Winner of the New Statesman SPERI Prize in Political Economy 2016

Saturday 30 March 2013

The View from Brussels

When incomplete ideas get embodied in institutions and the people in them

As I have said before, its too easy to be rude about austerity. It is harder to put yourself in the mindset of reasonable individuals who take a different view, and pinpoint exactly - in ways that they will understand - why their view is wrong. So this paper from Marco Buti and Nicolas Carnot (HT Philip Lane) is useful because it shows us that mindset. [1]

The argument in the paper is essentially this. “We recall that large adjustments are needed
in most economies to restore sustainable fiscal positions, not because of the arbitrary will of the markets or of EU institutions.” So the debate is about the precise speed of adjustment, and the Commission is trying to strike the “right balance”. In particular, it recognises the need for different speeds in different countries. I think this view characterises the position of many international organisations, including the OECD, and many in the IMF.

There is a big mistake being made here. It essentially involves the prioritisation of issues. Fiscal adjustment is seen as the overriding priority. Issues involving the state of the economy are secondary: they are one factor in judging the appropriate speed of adjustment. This is the wrong way around.

The major priority at the moment should be doing something about the demand led recession in the Eurozone (and other countries like the UK). The budgetary position of some countries is a secondary factor that may influence the country by country balance of any fiscal actions required to deal with this priority.

This point about priorities is not an expression of political preferences. It is about what basic macroeconomics tells us. The recession is a problem right now. If it is not dealt with now, the loss of resources is permanent and irretrievable, and in addition there is likely to be a more permanent scarring effect through hysteresis. Given the imbalances within the Eurozone, and the political tensions generated by creditor/debtor relationships, the costs of a recession could be greater still. Budget consolidation is a permanent, long term issue, and there is clearly a right and a wrong time to deal with it. Recessions are the wrong time, not just because it conflicts with other priorities, but because it may not even work, because of hysteresis effects, or political effects, or banking effects.

So why is this obvious to me, but not to those running policy? To repeat, my own view is in no sense about the relative importance, in some abstract sense, of deficit bias versus avoiding recessions. As regular readers will know, on deficit bias and long run goals for debt I am something of a hawk. I just do not see why we cannot avoid recessions and bring down government debt.

In some cases those running policy take a different view because of ulterior political motives, but not in all cases. I’m prepared to give those in the Commission, and other international organisations like the OECD and IMF, the benefit of the doubt on this. I believe an important influence on their mindset is that they are working in a framework in which overall demand stabilisation is not their problem. That is monetary policy, not fiscal policy. It is very revealing that in the Commission paper two phrases do not appear at all: they are  ‘zero lower bound’ (ZLB) and ‘liquidity trap’. Too few in government have recognised that when we hit the ZLB, the rules of the macroeconomic game fundamentally change, and the institutions of government - and those in them - have to adapt too.

This is hardly a novel point, but as Paul Krugman keeps stressing, it is absolutely central. It is why I get annoyed by those who insist that, if only we did monetary policy differently, all would be well - what I call ZLB denial. Few (unfortunately not all) deny the central role and importance of monetary policy in getting us out of recessions. When monetary policy fails - which it patently has, mainly [2] because of the ZLB - fiscal policy has to take its place. Countercyclical fiscal policy becomes as important as monetary policy normally is. Institutions, and habits of thinking, that are set up for normal times must adapt. The IMF recognised this in 2009, but I’m not sure the OECD or European Commission ever did.

We can see how this failure to change priorities influences the subsequent discourse by looking at two issues that are covered by the paper: OMT and Germany. The paper recognises the importance of OMT in altering market expectations. But they then say “As is clear as well however, the OMT announcement per se does not address the underlying sustainability concerns.” Of course OMT does not directly change the outlook for future primary balances. However it is a game changer in allowing periphery countries to change priorities. When you cannot sell your debt, this has to take priority over recession concerns (although fiscal consolidation can still be designed to try and avoid recession). What OMT allows countries to do is change priorities. If it had been implemented earlier, priorities could have been changed earlier. The paper does not see this, because for them fiscal consolidation remains the key priority.

