Out of the crisis. A radical change of strategy for the Eurozone.

AuthorGinzburg, Andrea
PositionReport
  1. Introduction

    Three years ago, Shambaugh (2012) remarked that the Eurozone area was facing three interlocking crises: a banking crisis, a sovereign debt crisis, and a growth crisis. Banks were undercapitalized and faced liquidity problems in a number of countries; the rise in bond yields was associated with difficulties in funding public debt; and lastly, economic growth was low in the euro area as a whole and unequally distributed across countries. Shambaugh stressed the interconnection of these crises: "the problems of weak banks and high sovereign debt are mutually reinforcing, and both are exacerbated by weak growth but also in turn constrain growth". His conclusion was that "policy responses that fail to take into account the interdependent nature of the problems will likely be incomplete or even counterproductive". It is not necessary to concur with all the stages of Shambaugh's analysis to agree with his conclusion, which still remains valid today in a situation that, when compared with the state of affairs at the time he was writing, reveals together with some positive changes--the persistence (if not a dramatic aggravation) of certain unresolved problems. The sovereign debt crisis has been averted by a rigorously deflationary fiscal policy that has been implemented without interruption since 2010. After July 2012, this was accompanied by a belated commitment on the part of the ECB to break the vicious circle of expectations that, in the absence of a debt-buyer of last resort, encouraged a massive liquidation of sovereign debt. Between 2010 and 2014, the Eurozone countries (EZ) implemented a huge contractionary policy "equal to four percentage points of the monetary union's economy ... The GIIPS [Greece, Ireland, Italy, Portugal and Spain] accounted for 48% of the fiscal swing, even though they accounted for only a third of Eurozone GDP. Eurozone core nations decided that they too had to embrace fiscal rectitude. As the monetary union's largest economy, tightening by Germany accounted for 32% of the Eurozone's overall fiscal tightening. France's austerity amounted to 13 % of the

    Eurozone total" (CEPR, 2015, pp.10-11). Owing to these austerity policies, only a few Eurozone nations have recovered their pre-crisis growth and employment rates (Figure 1), while socio-economic conditions in the periphery have worsened dramatically.

    With households, corporations, and governments simultaneously reducing expenditure, income and production have dropped and unemployment has soared, with youth and long-term unemployment and inactivity rates at record levels. Several years of harsh austerity have also taken their toll in terms of inequality and poverty, and have cancelled a significant part of the gains in living standards achieved by low-income households over the past 20 years. Welfare provisions have been cut everywhere: the European Union's ambitious targets for combating poverty and achieving social inclusion are self-delusive because of the constraints faced by the Member States on the periphery, which were hardest hit during the crisis and are no longer in a position to ensure even a minimum level of social inclusion (Arpe et al. 2015). The destruction of productive capacity, skill capabilities, and welfare protection will take years to redress. Meanwhile, the euro area is churning out the world's largest current account surplus in value terms (approximately 3.0% of GDP in 2015) (Figure 2).

    The bulk of this is accounted for by Germany (7.9% of GDP) and the Netherlands (10.6%), but also the former deficit countries are now recording balanced or surplus positions. The austerity measures opened up a process of alignment with Germany also for other economic indicators of the peripheral countries: since 2010, the European periphery has achieved a significant reduction in unit labour costs compared with Germany and EU27 (Cirillo and Guarascio, 2015 p. 5) (Figure 3).

    After 2010, the government primary balances of countries across the Eurozone also reached a surplus, converging with Germany's (see Saraceno, 2015). At first glance, the recession has 'induced' (or forced) the adjustment of all those indicators whose misalignment, according to many commentators--but also the Troika and Germany's political representatives--had been at the origin of the crisis. If one adds that the ECB's quantitative easing (QE) is encouraging the devaluation of the euro against the dollar and that oil prices are subdued, it could be argued, to rephrase Chairman Mao, that "everything under heaven is in order, and the situation is excellent". Contrary to expectations, however, the recovery is very sluggish, and is exposed to the risk of being derailed: in fact, QE alone is at best ineffective, and at worst conducive to new bubbles. With the rest of Eurozone in enduring recession and the international economy losing momentum, the German export engine--which is offered as a model for all Eurozone countries--may also falter, dragging the other countries with it.

