The ECB should further ease monetary policy. Inflation at 0.8% across the eurozone is below the target of “close to 2%.” Unemployment in most countries is still high and their economies weak. Under current conditions it is hard for the periphery countries to bring their costs the rest of the way back down to internationally competitive levels as they need to do. If inflation is below 1% euro-wide, then the periphery countries have to suffer painful deflation.read more
Throughout history, big economic and political shocks have often occurred in August, when leaders had gone on vacation in the belief that world affairs were quiet. Examples of geopolitical jolts that came in August include the outbreak of World War I, the Nazi-Soviet pact of 1939 and the Berlin Wall in 1961. Subsequent examples of economic and other surprises in August have included the Nixon shock of 1971 (when the American president enacted wage-price controls, took the dollar off gold, and imposed trade controls), 1982 eruption in Mexico of the international debt crisis, Iraq’s invasion of Kuwait in 1990, the 1991 Soviet coup, 1992 crisis in the European Exchange Rate Mechanism, Hurricane Katrina in 2005, and US subprime mortgage crisis of 2007. Many of these shocks constituted events that had previously not even appeared on most radar screens. They were considered unthinkable.read more
Any solution to the euro crisis must meet two objectives. One is short run and the other is long run. Unfortunately they tend to conflict.
The first necessary objective is to put Greece, Portugal, and other troubled countries back on a sustainable debt path, defined as a long-term trajectory where the ratio of debt to GDP is declining rather than rising. Austerity won’t restore debt sustainability. It has raised debt/GDP ratios, not lowered them. A write-down would do it. New bigger bail-outs might too, or might not. But either write-downs or bailouts would then create moral hazard and thus make even it even harder to satisfy the second necessary objective.read more
Why do so many countries so often wander far off the path of fiscal responsibility? Concern about budget deficits has become a burning political issue in the United States, has helped persuade the United Kingdom to enact stringent cuts despite a weak economy, and is the proximate cause of the Greek sovereign-debt crisis, which has grown to engulf the entire eurozone. Indeed, among industrialized countries, hardly a one is immune from fiscal woes.
Clearly, part of the blame lies with voters who don’t want to hear that budget discipline means cutting programs that matter to them, and with politicians who tell voters only what they want to hear. But another factor has attracted insufficient notice: systematically over-optimistic official forecasts.read more
The Hour of the Technocrats has arrived. In desperation from debt crises that their gridlocked political systems have created, Italy and Greece both in November chose new Prime Ministers who are technocratic economists rather than politicians: Mario Monti and Lucas Papademos, respectively. One can even describe them as professors: Monti has been president of the prestigious Bocconi University when not a European Commissioner in Brussels, and Papademos has been my colleague at Harvard Kennedy School in the year since he finished his term as Deputy Governor of the European Central Bank (even teaching a class I usually teach).read more
US News and World Report asks, “Who is handling its debt crisis better: Europe or the United States?” My answer follows.
In both Europe and the United States, the current public debt woes are attributable to mistakes made by political leaders going back more than a decade. In both cases the tremendous magnitude of the long-term debt problems has only become evident for all to see recently, by which time it was too late for the straightforward policy solutions that were viable options previously.read more
By now just about everybody agrees that the European bailout of Greece has failed: The debt will have to be restructured. As has been evident for well over a year, it is not possible to think of a plausible combination of Greek budget balance, sovereign risk premium, and economic growth rates that imply anything other than an explosive path for the future ratio of debt to GDP.
There is plenty of blame to go around. But three big mistakes can be attributed to the European leadership. This includes the European Central Bank – surprisingly, in that the ECB has otherwise been the most competent and successful of Europe-wide institutions.read more
The members of the eurozone and the EU have apparently decided that they must heroically rescue Greece, that this is better than having the IMF do it. Senior figures in Brussels feel that the latter alternative is unthinkable. I am a little confused about why. Martin Wolf writes in the Financial Times this week that to bring in the Fund “would demonstrate that this is not a true union at all.” But the EU and EMU and not true fiscal unions. If the citizens of Germany and other more successful countries were willing to bail out the Greeks, then fine; the EMU would be ready to be a fiscal union. But they are not; so it is not. Given that reality, what is wrong with something that “demonstrates” it?