BARCELONA – The countries on the so-called “periphery” of the eurozone (Greece, Spain, Portugal, Ireland, and perhaps some others) need to carry out complementary adjustments that are often discussed separately but actually need to be tackled jointly. Indeed, to restore these economies to health, three distinct types of adjustment are needed: between the eurozone and the world, between the eurozone’s periphery and core, and between debt and income in the heavily indebted peripheral countries, particularly Greece.
The solutions in each case are as clear as their implementation is complex. First, in order to relieve pressure on the peripheral countries (at least in part), the eurozone must export some of the needed adjustments through a significant depreciation of the euro, which is already taking place. This is the adjustment between the eurozone and the world.
Second, to regain competitiveness, the adjustment between the eurozone’s periphery and its core requires closing the inflation differential that built up during the pre-2008 capital-flow bonanza. In countries like Greece and Spain, this amounted to roughly 14% of GDP following the launch of the euro.
Last but not least, the adjustment between debt and income may be helped, over time, by higher overall eurozone inflation. But it is becoming increasingly clear that bringing the debt burden in line with the distressed countries’ payment capacities requires, at least in some of them (particularly Greece again), an ordered process of debt restructuring.
So far, European policymakers have chosen to do precisely the opposite on each front. They have tried to talk up the value of the euro, though currency markets have dismissed this as mere political rhetoric, and are rapidly bringing the euro closer to equilibrium.