The Eurocrisis concisely laid out

Jörg Bibow does a great job under the heading “On the alleged pains of the strong Euro. He discusses the current predicament:

ECB president Mario Draghi recently argued that the strengthening of the euro was partly responsible for the bank’s conspicuous miss of its two-percent price stability norm by an embarrassingly large margin, adding that the euro’s strength was “becoming increasingly relevant” in the ECB’s assessment of price stability.

In truth euro appreciation should attract neither fears nor blame. The euro area’s dangerously low rate of inflation owes primarily to domestic sources. Instead of debating the euro’s external value, it is high time for euro policymakers to concentrate on getting their own house in order. A sober assessment reveals that the supposedly too strong euro is at risk of turning into yet another scapegoat. Covering up euro policymakers’ unenviable record of staggering policy blunders is unwarranted.

Ultimately the single most relevant factor for price stability in an economy as large as the euro area is wage inflation corrected for productivity growth. The outstanding fact is that euro area wage inflation is approaching zero. Unit labor cost and business cost more generally are flat or falling. It is therefore no surprise at all that the ECB is failing on its price stability mandate. Rather, what is surprising is that euro policymakers keep on clobbering wages without remorse, apparently wishing to drive them ever lower. Seemingly justified by some holy calling to please the gods of austerity and competitiveness, euro policymakers keep on digging the hole they are trapped in ever deeper.


This is particularly relevant given that Capital’s flacks fear monger about the to-be-introduced minimum wage in Germany, and call on the French government to reduce the French minimum salary.

He also explains that flexible exchange rates undermine the efforts at improving competitiveness by wage repression:

Flat or falling business cost across the euro area tend to improve the external competitiveness of the currency union vis-à-vis the rest of the world as long as business cost are rising faster outside the area. But wage repression as a means of boosting international competitiveness is a futile endeavor given that the whole purpose of flexible exchange rates is to compensate for such inflation differentials. Moreover, in view of the euro area’s surging current account surplus of almost 3 percent of GDP, euro appreciation should be both expected and welcomed. Anything else would be in conflict with the G20 agenda for benign global rebalancing, which the euro area has committed itself to. From a global perspective euro appreciation has not been too much, but too little.

and that this repression damages domestic demand with all the nasty after-effects this carries:

While externally wage repression is normally an act of pure folly under flexible exchange rates, much damage is done internally. For wage repression undermines private spending, both consumption and investment. And notoriously depressing domestic demand, in turn, has budgetary consequences which, under the so-called Stability and Growth Pact, trigger austerity; further amplifying economic weakness. The continued pursuit of this strategy in an economy that is at the brink of deflation turns suicidal when that economy is also burdened with excessive debt legacies. As the IMF recently warned, debt deflation processes set in even before prices are actually falling. Trying to work off debt overhangs under deflationary conditions is self-defeating; unless currency weakness propels exports sufficiently to offset the self-inflicted wreckage. Seen in this light, euro policymakers’ nervousness about euro strength seems understandable – without however making their grossly negligent conduct any more excusable.

and finally corrects some misconceptions about why Germany’s austerity experiment allegedly worked:

What rescued Germany was the fact that exchange rates in Europe were no longer flexible. Repressing wages, Germany turned über-competitive relative to its euro partners while the ECB’s monetary stance, calibrated to fit the average, inflated bubbles in the periphery. Germany’s current account position swung from near balance into record surplus, the German authorities’ definition of restoring competitiveness. Prior to the crisis that surplus had its counterpart in Europe, mostly the euro area. So Germany did not drown by way of restoring competitiveness as others provided the spending that fired German exports. As it is others’ turn to restore their competitiveness today, Germany is in no mood to return the favor though; nor is the euro quite weak enough anymore to make the rest of the world volunteer sufficiently.

Great read!

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This entry was posted in austerity, deflation, economic policy, eurocrisis, macroeconomics. Bookmark the permalink.

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