Saturday, November 29, 2014

An Agenda to Save the Euro

NEW YORK – It has been three years since the outbreak of the euro crisis, and only an inveterate optimist would say that the worst is definitely over. Some, noting that the eurozone’s double-dip recession has ended, conclude that the austerity medicine has worked. But try telling that to those in countries that are still in depression, with per capita GDP still below pre-2008 levels, unemployment rates above 20%, and youth unemployment at more than 50%. At the current pace of “recovery,” no return to normality can be expected until well into the next decade.

A recent study by Federal Reserve economists concluded that America’s protracted high unemployment will have serious adverse effects on GDP growth for years to come. If that is true in the United States, where unemployment is 40% lower than in Europe, the prospects for European growth appear bleak indeed.

What is needed, above all, is fundamental reform in the structure of the eurozone. By now, there is a fairly clear understanding of what is required:

  • ·A real banking union, with common supervision, common deposit insurance, and common resolution; without this, money will continue to flow from the weakest countries to the strongest;
  • ·Some form of debt mutualization, such as Eurobonds: with Europe’s debt/GDP ratio lower than that of the US, the eurozone could borrow at negative real interest rates, as the US does. The lower interest rates would free money to stimulate the economy, breaking the crisis-hit countries’ vicious circle whereby austerity increases the debt burden, making debt less sustainable, by shrinking GDP;
  • ·Industrial policies to enable the laggard countries to catch up; this implies revising current strictures, which bar such policies as unacceptable interventions in free markets;
  • ·A central bank that focuses not only on inflation, but also on growth, employment, and financial stability;
  • ·Replacing anti-growth austerity policies with pro-growth policies focusing on investments in people, technology, and infrastructure.

Much of the euro’s design reflects the neoliberal economic doctrines that prevailed when the single currency was conceived. It was thought that keeping inflation low was necessary and almost sufficient for growth and stability; that making central banks independent was the only way to ensure confidence in the monetary system; that low debt and deficits would ensure economic convergence among member countries; and that a single market, with money and people flowing freely, would ensure efficiency and stability.

Each of these doctrines has proved to be wrong. The independent US and European central banks performed much more poorly in the run-up to the crisis than less independent banks in some leading emerging markets, because their focus on inflation distracted attention from the far more important problem of financial fragility.

Likewise, Spain and Ireland had fiscal surpluses and low debt/GDP ratios before the crisis. The crisis caused the deficits and high debt, not the other way around, and the fiscal constraints that Europe has agreed will neither facilitate rapid recovery from this crisis nor prevent the next one.

Finally, the free flow of people, like the free flow of money, seemed to make sense; factors of production would go to where their returns were highest. But migration from crisis-hit countries, partly to avoid repaying legacy debts (some of which were forced on these countries by the European Central Bank, which insisted that private losses be socialized), has been hollowing out the weaker economies. It can also result in a misallocation of labor.

Internal devaluation – lowering domestic wages and prices – is no substitute for exchange-rate flexibility. Indeed, there is increasing worry about deflation, which increases leverage and the burden of debt levels that are already too high. If internal devaluation were a good substitute, the gold standard would not have been a problem in the Great Depression, and Argentina could have managed to keep the peso’s peg to the dollar when its debt crisis erupted a decade ago.

No country has ever restored prosperity through austerity. Historically, a few small countries were lucky to have exports fill the gap in aggregate demand as public expenditure contracted, enabling them to avoid austerity’s depressing effects. But European exports have barely increased since 2008 (despite the decline in wages in some countries, most notably Greece and Italy). With global growth so tepid, exports will not restore Europe and America to prosperity any time soon.

Germany and some of the other northern European countries, demonstrating an unseemly lack of European solidarity, have declared that they should not be asked to pick up the bill for their profligate southern neighbors. This is wrong on several counts. For starters, lower interest rates that follow from Eurobonds or some similar mechanism would make the debt burden manageable. The US, it should be recalled, emerged from World War II with a very high debt burden, but the ensuing years marked the country’s most rapid growth ever.

