Rift and Mastery

PARIS – Like brothers in arms united in combat but divided in peace, Europe and the United States, which had fought depression jointly in 2009, started voicing disagreements in 2010 and begin 2011 with divergent positions on macroeconomic policy. The price of divergence could be steep: though the worst is over, effective coordination of policy is still needed at a time when rebalancing the global economy, as the G-20 has called for, is far from being accomplished.

The transatlantic divide is evident with respect to monetary policy. In November of last year, the US Federal Reserve’s decision to launch a new cycle of “quantitative easing” (buying up government bonds through monetary creation) triggered fierce criticism in Europe. While the European Central Bank has also been buying government bonds since last spring, the amount is relatively small (€70 billion, compared to the Fed’s $600 billion program), and is meant only to support troubled eurozone members, with particular care taken to avoid any impact on money supply.

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A similar divergence, though less acute, has appeared with respect to fiscal policy. In December, as Europeans shifted towards fiscal rigor, the US Congress extended for two years the tax cuts initiated by George W. Bush – which almost everyone interpreted as yet another effort to boost the US economy. True, fiscal retrenchment in Germany is more cautious than official rhetoric suggests. But, overall, the eurozone and Great Britain have clearly shifted towards austerity, which the US is still very reluctant to consider.

In Europe, this divergence is often attributed to what French President Charles de Gaulle used to refer to as America’s “exorbitant privilege”: the power to print the principal international reserve currency. But this explanation is only partly satisfying. Yes, China does pile up reserves in dollars. But no one forces it to do so, and the US would much prefer a stronger renminbi. Emerging-market countries could also invest in euros, if only they were offered such liquid assets as US Treasury bonds – therein lies the current debate over the proposed creation of “eurobonds.” And, while countries like Greece and Spain suffer from market constraints, such is not the case for Northern Europe.

A second interpretation of the transatlantic divide is that the two sides’ policies reflect the differences in their situations. This is clearly the case with labor markets and unemployment: American companies have reacted to recession with massive layoffs, whereas European companies – with the exception of Spanish firms, but not of British companies – have been doing their best to hoard labor.

As a result, productivity has stagnated in Europe since 2007, whereas it has improved by more than six percentage points in the US. Of course, another consequence is that the US unemployment rate is close to post-war peaks and will remain high much longer. And unemployed workers in the US lose their benefits after 99 weeks, making the political imperative for macroeconomic action much stronger than in Europe, where unemployment rose more slowly and benefits are more generous. As the economist Joseph Stiglitz puts it, America’s welfare state is, first and foremost, the Fed’s monetary policy.

But there is also a third, subtler reading of the EU-US split, which has to do with beliefs. In the view of most Europeans, none of the ground that has been lost – or only very little of it – can be recovered. So, because supply has shrunk, it would be dangerous for the central bank or the budget to over-stimulate demand. And, because tax revenues, too, will not recover, the gap will have to be bridged by fiscal austerity.

Americans, on the other hand, are convinced that whatever was lost during the recent recession will eventually be regained. The Obama administration says so, as does the Fed (albeit more prudently), and both act accordingly. In other words, Europeans are pessimistic about the future and thus are reluctant to stimulate growth, whereas Americans remain optimistic and prepared to give any policy instrument a chance. Thus, divergence over macroeconomic policy will continue – at least as long as investors remain willing to buy US public debt.

Several consequences follow from this divergence: difficulties in policy coordination, given no agreement on the diagnosis; a very probable return to large US external deficits while Europe remains in balance; and a weaker dollar, which will become evident if the crisis in the eurozone subsides.

All this could greatly complicate managing the G-20, and risks obscuring the question that all should be addressing: how to manage a global economy in which the balance between advanced and emerging countries is shifting at great speed.