The paper says “In Germany, the fiscal stance is now broadly neutral [3], hence consistent with
the call for a differentiated fiscal stance according to the budgetary space”. Which makes perfect sense (albeit using the rather tortured language of international organisation space), except at the ZLB. At the ZLB we need overall fiscal expansion in the Eurozone. The differentiation point still stands, so from an overall Eurozone perspective the Commission (and the OECD, and the IMF) should be arguing for substantial fiscal expansion in Germany. However, if your priority is fiscal consolidation, advocating doing nothing can seem quite radical and brave.

Right at the end there is a hint of recognition, but in a way that reinforces my point. To quote in full:

“A dedicated stabilisation fund could improve the conduct of fiscal policies throughout
the cycle by enforcing tighter policies in good times and providing additional leeway for cushioning downturns. Such a tool could strengthen the existing automatic
stabilisers while maintaining a credible rule-based framework. It would be particularly useful in the current predicament characterised by large cyclical differentials across the zone as well as a not insignificant average output gap. However, according to the Commission blueprint such a tool should only be considered in the longer term in the context of full fiscal and economic union.”

In other words countercyclical policy at the overall Eurozone level would be useful right now, but it needs to wait until we have the institutional change that can accommodate it. [4] Which tells me that those in the Commission think institutions are very important, but it does not tell me why existing institutions (and those within them) have to be behave in such a blinkered way.

[1] This can be seen as a companion piece to two others that looked at the power austerity has over politicians, and why some economists are suspicious of Keynesian fiscal stimulus. This post is about economists working in policy institutions.

[2] Unfortunately the ECB often gives the impression that as long as consumer price inflation is around about 2%, then nothing else (like other measures of inflation, or a recession) has anything to do with them. However I doubt very much that if the ECB had done what the Fed is now doing, a Eurozone recession would have been avoided.

[3] Whether this is true is another matter: see here for example. The latest OECD Economic Outlook has the German debt to GDP ratio falling steadily since 2011, despite a widening output gap.

[4] That institutional change will come too late for the current recession. I take a critical view of whether fiscal union for the Euro is either feasible or desirable here.


  1. The Buti / Carnot paper is very vague on the crucial distinctions between countries that issue their own currencies and EZ countries which don’t. The problems affecting each are very different. That makes me wonder whether the authors (and indeed the authors of similar papers) understand the distinctions.

    Concentrating on monetarily sovereign countries, and taking your question as why the mistake they make is “obvious to me, but not to those running policy?”, the answer is they just don’t understand macro. They’d don’t understand what Keynes meant when he said “Look after unemployment and the budget will look after itself”.

    To put that plain English: “stop worrying about consolidation”.

  2. "So why is this obvious to me, but not to those running policy?"
    "it does not tell me why existing institutions (and those within them) have to be behave in such a blinkered way"

    Blind ideology, with too much already invested politically and in terms of individual and institutional reputations to change course now.

    Also, perhaps we need to ask a more fundamental question -
    Quite simply, who stands to gain(or at least minimise their losses) from the austerity policies enacted?
    And/or - who stands to lose if austerity is not enacted?

    The answers to these questions may shed more light on their behaviour and motives, as well as illustrating that it IS in fact "obvious to those running policy".

  3. The separation of monetary and fiscal policy is a significant part of the problem. It allows those in charge of fiscal poolicy to reassure themselves that the central bank will take care of things. They therefore focus on what they perceive to be their job.
    This separation means that no one is feels responsible for the real outcomes in the economy.

  4. The IMF is the enforcement arm of "the Washington Consensus.' They have published many insightful papers that come to correct conclusions regarding macroeconomics and better policy, but then they continue to demand austerity, privatization, reduction of social insurance programs, and removal of corporate (especially banking) regulation. In most cases the results are disastrous for the target countries. This is why most South American countries are now following different policies and prospering as a result.

  5. I think most people, even many economists, unquestioningly believe that lower debt, smaller government, and lower taxes is almost always beneficial. They have not internalized that if we all save more then it means that we must borrow less, spend less, invest less, produce less, and work less.