If the eurozone adopts the program outlined above, there should be no need for Germany to pick up any tab. But under the perverse policies that Europe has adopted, one debt restructuring has been followed by another. If Germany and the other northern European countries continue to insist on pursuing current policies, they, together with their southern neighbors, will wind up paying a high price.

The euro was supposed to bring growth, prosperity, and a sense of unity to Europe. Instead, it has brought stagnation, instability, and divisiveness.

It does not have to be this way. The euro can be saved, but it will take more than fine speeches asserting a commitment to Europe. If Germany and others are not willing to do what it takes – if there is not enough solidarity to make the politics work – then the euro may have to be abandoned for the sake of salvaging the European project.

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    1. CommentedJan Vannieuwkerke

      Yes, solidarity is the key but perhaps the construction of Europe should be reconsidered. No longer based on the Treaty of Maastricht which considers primarely the "free" market and is resulting rapidly in the Europe of the Poor, but on the Treaty of Rome whose prime intentions were the continuous improvement of living standards and employment, solidarity and real democracy. It is still possible through solidarity to save not just the euro but also the European project.

    2. CommentedVan Poppel charles

      sir, you write " the independent US and European central banks performed poorely"; first: what are governments for?; second: for the moment we are witnessing a most strange situation: governements as fiscal authority, are introducing fiscal austerity ( cutting expenses and increasing taxes ) to restrain bugdet deficits, while other government institutions , central banks, to respect their legal goal being to favor a strong economy at stable prices , are injecting a massif amount of liquidities at an extremely low price into the economic system to stimulate economic growth. Who is going to win the contest?

        CommentedJose araujo

        No contest to be won, IMHO

        The massif amounts of liquidity are here no matter what central bankers do.

        The idea that low interest rates are caused by QE, is wrong. QE's are designed to change the risk perception and increase the rates, because we are living in times of strong risk aversion (liquidity preference) and that’s one of the few things a central bank can do in a liquidity trap situation.

        You are very right in spotting the paradox, though, fiscal austerity and monetary loosening it’s probably one of the most stupid ideas ever. New Deal worked because monetary loosening was used to fund fiscal stimulus, and that’s how we should be doing right now

    3. CommentedStamatis Kavvadias

      Prof. Stiglitz,

      The fractional reserve system that requires a "deposit insurance" (which needs to be common in the case of the euro), is fundamentally problematic and only appropriate for periods of economic boom (i.e., growth), or parts of the world that can experience such growth at the expense of other parts. The expectation of perpetual growth, which requires perpetual increase of the money supply, which in turn requires perpetual increase of debt (because virtually all money is created as debt), is an illusion and a largely unstable system.

      Perpetual growth cannot come from exploitation of increasing amounts of resources, because resources have limited quantities in the real world. The only place that perpetual growth would seem to be feasible, is the exploitation of perpetually deeper knowledge and this would be the, so called, knowledge economy. But, even in the field of exploiting the manufacturing of computer chips (which can fit exponentially increasing amounts of computational resources in fixed space), providing performance increases has become increasingly complex, actually stopping the course of delivering faster chips for any market. Generally, after some point, increasing resources cannot provide much more than the sum of the parts and, in fact, not even the sum of further increasing the parts is attainable, other than by diminishing the additive efficiency of these parts!

      On the flip side, the fractional reserve system requires perpetual growth of the money supply and is ***very bad*** at managing deleveraging or even a stable size of money supply and associated debt, causing recessions. A system based on "deposit insurance", results in bad incentives for the banks and risky but high performing loans, which they cannot back in the inescapable bust that will come. At this point, not only the taxpayer has to bailout depositors (the "deposit insurance" may easily not suffice) and this way socialize the losses for privately taken risk. In addition, the losses, in the parts of the banking system that cannot be covered by the "deposit insurance", result in layoffs, dysfunctional banks that do not lend, further bailouts and public indebtedness, decreased consumption and, generally, recession or even depression. "The debt deflation theory of great depressions" (Irving Fisher, 1933) takes place in a larger or smaller scale.
      [Read a very colorful presentation of the issue with deposit insurance here:]

      The latter part of the financial system (the one that cannot be covered by "deposit insurance", but still has to be bailed out), which you believe in regulating (as I understand from other writings of yours), will not be tolerated anymore to exist at the expense of the poorer part of society. The costs are too great.

