Economics

Europe’s Lost Keynesians

May 23, 2013 Kenneth Rogoff

There is no magic Keynesian bullet for the eurozone’s woes, despite what many commentators and much of the public seem to believe. The eurozone’s difficulties stem from European financial and monetary integration having gotten too far ahead of actual political, fiscal, and banking union – not exactly a problem that Keynes tried to address.

CAMBRIDGE – There is no magic Keynesian bullet for the eurozone’s woes. But the spectacularly muddle-headed argument nowadays that too much austerity is killing Europe is not surprising. Commentators are consumed by politics, flailing away at any available target, while the “anti-austerity” masses apparently believe that there are easy cyclical solutions to tough structural problems.

The eurozone’s difficulties, I have long argued, stem from European financial and monetary integration having gotten too far ahead of actual political, fiscal, and banking union. This is not a problem with which Keynes was familiar, much less one that he sought to address.

Above all, any realistic strategy for dealing with the eurozone crisis must involve massive write-downs (forgiveness) of peripheral countries’ debt. These countries’ massive combined bank and government debt – the distinction everywhere in Europe has become blurred – makes rapid sustained growth a dream.

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Kenneth Rogoff

Writing for PS since 2002
245 Commentaries

Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. He is co-author of This Time is Different: Eight Centuries of Financial Folly (Princeton University Press, 2011) and author of The Curse of Cash (Princeton University Press, 2016).

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0 Comments on this paragraph, 42 Comments on this article

Giovanni Macchia Sep 27, 2014

It has been demonstrated (see the article and the associated scientific pape at this link http://nymag.com/daily/intelligencer/2013/04/grad-student-who-shook-global-austerity-movement.html) that Reinhart and Rogoff scientific results about the need to maintain a Debt/GDP under 90% were simply wrong.
I think, according to the result of that scientific paper that Europe need to completely revise its austerity agenda, may be allowing national investment in well defined projects og sustainable growth.
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Paul Peters Jun 5, 2013

Allright, so words need to be accompanied with action. Why didn't anybody tell us that before ?! So the solution for generalized victimization by a bunch of shortterm-thinking opportunists who ended up filling the otherwise empty seats in an outdated oligarchy is to enforce egotism and autocannibalism ? Those forces added to their power in the first place..

Massive debt write-downs is a good idea though. The mutual strangling may add to the prospect of peace, but for how long? This should be advocated beyond personal controversy.
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Giovanni Macchia May 31, 2013

It is quite funny that Prof. Rogoff continues to suggest the austerity policy. It has been demonstrated (see the article and the associated scientific pape at this link http://nymag.com/daily/intelligencer/2013/04/grad-student-who-shook-global-austerity-movement.html) that Reinhart and Rogoff scientific results about the need to maintain a Debt/GDP under 90% were simply wrong.
I think, according to the result of that scientific paper that Europe need to completely revise its austerity agenda, may be allowing national investment in well defined projects og sustainable growth.
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Stephen Pain May 31, 2013

I wish I could really worry about this - but I do not. Economic policies are really irrelevant when you have some 40 trillion US dollars in offshore accounts - when the sovereign debt of the US cannot be paid ever. Spain, Greece and others have been made scapegoats for a system that allows a minority to skim off the cream from manufacturing and ...organized crime. There is no economic problem...except theft.
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Paul de La Motte May 30, 2013

Moderate inflation bringing down real estate, do you mean in nominal price? As for the real price, it can only go up. Inflation would make matters worse.
What is needed is a positive fiscal shock supporting investments, coupled with cuts in taxes and increased labour flexibility. Of course, such reforms can only be enforced by the EU commission as the short term negative effects of increased labour flexibility and tax cuts will erode political support. Investments only yielding GDP growth in the medium/long run.
In a nutshell, what is needed is a EU version of Thatcherism.
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G. A. Pakela May 28, 2013

Austerity should mean laying off state employees that are unnecessary, taking a haircut on pension obligations that cannot be financed through taxes on businesses and households, and reducing too generous welfare benefits that also place too high a burden on taxpayers.