    In their personal life more savings is desirable and more debt is undesirable, so they will not allow their intellect to conflict with what they perceive as common sense. Therefore they change their model assumptions until the outcome matches their prior, even if some assumptions, such as omitting the zero bound, aren't reasonable.

    Or said another way, as long as one believes that more debt is immoral, particularly by the government, then one will not accept any logic or model to the contrary, no matter how elegant. If your employment is safe in Brussels and the deflation resulting from your belief increases your purchasing power, then your morals on debt are highly unlikely to be changed by a personal epiphany. But I suspect that many economics professors in Greece and Cyprus have had recent revelations.

  6. I'm a policy wonk involved in these issues and what always strikes me is this: The EU legal framework never figures among the constraints on policy when economists discuss austerity vs stimulus in the eurozone.

    If ZLB is nonexistent in EU-speak, in economist-speak we never hear "Maastrich Treaty", "Stability and growth pact" and "Fiscal Compact", which set, on constitutional level, limits on deficits and debts. Currently, almost all Member States are in breach of these legal obligations underlying the euro. The treaties also stipulate that all Member States are solely responsible for their own debts, a.k.a. no bail-out clause.

    Could somebody please clarify why these facts don't figure in the economist discussions on austerity in the EZ? How could the Commission or the ECB advocate a policy line that is illegal, whether or not a ZLB situation exists or not?

    1. Well, the ECB has to come out and say that the legal framework has to be changed. Good heavens, if apartheid could be changed, so too could the bonkers laws of the eurozone. Let's be honest: regulation failed in the run-up to the crisis, as capital moved from the core to the periphery, moving Germany from current acct deficit to surplus with the likes of Spain, running up a massive deficit in Greece (and let's not just blame the Greeks, seriously). And now you want regulation to have teeth? That's like giving someone a ladder to get on a branch of a tree and then pulling away the ladder and saying, get down this instant!

    2. They don't believe it's bonkers. Because, you know, Weimar and inflation, not Brüning and deflation. Which *is* bonkers, to continent-destroying levels. But they don't know it.

  7. You do understand that these changes (that the ECB should come out with) imply a change to the EU treaties. That, in turn, means unanimity among 27 (soon 28) + referenda in various countries and that sort of thing. It will never happen, so we might as well try to focus on solutions that are in the boundaries of even remotely possible.

    This is not arrogance but plain realism. Euro bonds, automatic stabilizers at the level of the EZ or a change in the ECB treaty (to create a real LoLR) are 100 per cent out of bounds when trying to find solutions to the current problems. Unfortunately. Even an EU seat at the UN Security Council will happen before these kinds of changes and even that is totally unrealistic.

    1. If what you're saying is true, it simply means that Europe is disfunctional, it simply cannot solve a classical demand-deficit economic crisis. And I'm afraid you're right.

  8. I think Anglos have a tendency to take euro-rhetoric far too much at face value.

    EU institutions, especially Brussels-based euro-institutions (as opposed to the ECB), don't think. They can only *rationalize*. They are forced to work with a completely incoherent set of economic principles laid down in the Maastricht Treaty AND the completely incoherent fudges of veto-laden, late-night meetings of the European Council. They believe their role, in public at least, is merely to defend that nonsense with semi-plausible rationalizations. They are not economic policymakers but, as Jon Stewart might say, post-summit turd-polishers of the delicacies EU leaders leave them.

    The Commission simply defends the suboptimal outcomes that are the fruit of the balance of power between the Member States. Currently euro rules need to be changed to help the economies hit by the asymmetric shock and so the system can be a little bit less of a flagrant violation of Optimum Currency Area theory basics, this can only be done by unanimity, and the Core is benefiting from capital flight. This means Germany has all the cards and everyone else is utterly dependent. There is (almost) no incentive for Germany give way in the slightest.

    The Commission is also dependent, to "save the euro" and the European economy, on Germany. *That* is the rationality of Commission's "reasoning": They justify the preferences of Germany, they dress it up as actually inevitable and in "pan-European" interest, and hope this will eventually lead to German solidarity. If they go off-message, Germany could simply cease to cooperate on the ESM/EFSF, the bailouts, the banking union, whatever. No more, no less. At least, this is what the Commission apparently believes. There is no sense engaging with the Commission's or Olli Rehn's "reasoning" on any other level that.

