Winner of the New Statesman SPERI Prize in Political Economy 2016

Wednesday, 11 January 2012

Correcting Eurozone Imbalances

I have been thinking about the extent to which real exchange rate misalignment within the Eurozone (essentially most countries have lost competitiveness with Germany) requires austerity outside Germany. I have argued that a much tighter fiscal policy (austerity) outside Germany would have been a good idea before 2007 to prevent these imbalances occurring in the first place. However that does not necessarily imply it is required now, for two reasons. First, misalignment is eventually self-correcting, as less competitive countries sell less goods etc. Second, perceived debt risk which is driving up long term interest rates provides an additional deflationary force in many of these uncompetitive countries.
                This question is essentially a forecasting issue, so I looked at the OECD Economic Outlook forecasts. The table below comes from there. It contains a bit of a puzzle. If you look at unemployment rates, you see just the kind of pattern you would expect if correction was underway (except perhaps for Italy). German unemployment is way below the Eurozone average,  and the German average level in the decade before the recession, whereas the opposite is true for Ireland and Spain. The OECD’s calculation of the output gap tells the same relative story: everyone is below the non-inflationary level of output, but Germany by not that much, and Ireland and Spain by much more.
                If we look at inflation, however, we get a much more depressing story. Take the GDP deflator (the price of domestically produced output) for example. Inflation in Ireland is less than 1% below Germany, and that is the most favourable comparison. The signs of real exchange rate correction are weak.  
                There are two possibilities here. One possibility is that these inflation forecasts are way too conservative. In particular, low unemployment in Germany will lead to more rapid inflation than is forecast here. The alternative story is that the inflation forecasts are broadly correct, and they illustrate both the difficulty in getting inflation down outside Germany when it is so close to zero, and the difficulty in getting inflation up in Germany when its economy remains depressed. In particular, if the output gap number is right, then it is hard to see German inflation rising much above 2%. 


Unemployment (%)
Output Gap
Ave Forecast Inflation % 2011-13

1998-2007
2011
2012
2013
2011-13
Compensation
GDP
Consumer prices
Eurozone
8.6
10.1
10.4
10.1
-3.2%
2.1
1.3
1.8
Germany
8.8
5.7
5.7
5.4
-1.2%
2.4
1.1
1.8
Ireland
4.8
14.2
14.0
13.4
-7.1%
1.7
0.4
0.9
Spain
10.6
22.5
23.0
22.4
-5.7%
1.9
0.8
1.8
Italy
8.7
8.1
8.4
8.7
-2.3%
2.1
1.4
1.8
France
8.8
9.4
9.9
9.8
-4.2%
2.6
1.3
1.5

4 comments:

  1. Mundell is correct, free trade = pegged currency.

    The solution for the PIIGS lies in becoming South Carolina.

    Reduce their regulations.
    Reduce red tape.
    Reduce tax burdens on corporations.
    Cut pensions to 50% of salary (as suggested by Mundell).

    Competing with Germany is EASY, you just have to earn less, and have less enviro protections, and less bureaucracy THAN GERMANY.

    The American south has readily made up for their lack of productivity compared to the north states.

    Give themselves over tot he private sector, announce Greece is TRULY OPEN FOR BUSINESS.

    All be well.

    ReplyDelete
  2. "If we look at inflation,...There are two possibilities here"

    Maybe there is a third possibility, namely that the inflation in the periphery is in large measure imported from the center with Germany playing a crucial roll.

    Maybe the PIIGS are, after all, just sitting ducks unable to profits from even an eventual higher rate of inflation in Germany. In the absence of import tariffs or meaningful transport costs the price of the non trandables cannot be determined by domestic conditions, so the price ends up by being also determined endogenously.

    ReplyDelete
  3. I forgot to mention that VAT could be used as a putative tariff.

    ReplyDelete
  4. In my penultimate commented the price is to be determined exogenously and not endogenously as stated.

    ReplyDelete

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