The reforms should include labor reforms that allow companies to lay off or fire employees at will; and an across the board reduction in income taxes, corporate taxes and the VATs. No amount of econometric modeling will tell you what the result will be with any certainty, but even econometric models will indicate that this is the right direction.

For those among you who are economic historians (J. Bradford) go back and read chapter 7 of Otto Eckstein's "Core Inflation" published in 1981. While we are not in an inflationary environment as existed then, that only means that you can both stimulate the demand side and supply side with near impunity. But it is better to do so by reducing costs to the private sector in terms of consumption spending and investment.
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Heriberto Arribas May 28, 2013

First we have to answer the question: is Germany interested in ending the European Debt Crisis?

Germany is the main beneficiary. Without the debt crisis, the Euro would strengthen and German's exports would drop.

The Federal Reserve and the Bank of Japan is spending billions, the bank of Europe, no.
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Procyon Mukherjee May 27, 2013

Just a simple pointer on the proposed German inflation, for which the wait had been longer than expected; last year in May 2012 when the Metal Worker's Union settled the wage increase at 4.3%, which was twice the inflation rate, many had predicted German inflation to rise (to offset against the fall in the other EU area). The Chemical workers settled on 4.5% although they were asking for 6-7% increase. On the contrary the German inflation touched a mere 1.1% in April 2013 when the last reports came in.

The growth in the first quarter has been mere 0.5%, so while we talk about all four birds, we cannot miss the main bird, how do we raise the productivity and competitiveness of Germany itself.
- Stamatis Kavvadias May 30, 2013
  
  They do not have a productivity problem. they have a demand problem.
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J Norman May 27, 2013

" the spectacularly muddle-headed argument nowadays that too much austerity is killing Europe"

How insensitive! No wonder Krugman was so annoyed with this article. The truth is that too much austerity is literally killing parts of Europe, directly via raised suicide rates and indirectly via sky-high unemployment levels. Rogoff could have produced a much better article by simply leaving out the strawman-bashing rhetoric.
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J. Bradford DeLong May 25, 2013

There are two ways to think about why North Atlantic economies are depressed. The first is that would-be spenders (including people and businesses that buy durable capital goods) want to spend less than income earners would earn if there were full employment. The second is that would-be lenders want to lend more than would-be borrowers would want to borrow and than financial intermediaries would be willing to let them borrow if there were full employment. These two ways of thinking about it are, in the math, identical. But they highlight different aspects of the situation.

Ken Rogoff tends to naturally think in the debtors-creditors framework. I tend to think in the spending-income framework. Although the math of each is consistent with the math of the other--in fact, you can turn one into the other via algebra--this does, I think, drive a difference in our orientations.

From my perspective, if the German government spends on Germans, it produces a boom and inflation in Germany. If the boom continues long enough and is strong enough, German internal prices and costs rise--and southern Europe's and France's competitiveness problems melt away as the burden of the outstanding debt is reduced as well. Yes, it would be very nice if France and southern Europe as well were to undertake thorough-going pro-productivity pro-competitiveness social reforms, and Germany should demand them as the price of its raising its debt and borrowing to spend on Germans and so create a moderate-inflationary boom. But those reforms are not of the essence of the current short-term problem, which is too much debt in the periphery and too-high wage levels in the periphery and in France relative to Germany.

By contrast, if the German government borrows to spend making Spanish creditors of Spanish banks whole--well, that does not generate the inflation in Germany that is the easiest path to eliminate Europe's internal structural wage imbalances, and it does generate a massive defeat for the government that adopts it in the next elections in the Bundesrepublik.

As I see it, fiscal expansion in Germany is a stone that kills four birds: the boost-general-European-demand bird through directly boosting spending so that it matches full-employment incomes, the eliminate-structural-wage-level-imbalances bird through inflation, the through-inflation-impose-haircuts-on-creditors bird, and the make-the-German-electorate-happy bird. By contrast, as I see it at least, Ken's stone is a much more efficient stone, but it only hits two birds: the impose-haircuts-on-creditors bird, and the boost-general-European-demand bird as reductions in debt burdens diminish the desire of those on whom haircuts have been imposed to lend in the future and also increase the desire of those who were underwater to resume normal borrowing patterns. To hit four birds with one stone is, I think, better than to hit two.