    (I add it does make sense to engage the German government in argument, although to be frank its current policy, if it is strangling the European economy, is working out very well for Germany itself. It especially makes sense to argue with the ECB, as The Economist does, because it theoretically is accountable to the entire eurozone, and its policy since OMT has been extraordinarily conservative (inflation forecast of 1.4% this year, continuous staggering increase in unemployment).)

  9. That last comment *is* telling, and of more than you credit it for: it says that, in their view, *only* these new yet-unborn institutions have the ability to perform this magic we crave. So one asks oneself "Why, Oneself? Why do these sad people, these forlorn institutions, believe themselves powerless?" And the answer is that the EU institutions do not have, or believe they have, the statutory power to conduct expansionary fiscal or monetary policy. In other words, they are not the hope we hope for. And those political figures in a position to act (Merkel, yes, but tellingly also the Social Democrats, which tells us that in this she likely does reflect Germans' broad view) believe the electoral cost is too high if they do so without the cover of non-political, supranational agencies that do not yet exist.

    So we march along, doing just enough to keep the creature alive long enough for its savior to be born. And yet, with every day's pain and acrimony, the likelihood of this nativity lessens...

  10. CJWilly sums it all up quite accurately. In all sincerity, for the Anglo macro advice to be helpful (and it sure sounds nice from an economic point of view), it should be tailored a lot more to the political realities.

    The eurozone has had a certain legal architecture from the start: (1) very limited role of the central bank compared to the FED; primary financing via markets only 2) deficit and debt discipline on the member state level and a pious wish for the national structural policies to converge; this has not worked of course and 3) next to no fiscal transfers on the EZ level to buffer shocks and everyone responsible for their own debts.

    I believe this basic structure is the only viable option for the future, although with a bit more on the enforcement side and a bit more leeway to the ECB. We have to bear in mind that deviation from these principles (in from of bailouts) has a political cost in the North which is growing bigger all the time.

    Anything else would require quite a revolution to the workings of the EU which I do not consider realistic at all, no matter what the Commission suggests. This is the environment in which the austerity/stimulus debate takes place in the EZ.

    1. Problem with that is that the current framework does not work, not on the current terms, meaning single currency without fiscal integration, meaning no transfer mechanism. And it is not going to start working by some miraculous revocation of the laws of Economics, so the status quo is untenable. There is no way to enforce balance-of-payments equilibrium, and without currency fluctuation there is no obvious way for adjustments to occur naturally. And eventually, the collapse of the periphery will affect the German economy - they may have insulated their banks, but I find it hard to believe they can fully replace those markets. And then what?

    2. Ok, I agree with you. But why is 99 per cent of European mainstream press + 100 per cent of European leaders in complete disagreement with you? Is the whole continent out of their minds? They seem to be thinking that there is a way out of this under the current setup, and in Europe most people are aware of the institutional constraints we are facing.

      Again: If the dysfunctionality of the EZ is so clear-cut, then why is there literally NOBODY in the European mainstream acknowledging this in a major way? And why are the markets so calm about all this?

    3. To be more exact: there are of course some people who are advocating these kinds of changes but everyone knows they are totally unrealistic because they require unanimity + reference + all that.

      It's very clear that a substantive transfer union will not work in Europe before there´s a European people with common language, common political institutions & press and all that (and we are not holding our breaths for that to come about...).

    4. So, if I've got you right, you do agree the current framework is unworkable; and you think replacing it with an actual working framework is politically impossible (I tend to agree, by the way). That leaves us with the abandonment of the Euro as a possible, if still painful, alternative. Or am I missing a Fourth Way?

      To fill in a couple of missing logical steps, simply dropping individual loci of crisis piecemeal will only prolong the process, while keeping the EU in a state of continual crisis. Because the imbalance is structural, and will plague any two nations that are plugged into the structure.

    5. The point is exactly that given the current constraints (and incentive structures?), the break-up of the Euro seems inevitable. Still, maybe 0,5 per cent of the population seem to hold this view on the old continent and there seem to be next to no plans coming from the academia to prepare for this inevitability.

