European Musings

A couple quick notes on Europe—though it hasn’t been in the news much recently, the slow-moving crisis seems to be grinding on. Interestingly, Europe seems to be in a similar equilibrium state as the US—quarter to quarter growth remains fairly steady (but below potential), but policymakers seem incapable of getting the economies over the hump and back to full potential (and, shockingly, even preventing actively harmful policy seems to be a struggle). Europe’s situation, however, is worse for a number of reasons:

1)      Much worse fiscal policymaking. As bad as the US has been, Europe has been worse. No initial stimulus, much more intensive focus on front-loaded austerity in the periphery, in the face of evidence that these policies are counterproductive, and a lack of offsetting fiscal expansion in Germany.

2)      Worse central banking—a lot of the early (08-10) fiscal panic could have been ameliorated if the ECB had begun supporting peripheral economies earlier—Jean Claude Trichet was terrible (he raised rates in the face of rising unemployment in 2011), but Draghi has been a bit better since he assumed the role as head of the ECB. In particular, his statement that he would do “whatever it takes” to preserve the Euro had a dramatic impact on borrowing costs in the periphery. However, Draghi still has policy a lot tighter than it should be given core inflation and the unemployment rate, though much of that could be resistance from Germany.

3)      Common currency/imperfect monetary union—this is probably the biggest disadvantage Europe has relative to the United States. Monetary unions are particularly susceptible to asymmetric shocks; that is, when parts of the monetary union are performing considerably differently than economies in other areas of the monetary union. With more fiscal and political integration on the continent, it would be a relatively simple matter to transfer resources from better-performing areas (Germany) to under-performing areas (Greece, Spain, Portugal, etc). In the US this happens automatically—federal benefits (Medicaid, SSN, disability, SNAP, etc) automatically rise in a recession in areas that are particularly hard hit, and they are primarily financed by centers of economic wealth (areas with lots of people working and paying taxes). In Europe, rules preventing the subsidization or responsibility for other countries’ debt prevent fiscal transfers of this nature on a country-country basis, and the lack of fiscal integration means that benefits are handled on a country by country basis. In the absence of transfers, ideally slower-growing countries would be able to devalue their currency against countries with stronger economic growth, thereby allowing tourism/exports to drive economic growth and make their economies more competitive again. Without the option of devaluation or fiscal transfers, intercontinental migration combined with internal devaluation in the core becomes the only option to improve economic growth and balance competitiveness on the continent. Fortunately, it looks like this is starting to happen, but this is an incredibly arduous and painful mechanism to restore balance and competitiveness to the periphery.

Therefore, on the whole, Europe’s future continues to be bleak—at this point, preventing the breakup of the Euro (regardless of growth/unemployment) will be considered a win by policymakers. Tragic for the generation being destroyed in the periphery by long-term unemployment.

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