But I may be wrong: Ken is one of those people whose judgment is significantly more likely than not to be better than my own.
- Gerald Silverberg May 30, 2013
  
  Why bother with German government stimulus? Across-the-board wage increases in Germany would accomplish the same thing without raising indebtedness, thereby rebalancing the unit-labor-cost disparity with the periphery, raising German inflation, lowering the current account surplus by stimulating German imports and export demand in the rest of the EZ. It would have to be compensated by a devaluation of the Euro, to preserve German competitiveness vis-a-vis rest of world and improve that of the rest of the EZ. Whether peripheral debt write-offs would still be necessary is an open question (the "second Merkel Moratorium": http://silverberg-on-meltdown-economics.blogspot.co.at/2013/05/the-creditanstalt-vienna-announces.html).
  
  Instead the Bundesbank is suing the ECB in the German Constitutional Court over OMT, the only successful and costless(!) Euro stabilization program thus far. Is this any way to run a currency zone?
  
  But I said all of this already in January 2011: http://sites.google.com/site/savingtheeuro.
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- Tomas Kurian May 27, 2013
  
  These four birds solution imply, that German government wants to fulfill these goals for the common good and is acting in line with interests of all Europeans.
  
  But this is not so. German government is acting on behalf of German industrial groups, who are just fine ( couldn´t be happier, indeed) with the present status quo.
  
  Money is flowing to Germany.
  France and South is not competitive, Germany is in a position to buy Greek islands and other assets at highly deflated prices,....among other goodies that are there, stemming from this situation.
  
  Some thinkers are already pointing to the fact, that "lesser nations" are dying out without single shot. (good old German dream, isn´t it ?
  Why to build concentration camps when whole countries are operating as they were one, run by bribed leaders from euromoney ?)
  
  So, why to change anything ?
  And you can also see, why there is no change going to happen.
  
  There is a solution. However, it lies a bit deeper and needs an upgrade of financial system to fully digital and introduction of taxes on deposits in connection with other mesaures.
  More at: www.genomofcapitalism.com
  
  Current problems lie in the need of having trade surplusses and unless this need is eradicated with new economical model described above, the problems will persist. After all, they are the same that lead to the WWII - need to capture foreign markets as export colonies. That never does bode well in Europe.
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- Michael Heller May 26, 2013
  
  Brad, I enjoyed the bird analogies, but you lost me with the Keynesian Zaubermittel (magic) -- “German internal prices and costs rise, and southern Europe's and France's competitiveness problems *melt away*”, i.e. no country aside from Germany actually has to DO much short-term to eliminate wage distortion and become competitive. Schumpeter would see your example as Keynesian short-run policy ignoring short-run benefits of longer-run policy.
  
  In your plan the reforms are an afterthought. You neglect that without conditionality there's no lever. Where’s the political economy in your equation? How can Germany “demand” reform from other countries as the price of Germany internally raising its own debt and inflating its own economy? There simply is no direct lever to join these two cross-country ‘price’ movements.
  
  The unconditional fiscal charity you propose risks undoing Germany’s (i.e. Europe’s) competitiveness. France will chuckle, southern Europe will go back to business as usual. Pew Polls recently found that Germans worry less about inflation than any other country. So you may be right that inflation won’t lose an election. But Germans are too smart to be gamed by redistributionist rabbit-hat tricks. Since debt bonfires cannot be avoided, German elections would more likely be won if over-the-counter debt restructuring were transparently seen to act as lever for reform in the countries which have the dead wood.
  
  So a combination of moderate inflation, consistent austerity, and deep structural reforms and write-downs appears quite realistic. Debt cabbage must be shredded, and inevitably the recipe will include sauerkraut.
  