      It seems odd.

      Being a humble person, I assume there must be a fourth way (assuming also, like you do, that the current mode of "muddling through" + a bit of fine tuning is not it). I would be very curious to hear what it is because the markets seem to know that it exists, or then they don't care about the inevitable, upcoming break-up of the euro.

    6. Well, the Middling Muddling Way *could* work. Assuming that the periphery is willing to endure the pain of about a decade of grinding deflation, and Germany could somehow deal with the shrinking of that particular (huge) slice of their export market. For both of those to pan out... I've actually talked up, elsewhere, the European commitment to the EU, and the Euro, which Anglophone talking heads appear to dismiss far too glibly. But this seems to me to be a whole other, higher, realm of endurance and commitment, and electoral results in Italy, as well as whatever data I can get on the politics of other nations, seem to indicate that self-abnegating political will does not stretch that far.

      As for The Markets... the markets don't price the happiness of the population - they price risk. And I think that since Draghi finessed the (apparently hopeless) Greek situation, they are willing to believe various nations' debts are fairly likely to be repaid in full, because the various institutional actors have seemed determined to insure it. I suspect that those same actors are *much* less likely to engage in Toweringly Heroic Rescues once German banks' exposure has been unraveled, but then I don't actually have a very high opinion of said Markets' intelligence.

  11. if economic theory is beyond reasonable doubt, (1) how did we ever end up in this slump and (2) how can there still be such large differences in prosperity between countries?
    Maybe economists overestimate what influence their theories, and monetary and fiscal policy instruments, actually have on the economy of a country. And to make matters even more difficult, what works in country a, does not work in country b for a variety of reasons.
    I look at economists more as historians: they are good a explaining what happened in the past, with their models and theories, but have a bad track record for bringing sustainable future economic prosperity.

  12. Dear Professor Wren-Lewis,

    As a German tax-payer and voter, I am interested in your theory that, from an overall Eurozone perspective, the Commission (and the OECD, and the IMF) should be arguing for substantial fiscal expansion in Germany. I am willing to be persuaded, but that requires concrete figures. How much money should the German government spend, and for what? And what would the effect be?

    We in Germany do not believe that we have or can create enough money to save the periphery or solve a substantial part of its problems. That may be wrong, but to convince us you must be more specific.

    I await your response.

    Yours faithfully,

    Hanno Achenbach

    My e-mail address:

    1. Start increasing state salaries. Pour money into research. But most importantly, let France and Italy off the hook, let them deficit-spend.

    2. The German Government can do some spending, sure: infrastructure, basic research. But what you really want is to heat up the economy a couple of percentage points, and the simplest way to achieve that is for the Bundesbank to loosen its money policy. Except that every time I've seen that suggested, Germans have reacted like thirteen-year-old American girls in sex-ed class.

    3. Balázs and Pedro Dias:

      You are not being exactly specific. Actually, a lot of money is going into research. How that and raising state salaries is going to save Greece etc. is beyond me (and, I suspect, anybody with any judgement. Our roads are worse than the Spanish ones, but look what it brought the Spaniards. A huge amount of money is going into the infrastructure for wind energy. Contrary to what the FT says, there have been no cuts for health, social security and environment. Considering our unemployment rate, our output gap would not appear to be that high. As for money policy, the present rate of interest as fixed by the ECB is considered too low for Germany, even if it is too high for the periphery. The Bundesbank has only one vote in the ECB, and its president Jens Weidmann is often in a minority of one.

      Under the rules of the European Union, Germany cannot prevent France or Italy from deficit-spending as much as they want - but they will run into a wall of high interest-rates.

      My request for specifics was directed to Simon Wren-Lewis. I hope he will take the time to deliver them. I am looking forward to them.

      Hanno Achenbach

    4. You need about 2% more inflation in Germany than you have now. It's basic macro. Sorry if it's beyond you. I don't think Simon will answer you because you haven't done your homework. All I can do is to encourage you to read. You can start with these:

    5. Dear Mrs./Ms./Miss/Mr. Balázs (Mister, to judge by your tone),

      My question to Prof. Wren-Lewis was about the specifics of the expansionary fiscal policy he recommends for Germany.

