Ryan Avent over at the Economist has an interesting take on Europe’s recent economic divergence from American performance during the perpetual Euro-crisis. Avent thinks that policymakers have learned from the experience during the Great Depression; while not perfect, American growth during the last 4 years has been much better than that experienced during the early 1930’s. However, Europe, particularly in the last 2 years, has failed to keep pace with American growth. Rather than attribute this failure to a lack of economic understanding, Avent ascribes this (poor) economic performance and policymaking to Europe’s failure to create an institutional framework capable of allowing the formulation of better policy:
There are obvious parallels to the euro-area crisis. The single currency entails many of the same constraints as the gold standard. Had no lessons at all been learned from the 1930s, the euro area’s economic trajectory would surely have more closely resembled that of the Depression, perhaps made somewhat less serious by modern safety nets and mature (perhaps that’s the wrong word) democratic governments. It still might; Matt O’Brien updates the Depression story here. But today’s policymakers do know more about how not to fight crises than their 1930s counterparts. That difference in knowledge is the reason the euro area is falling hundreds of billions short of an achievable output path rather then several trillion. And so I think there might be a different and more effective way to describe what’s happening in Europe.
Let’s say that America’s output path represents “intellectual potential”. The gap between a Depression-like path for America’s economy and its actual path represents a gain attributable to the macroeconomic knowledge attained since the 1930s. I, like many others, think that the American economy could be doing even better—could in fact be operating at estimated potential. But policymakers lack an intellectual consensus on how to get there. Thus, intellectual potential.
Europe is falling short of intellectual potential. This shortfall isn’t “structural” in the usual sense; it has only emerged over the past two years or so. It could be due to a “Great Forgetting” in the euro area—a systematic loss of macroeconomic knowledge isolated to one corner of the global economy—but that seems unlikely, and the European Central Bank’s refusal to give in to liquidationism suggests the lessons of the Depression have not leaked out of Mario Draghi’s brain.
No, the gap instead corresponds to the euro area’s failure to implement an institutional framework capable of delivering intellectual potential.
I’m not convinced that Avent is correct here–while the ECB has generally performed just barely adequately enough to preserve the Euro, monetary policy in a recession when an economy is at the zero-lower-bound is, at best, moderately effective, and that is only when monetary policy becomes very unconventional and aggressive. The true lesson that the Great Depression and the 08 financial crisis have taught us is that at the zero-lower-bound, fiscal policy is the most effective growth stimulus. It seems fairly obvious to me that the intellectual consensus in Europe has revolved around austerity; changing the institutional framework without changing attitudes toward fiscal policy wouldn’t achieve much (unless a fiscal governance structure could be erected that took fiscal policy out of policymakers hands, to some extent, through the use of automatic stabilizer transfer payments, like unemployment benefits in the US).
The same problems that plagued Europe during the 30’s on the Gold Standard plague Europe today–capital outflows in debtor countries drive up interest rates, and countries with current account surpluses refuse to spend money, afraid of squandering their competitive advantage. To reiterate Avent’s point:
“Had no lessons at all been learned from the 1930s, the euro area’s economic trajectory would surely have more closely resembled that of the Depression, perhaps made somewhat less serious by modern safety nets and mature…democratic governments.”
The graph below is European GDP/capita–100 is set to the peak year, meaning 1929 and 2007 (via Krugman):
Sure looks to me like Europe hasn’t really learned any lessons…