  But Rogoff is still right to conclude that the bottleneck is institutional. Without greater legal-political union there is no central power to adjudicate between creditors & borrowers or to manage write-downs. The IMF, which played that role in previous regional debt crises, seems sidelined by the facts of monetary union, whilst fiscal & political union still only has its baby teeth. Institutional growth is the priority, Grow baby grow.
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Paul A. Myers May 25, 2013

In the major eurozone economies, the big banks need to be broken up, which should be easy once you write down the bad assets since all the bank equity will be negative. Bank concentration is the big unspoken elephant in the room: in the US, the six biggest banks have assets equal to 70 percent of GDP, in Germany two total more than 130 percent, and in France three banks total way in excess of 200 percent.

So the big European economies all have big, criminally stupid banks loaded with hundreds of billions of worthless assets. How does this come about? The answer is by having incredibly incompetent and dumb finance ministries.

So the national finance ministries are straight-up failures. Now here is an opportunity. Disestablish the national finance ministries and move the functions to the eurozone level. Bye bye Paris, bye bye Berlin, bye bye Rome--hello Brussels.

The Club Med countries may be guilty of spending what they didn't have, but the truly awful behavior was at the finance ministries in the northern European countries. They had very grandiose visions and very modest abilities.
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Marco Cattaneo May 24, 2013

Rogoff is wrong. The solution exists: restoring European peripheral countries monetary autonomy by introducing parallel monetary instruments (Tax Credit Certificates) alongside the euro, to be used to reduce labor costs so to realign Southern Europe's competitiveness vs Germany. http://bastaconleurocrisi.blogspot.it/2013/01/tax-credit-certificates-tcc-tool-to.html
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Frank Hollenbeck May 24, 2013

From Mises, plain talk, 1948, talking about the post Malthus Say debates of the early 1800s. "Those authors and politicians who made the alleged scarcity of money responsible for all ills and advocated inflation as the panacea were no longer considered economist but "monetary cranks" the struggle between the champions of sound money and the inflationist went on for many decades. But it was no longer considered a controversy between various schools of economist. It was viewed as a conflict between economist and anti-economist, between reasonable men and ignorant zealots." With this article Rogoff has clearly put himself in the camp of the ignorant zealots!
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Frank Hollenbeck May 24, 2013

Debt write-down? what exactly is this Harvard professor smoking? does he realize that European banks are the entities holding all this debt, and that a write= down is basically Cyprus, European wide? does he even know what deposit insurance is? This is what is teaching our children at the World's best school? wow, just amazing that this would even get the smallest amount of attention. Its so full of misconceptions it is hard to believe.
- Ed Jansen May 24, 2013
  
  I don't think I miss your point. Yes, there will be pain. Be it by inflation, by bailout, by higher intrest on the bonds, there is no way around it. (read my earlier comments on this page).
  The question is how do we divide the pain? This is perhaps more a political question than an economic one.
  
  -do we want to see people starve to death on the streets of Athens or Lisbon?
  -do we want social unrest and the rise of populist far right/left parties destabilising the countries?
  I hope not.
  Therefore we need solidarity.
  
  (Limited) inflation looks to me the best way out of the ciris, rather than pure austerity. Inflation of the euro has the benefit of becoming more competitive on the world market.
  That means printing money indeed !
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- Frank Hollenbeck May 24, 2013
  
  I think you missed my point.
  If governments write down their debt, their banks go belly up immediately (just like Greece). However, the government is still liable for deposits. Its not like they have money set aside to pay if the entire system collapses. The only way they can cover those liabilities is to print money. people will get back the nominal value of their deposits, but will see the real value of their deposits plummet.
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- Ed Jansen May 24, 2013
  
  I agree with you that economics is too important to leave to economists..that is why I am here..
  But debt write-down can be a good thing.
  What if i own 10.000 and lend 5.000 to someone.
  Then i can say to the rest of the world i own 10.000 and i'm getting a good intrest on the 5.000 i lend to others.
  But what if i know I will not get back my 5.000.
  Can I still tell the world I own 10.000; I could, but is it fair?
  Don think so.
  It is not true that debt write-down is a 'European wide Cyprus', as you say. It is a zero-sum game. What one looses, another wins. If you write down my debt, I win, and you loose the same amount of money. Therefore it is neutral as a whole..
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Jens Kolhammar May 24, 2013

Why is Rogoff continuing to fight straw men? Where are these influential Keynesians who only think stimulus will solve the Eurozone’s problem that he keep on attacking?
- Ralph Musgrave May 24, 2013
  
  Quite. I.e. the “straw men” / responsible Keynsians don’t exist. The people calling for an end to austerity are the economically unsophisticated: ordinary people, trade unions, etc. And they can’t be blamed: austerity has hit them hard.
  