    One may wonder whether the very idea of a model to be imitated is in fact the origin of a systematic flaw in current analyses of the crisis: the fallacy of composition (the idea that what is true of the parts must also be true of the whole). This fallacy is particularly evident in the limitations of the export-led model: as is often recalled (Whyte 2010, and Krugman and Saraceno on their blogs, among others), it is impossible for all countries to base their growth on exports. More generally, as in the case of the interlocking crises cited above, if the mutual, systemic relations of actors are not explicitly taken into consideration, the risk of a fallacy of composition will always loom. This warning should also be borne in mind if the nationalistic bias that results from taking a country as the unit of analysis is to be avoided: in fact, countries include actors with different destinies: banks, businesses, workers, the unemployed, rentiers, pensioners, children, etc.). The unknown factor (the crucial object of the dispute) in every crisis is how the present and future costs of the crisis will be allocated, in particular between creditors and debtors. If we consider only countries, we neglect the internal distribution of the economic and social costs of the crisis. For reason of space, however, this aspect will be dealt with only briefly.

  2. The limitations of a consensus narrative on "why the crisis became so bad and lasted so long"

    In November 2015, a conspicuous number of prestigious economists (1) signed a document entitled Rebooting the Eurozone: Step 1--Agreeing a crisis narrative (CEPR 2015). Although claiming to come from different backgrounds, the authors found it "surprisingly easy to agree upon a narrative and a list of the main causes of the EZ Crisis". The key terms in their account are "excessive intra-EZ capital flows" and "sudden stop". The crisis is interpreted as a standard balance of payments crisis that can be analysed using models previously applied to developing countries. A country's membership of a monetary union is considered irrelevant except for the greater opacity in signalling the risks involved in the formation of large capital flow imbalances. "EZ also mattered since the incomplete institutional infrastructure [no lender of last resort, impossibility of devaluation] amplified the initial loss of trust in the deficit nations" (italics added). The main message, which assigns blame and transmits recipes for the future, is that "All the nations stricken by the Crisis were running current account deficits. None of those running current account surpluses were hit".

    Together with an important admission, to which we will return below, the paper contains two striking omissions and a number of unconvincing or contradictory statements. The first significant omission is the absence of any reference to the complementary relationship between the formation of a persistent, growing current account surplus by the core countries (in particular Germany) after 1999, and the corresponding deficit of the peripheral European countries with respect to Germany. Trade surpluses lead to debt imbalances. By definition, a current account deficit entails net capital inflows. Germany's large current account surpluses fuelled German banks' lending to southern Europe. The "consensus narrative" of the causes of the crisis tends to neglect the surplus aspect (which could have prompted expansionary fantasies or, even worse, criticisms of the export-led model), arguing that the crisis was triggered unilaterally by excessive foreign indebtedness on the part of peripheral countries: huge capital flows were drawn from the core to the periphery, facilitated by the monetary union and its regulatory framework. (2)

    The crisis started--we read in the CEPR document--with a "sudden stop" in cross-border lending: the EZ institutions and short-sighted government choices combined to trigger a vicious cycle between banks and their governments that amplified and spread the crisis. The term 'sudden stop' had previously been used in the literature to describe a sudden slowdown in private capital flows to emerging market economies after the formation of large current account deficits. It was usually followed by a sharp fall in demand, production, and employment, and by drastic exchange rate depreciation. The assignment of a central role in the EZ crisis to a phenomenon observed in emerging markets is interesting because the entire institutional architecture of the Monetary Union was based instead on the assumption that countries that met the Maastricht criteria for accession were all on a level playing field. This concern to stress that "the debt evolution was not a core-periphery story" is also found in the CEPR document: in fact, the private and public debt buildup included France. Even though house prices rose more in the GIIPS than in Germany, it is reaffirmed that "there was no simple...

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