Sunday, April 11, 2010

Germany is not a model for the euro area

Over the last few weeks, there has been a hot debate about the role of Germany in the light of the Greek debt crisis. Is it a model for the eurozone? The immediate answer would be no due to its obsession on monetary stability.
On Greece, the heads of government decided that 'as part of a package involving substantial international Monetary Fund financing and a majority of European financing, euroa rea member states are ready to contribute to co-ordinated bilateral loans"*. Then it continued ' Any disbursement would be decided by the euro member states by unanimity subject to strong conditionality and based on an assessment by the European Commission and the European Central Bank".
Germany, the most powerful euro area member country has imposed its views, but the final outcome was not shared by France, nor by the ECB which is contrary to any intervention of the IMF. But it is not clear whether this is a workable solution.
First, the fiscal consolidation of Greece looks unrealistic as it means reducing the deficit by 10 percentage points of GDP. Simulations made by several economists- including a french economist, Patrick Arthus- point out that a reduction of 1% in public spending causes a decrease in the budget deficit of only half point.
Second, Greece's problem is that it is paying too high interest rates and has a solvency problem. Even if loans will be provided at a 5 per cent rate, Greece should have access to financial markets.
We can understand the political argument that holders of Greek bonds will be reassured that the euro area will never let Greece fail. Why should Europeans accept default for Greece?
Last week's statement says that 'the current situation demonstrates the need to strengthen and complement the existing framework to ensure fiscal sustainability in the eurozone and enhance its capacity to act in times of crises. for the future, surveillance of economic and budgetary risks, and the instruments for their prevention, including the excessive deficit procedure, must be strengthened'.
The idea is that peripheral countries have a structurally weak fiscal position whihc reflects a lack of fiscal discipline (in the German sense). This is true of Greece and to a lesser extent of Portugal. But Ireland and Spain had strong fiscal positions, but weaknesses in private sector deficits due to the house bubble. That means that monitoring and surveillance should focus on the private sector, not only the public sector.
But in fact, the asset bubbles and credit expansion in the private sector in the periphery also reflects the absence of growth in the core. Honest economists must then acknowledge that the cause of the fiscal deficits is the result of the ECB monetary policy to accomadte the weak demand growth in the eurozone's core, and in particular in Germany.
German policymakers are not keen to discuss about weaknesses in global demand and other macroeconomic imbalances in the euro area. They wish to see a rapid reduction in fiscal deficits in euro area countries and this is why they insist on an 'improved economic co-ordination". the risk is that the eurozone might become de facto a big Germany with a structurally weak internal demand. Germany and other economies - like China- might find a way out through increased exports to emerging countries. For its structurally weaker partners - especially those burdened by uncompetitive production costs- the result would be years of stagnation or even deflation. Is this a model of economic 'stability'?
M.Wolf (FT March 30) argues that "the project of monetary union confronts a huge challenge. It has no easy way of resolving the Greek crisis. But the bigger issue is that the eurozone will not work as Germany wishes. As I have argued previously, the eurozone can become Germanic only by exporting huge excess supply or pushing large parts of the eurozone economy into prolonged slump, or, more likely, both. Germany could be Germany because others were not. If the eurozone itself became Germany, I cannot see how it would work. Evidently, Germany can get its way in the short run, but it cannot make the eurozone succeed in the way it desires. Huge fiscal deficits are a symptom of the crisis, not a cause".
As ancient Greeks said, we have the classical definition of tragedy: hubris (arrogance); ate (folly); nemesis (destruction).

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