      Instead of persisting in the dysfunctional fractional reserve system and, effectively, proposing broader socialization of banker losses, please get down to work and propose something better for the 21st century, that is not so inextricably tied to a notion of growth. The time of the growth doctrine is over and if economists do not rise to the level of the challenge, social initiatives will overthrow the financial system, along with any benefits it could have if it were functional.

    4. CommentedMarc Sargen

      Of course the proper response is no country has ever gotten into trouble through austerity. That is because prosperity is always relative to where you have been. Everyone feels prosperous when they are spending & maxing out the debt but there is always a limit to that type of prosperity.

        CommentedJose araujo

        Well, just to name a few. The great depression was a austerity problem and the new depression is also caused by austerity. When you are facing a demand problem austerity only creates problems.

        But it’s not just that, you see when you think a bit harder about the nature of savings and spending, you realize that there is no such thing as saved resources. Money has no vale per se, it’s just a bunch of zeros and ones in a computer system, or a pile of gold buried under a mountain. When you realize this simple fact you conclude that austerity only has a role to play in full-employment, not in crises situation, and that it is austerity that causes crises (demand shocks).

    5. CommentedMarc Sargen

      I keep hearing about the need for a Central Euro Bond but it is never tied to fiscal enforcement. Euro Bond would only maintain low interest & high interest if the markets believed that they were under control & not subject to default, delays, & restructuring. One uncontrolled, overspending economy can stain the rest of Europe. Without a why to oversee the fiscal policies of sovereign nations a Eurobond will more likely worsen the rates of Germany than reassure the market of the creditability of Greece.

    6. CommentedGavin Putland

      Indeed, internal devaluation cannot substitute for exchange-rate flexibility. But FISCAL DEVALUATION can - especially "maximalist fiscal devaluation" (Google it).

    7. CommentedJose araujo

      Euro needs to difenrentiate between imported value and internal value, we need to protect to some degrees the different european economies.

      VAT is a stupid tax, we need assymetric consequences and to tax the imports within the EU higher then what is produced in the EU countries, if not economies of scale will lead to spacial agglomeration.

      Regarding the famous internal devaluation, we need PROOF that lowering wages promotes competitiity, because Germany has higher wages then Spain or Portugal, and its far more competitive...

    8. Commentedantoine Coum

      The main problem for the eurozone is the lack of a federal political power accountable to citizens through a real democratic process while now all the members of the European Commission are technocrats.

    9. CommentedMK Anon

      After versailes' treaty at the end of WW I, germans were imposed totally
      unfair and unbearable conditions. They are now doing the same mistake:
      imposing the Euro to southern europe, with deflation and increasing
      debt, austerity. No wonder nationalist parties are stronger than ever.
      Europe is not a democracy anymore. And if you have to get an imposed
      leader, better one that says they care for you than another one, as the
      german government, that proposes to take over a couple of your territory
      as part of the repayment...

      The parallel that Pr. Stiglitz makes to argentina's 2001 crisis is
      extremely relevant. Argentina's exchange rate dropped by 40$, that was a
      very difficult year.. but then a 14 years growth period at extremely
      high growth rate ensued. In Europe, we are 5 years down the crisis and
      there is still no recovery in southern europe, only a long agony. I call
      criminals those who forced those countries to stay within the Euro zone.
      But they had to stay, so the big banks, leeches of our economic system,
      could rip them of their last drop of blood.

    10. CommentedTomas Kurian

      Free flow of people - such nice euphenism.

      In Antic times, Romans had a habit of invading foreign lands, killing thousands of their inhabitants and dragging other thousands to their homeland as slaves to work in abysmal conditions.

      Today, countries are ruined through clever financial schemes of neocolonialism and after they have literaly no money to conduct business in their home their citizens are given " generous opportunity" to abandon their family, homeland and to move to work to dying countries that caused their downturn ( or to die from hunger at home).

      Slavery indeed has reached new level.

      Europe is not USA, we don´t share the same language. To try to force people to leave their countries their forefathers shed blood for is receipe for disaster.