent if the ECB had not driven them into depression by letting their money supply implode.
The bank can reflate Club Med off the reefs. It chooses not to act for political reasons because this means higher inflation for Germany. That is the dirty secret. Everybody must be crucified to keep German internal inflation under 2pc.”

The whole article here is a must read.

My comment: the lack of decision of the governments in the eurozone is not happenstance: it reflects this basic conflict of national objectives and requirements. It shows very clearly that one size fits none, and that the continental centralization of macroeconomic policy is terribly dangerous.  That is, unworkable.

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