No Mysteries in Eurozone Crisis

Jeff Madrick

Little is more tragic about the eurozone crisis than that we know how to minimize it and provide the best chance for stability and growth yet we are not doing what we must. As an American, I should say ‘they’ are not doing it. It was just announced that eurozone unemployment reached a rate of 10.8 percent in February. What we should all recognize is that there are no mysteries about what to do.

The UK and the US have central banks of last resort. The Eurozone has resisted this. But the best evidence that such far more aggressive monetary policy is needed came last December when the relatively new European Central Bank chief, Mario Draghi, did an end-around and started to push hundreds of billions of euros into the banking system. Almost immediately, Spanish and Italian interest rates started to drop and Europe breathed a sigh of relief.

Ultimately, Draghi made a trillion euros available to banks at very low rates and they bought sovereign debt. An absolutely unnecessary crisis was averted. Keep in mind, as an example, that the Italian deficit is not very high. But because its debt-to-GDP level is indeed high, every increase in interest compounds the obstacles for rolling over debt. These unnecessarily high rates can be avoided.

The Europeans, led by the Germans, worry this monetary easing will someday become inflationary—or that the ECB will be holding losses on their books, as will the Bundesbank. But there is little doubt that an exit policy for the central banks can be implemented when and if economies are healthy again. As for inflation, a little would be welcome to water down future debts. And there is no sign at all that a lot is on the way.

Despite the Draghi initiative, the markets started to worry about Spain again in the last couple of weeks. Why? Because it didn’t adopt sufficiently tough austerity policies, said the chest thumpers, not only in Germany but elsewhere in the EU hierarchy. And last week, Spain announced that they were succumbing to the pressure again and about to raise taxes and cut spending even more after having asked for more flexibility on meeting deficit targets.

Oh my! The reason Spain can’t adequately reduce its deficit-to-GDP ratio is those very austerity policies, of course. It is a dog trying to catch its tail. Austerity economics—higher taxes and reduced spending—has failed in every eurozone nation where it has been tried: Ireland, Spain, Italy, Portugal, and Greece. All have fallen far short of their deficit targets—the ones set by these over-confident men and women who have retreated to pre-Depression economics. All are in recession, Greece in Depression.

Ireland was momentarily the one example that was cited as a success story because in 2011 it had two quarters of GDP growth. Never mind that its GDP was still 12 or 14 percent below its pre-recession high. Now it is likely in recession again as GDP has gain fallen fast.

The best example of austerity’s failure, however, is a non-eurozone country, the UK. Adam Posen of the Bank of England monetary policy committee asks wisely in a recent speech why the US economy has done better than the UK’s. As he points out, both suffered about an equal loss during the recession, reaching a trough in mid-2009. But the US bounced back much more rapidly in terms of both consumption and investment. Indeed, the UK may be falling into recession again. Certainly, its unemployment rate is rising. Though the UK employment picture hadn’t suffered as much as in the US, the unemployment rate is roughly now the same, and moving in the opposite direction.

Some inexplicably claim success for the UK austerity plan, which included a hike in the VAT, because its interest rates are not rising. But that’s because it has a central bank that can pour on the credit and also help depreciate the pound. A falling pound maintains a modicum of growth to offset the retardation from austerity. But what good is a low interest rate if it is not stimulating investment?

Both the Federal Reserve and the Bank of England have loosened monetary policy to about the same degree, according to his calculations. And inflation is controlled in both nations.

Why the UK failure? Posen attributes the slow growth to both austerity and higher oil prices.

If this is a good case study of austerity’s failure, the consequences are far worse in the eurozone because none of these countries can devalue or step on the monetary throttle adequately. They are left to chase their tails.

The middle and poorer classes pay the price, of course. Good research by the IMF shows that historically the middle and working class bear the punishment of austerity more than the richer classes. Profits fall much less than do wages and rise much more quickly.

There is at last a growing political reaction in Europe. Social Democrats in Germany are criticizing their own government. In the UK, Spain and Italy, the British historian Robin Blackburn tells me, there are stirrings. The Greek left wing is gaining votes.

No single fact stands out to me as much as this one. The average eurozone deficit-to-GDP ratio was only 0.5 percent in 2006. Public profligacy except in Greece did not cause the crisis. Ending public profligacy is not the solution. Growth is needed, then redressing current account imbalances.

What is needed is more aggressive ECB accommodation. But as Britain shows, that will not be enough. Austerity must end for now in the peripheral nations and Germany, the Netherlands and a few others must stimulate fiscally. Then there should be a concerted effort to raise wages, but that’s for another blog.

There is no mystery about what to do, but those in charge willfully reject them and seek comfort in theories proved so wrong in the Great Depression.

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