      Paul Krugman's blogs you refer to are all about monetary pölicy, not fiscal policy, and at the time he wrote them (he has since come to realise its limits ), his recipe was inflation over and over again.

      Now, we German voters want none of that. because inflation takes from the poor, whose income will not rise as fast as prices, and gives to rich debtors who work with credit to get richer - on ne prete qu'aux riches.

      And just as an aside: Krugman's recipes to „End this depression now“ are very much less impressive than his rhetoric, or do you really believe that rehiring fired teachers, policemen and firemen will make such a difference?

      So I am still hoping for a reply from Simon Wren-Lewis with convincing recipes.

      Of course, if he also believes in inflation, he need not trouble – for me, the case would be closed, and I would let history be the judge. As somebody on his blog pointed out, macroeconomists seem to be better as historians supplying ex post explanations than as predictors or suppliers of recipes for crises – so much for basic macro. But hope springs eternal, and Simon seems such a nice person that I will wait and hope you are wrong. Otherwise, I would join Rik, 1 April 2013 12:02 below.

      Yours faithfully,

      Hanno Achenbach

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    7. 1) Krugman says that in a liquidity trap monetary policy has limits, so you can only reach full employment by fiscal expansion. 2) Inflation is bad for savers and good for debtors, now if you say that poor have savings, I really don't follow you.

      I know more or less what Germans believe in, but you might not know what the rest of Europe thinks, so let me explain. Germany basically made the rest of Europe pay for the costs of reunification by boosting inflation from the late 90s on. ECB interest rates, basically controled by the bundesbank, were kept down. It was perfect for Germany, but overheated the peripheries. In layman's terms, you sold your cheap Opels in Spain, on credit, financed by your own banks. Then the crisis struck, the bubbles burst, and we got into this asymmetric shock situation that could only be corrected by either deflation in the peripheries (which is tough, comes with high unemployment rate), or inflation in the center which you refuse. Inflation would be bad for the average rich German retiree with safe savings, but come on, going for 2% to 4% will not kill you, this is exactly what you forced on the peripheries in the early 2000s. In any case, it's hardly as bad as the current situation is for an average Spanish 25 year old who can't find a job. Saying that inflation is bad for the poor is hypocritical, to say the least, what's bad for the poor is unemployment.

      Now, that you don't understand this, that's one thing, I don't know you, but you didn't struck me as somebody smart enough to adapt his views to the facts. But that your leaders don't know this, it has only two explanations: 1) either they are also stupid, or 2) this thing is part of Germany's game plan of controling Europe. I would even say something good can come out of 2), like forcing a real union (although it's hard to imagine to found the new Europe on such an imperialistic setup), but I'm afraid, judging on what comes out regularly from the mouths of Olli Rehn or Weidmann, that it's plain stupidity. In any case, whichever it is, the result is that Europe will fall, taking down Germany with it (again, layman's terms: who will you sell your Opels?)

    8. What Balázs says. As for the dig at Krugman's prescriptions, you are absolutely correct that they are not silver bullets - nor has he ever claimed they were, or that there is such a thing. The rehiring of public workers would bring us back to a much less dire unemployment situation, not to full employment. Likewise, allowing slightly higher inflation in the core economies is not a solution, as such, just a palliative, a way to reduce the pain of peripheral adjustments to a level that might be politically tenable.

      As for your insistence on "specifics"... Why? All the Bundesbank needs to do is loosen credit. What's done with the funds does not greatly matter. Like I said, if the government can find useful infrastructure projects, awesome. But Germans spending a bit more on pure indulgence would work every bit as well in helping the periphery.

    9. Fresh post from Krugman, right on the point:

    10. @Balázs
      Two personal remarks:

      I should never believed that there was even one person on God's earth that did not associate inflation with higher prices and therefore a higher cost of living which immediately hurts poor people without savings harder than people who have some reserves (even if those will shrink with time).

      For me as a German , it is a never-ending source of wonder what odd ideas some people are willing to believe about us.