  With a view to attacking Keynsianism, Rogoff claims the latter economically unsophisticated folk are “Keynsians”. Pull the other one Rogoff – try some other form of verbal trickery if you like, but I doubt you’ll fool me.
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Ralph Musgrave May 24, 2013

Rogoff criticises Keynes for not addressing Eurozone type problems. Well that’s because large Eurozone type entities didn’t exist in Keynes day. Doh!
- Procyon Mukherjee May 24, 2013
  
  Dear Ralph,
  
  Are you sure about this tenet that Chinese productivity is one fifth of the Western World? Just compare the productivity of Chinese workers in the BMW plant in Shenyang with that in Munich and you would know better.
  
  If the currency is the simple means to competitiveness, think what has happened in Yen vis-a-vis Dollar from 2009 to 2013, Yen has come back to where it had started, does it prove anything?
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Procyon Mukherjee May 24, 2013

In this age of convergence, let us not miss the micro picture of Europe. Let's look at some of the top Steel firms and their first quarter results: Arcellor-Mittal, ThussenKrupp, Corus, all making whopping losses, they have clearly head-winds stemming from demand softening (Steel has lost 30% since the time crisis struck).

This can only change if Europe is competitive to be able to export to outside of the Euro region; the prospects look bleak as the regions of demand has shifted to the East, where it makes far better sense to invest there itself. When you invest there, it makes far better sense to not bring back the capital. So the spending in Europe remains dampened.

I do not see how by this debate of debt right downs we would solve the fundamental problem of improving competitiveness where European products can move outside of the Euro region in the short term.
- Ralph Musgrave May 24, 2013
  
  Changes in competitiveness of the Eurozone AS A WHOLE can easily be dealt with by adjusting the price of the Euro vis a vis other currencies. How do you imagine China manages to compete with advanced western countries despite productivity in China being about one fifth that of western countries?
  
  The problem addressed by Rogoff is AN ENTIRELY DIFFERENT PROBLEM. It’s a problem of changes in competitiveness of one EZ country relative to another.
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Ed Jansen May 23, 2013

Inflation, write-downs, euro bonds, it is all the same thing. It does matter how you call it, it boils down to the same thing: less wealth.
Rogoff fails to mention how the northern European states have profitted from the lack of serious competition. They could 'export' to the south an d count themselves rich. But now the northern countries have to pay the bill of the exports themselves !
What matters more is the competiveness of the EU towards the rest of the world. Can the EU as a whole compete on the world market. That is the main question.
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Joachim Nuetzel May 23, 2013

Both Kenneth Rogoff and Christopher T. Mahoney are constantly promoting most severe crime.
- Ken Presting May 24, 2013
  
  This comment has the EU situation precisely reversed. Prof. Rogoff is very clear that whatever else we'd like to say about EU capital, we must admit that huge amounts have been simply lost. Pretending that it wasn't is a kind of fraud.
  
  More importantly, the way most of that capital was lost was by plain fraud by politicians (eg in Italy and Greece) or by speculators exploiting vulnerable homebuyers (as most of the OECD).
  