      @ Pedro Dias

      Dear Pedro,

      Thank you for the moderation of your tone, even if you prefer to be wrong with Balázs.

      I know of no evidence that the Bundesbank is throttling credit. If you can present it, I would reconsider; if you can't, it should be you to do so.

      If you think we can do without specifics, then we must agree to differ. To me, it is important to know how much robbing the German poor and giving to rich German debtors would help the periphery.

      Yours faithfully,

      Hanno Achenbach

    11. "I should never believed that there was even one person on God's earth that did not associate inflation with higher prices and therefore a higher cost of living which immediately hurts poor people without savings harder than people who have some reserves (even if those will shrink with time)."

      Inflation means growing prices and growing salaries, why on earth would that hurt the poor? Just sit down and think a bit. I suspect that you think that inflation means that prices grow faster than salaries, in this case you're simply wrong. You should maybe look at some data.

    12. Actually, if you don't like the notion of inflation (because you think it means price inflation without salary inflation), then forget it. The prescription is to increase _salaries_ in Germany with respect to salaries in the perifieries so Germans can by their stuff (e.g, go and have holidays in Spain or eat more olive oil, maybe put an opel factory there). There are two ways to do it, either you decrease nominal salaries in Spain, which is hard and painful (empirically), or you increase salaries in Germany. You can't say that increasing salaries would hurt the poor, can you?

    13. This comment has been removed by the author.

    14. Here is a site to start looking at data:

      Choose a random country, and plot consumer_price_index/wages vs inflation, and let me know if you find any correlation in general. Of course you'll find some examples where it's positive, and some where it's negative, but there is no economic law that says it has to be either.

      And I would actually like to apologize for my tone, you're not alone believing in the fallacy that inflation automatically hurts the poor. I thought that reading and even posting on macroeconomic blogs you knew otherwise, in which case your stance would have been hypocritical, which made my sarcasm-juices going.

  13. Two points:

    1. Hyperinflation has been a European problem in history: Mississippi Bubble, French Revolution, Russian Revolution, Weimar Germany, Pengo et al. (All cases started as political problems that became economic, but never mind).

    2. To create 'Europe' i.e. the political European Union from what is a Western culture that takes in Europe proper, all those English-language white dominion countries of the UK Empire, and sub-Saharan Africa, and the Philippines, (and probably Japan, South Korea, and Taiwan), it takes a lot of ignoring things.

  14. Again you are messing up what should be or what should have been done and what is possible.
    1. The EU and the EZ is a legal construct. Basically a treaty between several countries. Like when you buy, or better rent, a house that gives a whole range of rights and obligations to the parties to the contract.
    2. The EZ doesnot really know a central fiscal policy, not even to mention a way how to let it function alongside a monetary policy.
    3. The thing is set up around the no bail out principle. They have dropped that partly (basically without adjusting the treaty) but that looks to be all the room there was for adjustment. Temporary (at least so it is sold to the homecrowd) assistance, with marginal risk (at least so it is sold), and without much legal basis in the allmighty treaty, to other EU states.
    Changes need basically unanimity.
    4. It might be the best thing for the EZ as a whole to stimulate more. But that not necesary is the best thing for the countries that have to guarantee that (Northern ones).
    5. In that respect Germany has its own fiscal policy. Which is eg getting to an own zero deficit and not let the debt rise over 90%. In that light and without having itself need for stimulus it won't happen.
    6. For the South some stimulus probably would work.
    However in the present context nobody is going to lend them the money for it. Not the market and not the fellow EZ countries. So it simply is not a real option.
    I am doubtful about stimulus up North for the sake of the South. The countries are simply uncompetitive with all sorts of large deficits. But anyway that won't happen as well.
    7. Re the role of the ECB. Its mandate is strictly limited. And basically it already stepped over it. Anyway Germany which de facto carries the ECB will most likely not allow further steps. As that would via the backdoor dumpt the risk with them (as the PIIGS are only pro forma guarantors of the ECB, the backing towards the market is coming from the North). Merkel allows de facto rescues via all sort of ECB measures as it is out of the eye of the voter.
    Mandate is pricestability not economic growth or employment. The treaty would have to be adjusted and that won't happen. As some countries have clearly other interests (and likley will not get away with that at home politically).
    So also from that angle no room. Good or bad irrelevant it won't happen.
    8. OMT is conditional a thing a lot of people forget. There need to be a bail out package in place. Which will demand austerity (hard to see it otherwise at least). So no help from there.
    9. Only way it could be different is that in case of a break up the Northern Governments could frighten their voters so much that a friendly bail out becomes possible. Simply doesnot look very likely to happen. And anyway most damage will already have been done.
    10. Last point. It is clear that the reforms that have to take place are simply not happening when the financial pressure is off. Hardly a great incentive to give extra funds and are like with Greece confronted with a government that use it to defer reforms as long as possible.
    The situation that you are assuming to be there: 'speed of reforms are not influenced by financial pressure', is simply not there in practice. As they say: in theory, theory and practice are the same in practice it is different. Well at least in this case.

    So in a nutshell a completely useless discussion. Time was better spend in looking which structural measures might do the job and take the least harmful ones.

    NB. Stimulus is basically in this respect mainly giving in to political pressure from either the street/voter or the government. It has hardly anything to do a 'real' stimulus. The money is basically used to defer reforms. A proper stimulus would hopefully invest it in sectors with a bit more potential.

  15. One way to looks the euro-zone's position is to say that they are aware that divergence in debt between the periphery and the core from 1999-2008 was accompanied by divergences in wage adjusted unit labour costs - therefore competitiveness - and thence by diverging trade balances, with the core going deeper into trade surplus and France and the periphery deeper into trade deficit.

    To undo this, the periphery needed to get wages down, but wages are sticky as long as labour has bargaining power. To get labour to give up its bargaining power, it is necessary to increase unemployment. So rising unemployment isn't some accidental bad side-effect of austerity; it's the whole point.

    Someone, I think Hobsbawm, wrote that the UK leaving Gold was inevitable in the long run, because the decade's long periods of deflation, falling wages and unemployment that were used in the C19th to correct outflows of Gold became impossible to impose in the C20th because of the rising power of labour. It was a choice between Gold and employment, and while employers used to choose Gold, by the C20th unions had power and always chose employment.

    The euro-zone is in a similar fix. They want to keep the euro, but if they let the periphery rip, the gulf in wages will get wider, so will trade imbalances, and in the end the thing will come apart no matter what anyone wants.

    So the euro-zone does its thing by imposing what seem to us to be ridiculous amounts of austerity and internal deflation to try to close the various gaps between core and periphery? I don't know if it will work, but this was on the cards as soon as Greece decided to share a currency with Germany.

  16. Dear Simon,
    Thanks for the post. Forgive me if I have not followed your blog sufficiently closely, but I am confused on all this.

    To me, the argument against austerity run something like this.

    Of course its right that a forensic rise in government spending on some well-designed project like an externality-producing innovation scheme or publically-benefical piece of infrastructure will be good for the economy. But the problem is that at least some states are just so dysfunctional that any rise in spending will just go into the pockets of the elite. With the best will in the world, Greece seems like an example of this. So is the argument then at the lower bound simply any rise in spending, no matter how mis-spent, will go into an output rise? I just don't see how the a corrupt elite, who, for example, end up using the money to buy more property in London, helps domestic output?

    The other argument is closely related and it is that any stimulus, in some economies, will simply reward currently well-connected insiders. They might be, for example, currently protected workers via labour market legislation, or those able to simply gain e.g. better pensions or fewer hours (think of UK GPs for example who gained large pay rises and a reduction in hours). So again, not only does the money go into a small group's pockets, but it puts off the time for reform. In other words, reform is endogenous to spending.

    If you accept that some governments can avoid wasting the money and some cannot, then I think I see the case for some fiscal expansion in the former to attempt to drag up the latter. Is that the case that is being argued? But if reform is negatively correlated with spending how can reform of the latter be brought about?

  17. Another strange thing about the Buti and Carnot paper is that it doesn't refer to unemployment at all. Perhaps they don't think it's a problem they can do anything about.


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