  Rogoff's point is not really Keynesian, but rather a simple matter of honest, non-creative accounting. Nobody can re-create the money which was lost. Once we stop that self-deception, we proceed with the harder work of political integration and effective regulation.
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James Ross May 23, 2013

At last someone in a position of influence has said the forbidden words - write-down.
Thanks.
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Frank Hollenbeck May 23, 2013

A Harvard professor telling us that the "solution" is inflation. Economics is not like chemistry or physics were knowledge is always moving forward. We knew more economics in the mid 1800s that we know today. Had Rogoff made such a statement in 1870, he would have been considered a monetary crank!. As Mises said, " In fact, inflationism is the oldest of all fallacies"
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Christopher T. Mahoney May 23, 2013

Keynes did not address the problem of a failed monetary union, but he did address the consequences of an unsustainable foriegn-currency debt burden, in "The Economic Consequences of the Peace" (1919):
"If the European Civil War is to end with France and Italy abusing their momentary victorious power to destroy Germany and Austria-Hungary now prostrate, they invite their own destruction also, by being so deeply and inextricably intertwined with their victims."
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Lee Hubbard May 23, 2013

One of the most significant, perhaps, the most significant, observation Prof Rogoff makes is:

"Northern taxpayers will be forced to inject massive amounts of capital into banks, even if the authorities impose significant losses on banks’ large and wholesale creditors, as well they should. These hundreds of billions of euros are already lost, and the game of pretending otherwise cannot continue indefinitely."

When you foolishly lend money to people with a track record for irresponsibility, when the inevitable occurs, it's silly to pretend you can still collect the debt.
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Walter Gingery May 23, 2013

Presumably the Keynesians responsible for the "spectacularly muddle-headed arguments" include Paul Krugman (see his recent review-article in the New York Review of Books "How the Case for Austerity Has Crumbled") and Mark Blyth, author of "Austerity: the History of a Dangerous Idea."
What's so discouraging is that Rogoff's idea of a "realistic" strategy calls for massive write-downs of debt and inflation --- precisely what the Germans have consistently and adamantly rejected. What we need next from him is practical proposal of how to bring them around.
- Christopher T. Mahoney May 23, 2013
  
  The way to bring the Germans around is for a coup by the ECB Governing Board against the Bundesbank. If only France and Italy would agree to lead the revolt, there are enough votes to implement the policies which Lars Christiansen has advocated. But the problem is that Hollande is an economic ignoramus and Letta is a "good european". What will produce more revolutionary attitudes will be higher unemployment and ever greater spending cuts. It will happen.
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Frank Aten May 23, 2013

One has to assume wages must rise which is not an absolute and if that doesn't happen (which it has not for some time now) then the debt burden becomes even more excruciating. and the other is that debt growth MUST be lower than inflation to actually reduce debts burden by inflation.
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G. A. Pakela May 23, 2013

Exactly how do you implement a policy of "sustained moderate inflation?" As we have seen in all of the major central banks, pumping mone into the economy by purchasing government debt has not led to an increase in inflation, other than temporary commodity/gold inflation.

And if you do default in some manner, the going forward cost of government deficits will still force governments to confront the need to implement austerity budgets.

A better approach would be to restructure out-of-market government salaries, pensions and benefits and systematically lower the VATs, personal and corporate income taxes. Allow each Euro zone countries' private sectors led the way out of stagnation.
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Mark Pitts May 23, 2013

A well balanced article, except that it ignores the obligations of the peripheral states to make structural reforms to make it all work, viz. entitlement reform, labor flexibility, ceding sovereignty to the EU, and finding a way to get their citizens to pay taxes.
- William Wallace May 24, 2013
  
  Exactly the measures taken by Spain, for example. But tax evasion, well, that is a sport played across the EU, just in a more sophisticated form up north.
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Frank O'Callaghan May 23, 2013

Excellent article. There is an obvious case for a debt write off for the stressed economies of the 'PIGS'. There is also a strong case against austerity as it has failed spectacularly as an experiment.

The case for a redistribution of the burden of paying for the system is even stronger still. Over the past thirty years companies and wealthy individuals have seen their wealth increase hugely while their effective tax rate has plummeted. This must be redressed.

The State must also become more cost effective. Many bureaucracies now exist only to perpetuate themselves and their access to resources.
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James Daniel Paul May 23, 2013

First words of wisdom from you Prof. Kenneth. Its hard to hear such thoughts from Europe any more. European Economist would recommend immediate depreciation of Euro for the debt forgiven!!
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