Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 10 November 2014

Getting the Germany argument right

As the Eurozone experiences a prolonged demand-deficient recession, and given Germany’s pivotal role in making that happen, it is important to get the argument against current German policy right. It seems to me there are two wrong directions to take here. The first is to argue that Germany needs to undertake fiscal expansion because it has more ‘fiscal space’, to use a phrase the IMF use a lot which I dislike. The second is to argue that Germany needs to expand to help its Eurozone neighbours.

The problem with the first argument is that it legitimises the fiscal rules which are ultimately the source of the Eurozone’s current difficulties. If we look at the Eurozone as a whole, its fiscal policy is tighter than in the UK and US. As Fraser Nelson notes, the UK has a larger structural deficit than any other EU country. With interest rates at their zero lower bound, this shows that UK policy - while far from appropriate - is not quite as inappropriate as in the rest of the EU. The right policy when you are in a liquidity trap is to have a fiscal stimulus large enough to get you out of that trap. Within the Eurozone, the only countries that might be exempted from this fiscal expansion are those on the periphery. Otherwise we need a fiscal expansion in France, Italy, Spain, the Netherlands etc, as well as Germany.

The problem with the second argument is twofold. First, it tunes in with the popular sentiment in Germany that the country is yet again being asked to ‘bail out’ its Eurozone neighbours. Second, it implicitly suggests that the current German macroeconomic position is appropriate, but that Germany must move away from this position for the sake of the Eurozone as a whole. The obvious German response is to list all the reasons why their economy is currently on track (see, for example, Otmar Issing in the FT recently), and suggest therefore that other countries should look at their own policies for salvation. This is how we end up needlessly discussing structural reforms in France, Italy and so on.

The uncomfortable truth for Germany, which both the previous arguments can miss, is that the appropriate macroeconomic position for Germany at the moment is a boom, with inflation running well above 2%. The current competitiveness misalignment is a result of low nominal wage growth in Germany over the 2000 to 2007 period, which was in effect (and perhaps unintentionally) a beggar my neighbour policy with respect to the rest of the Eurozone. Germany’s current position is unsustainable, as its huge current account surplus and relative cyclical position shows. It will be corrected by undoing what happened from 2000 to 2007. Over the next five or ten years, German inflation will exceed the Eurozone average until its long term relative competitive position is restored.[1]

The only choice is how this happens. From the perspective of the Eurozone as a whole, the efficient solution would be above 2% inflation in Germany, and below 2% inflation elsewhere. That is what would happen if the ECB was able to do its job, and Germany would get no choice in the matter. Normally above 2% inflation in Germany would require a boom (a positive output gap), but if it can be achieved without that fine, although I would note that current German inflation is only 0.8%. Arguments that point to currently low unemployment and a zero output gap in Germany are therefore irrelevant while German inflation is so low. The inefficient alternative solution is for 2% or less inflation in Germany, and actual or near deflation outside. Why is this solution inefficient? Because to get inflation that low outside Germany requires the Eurozone recession we are now experiencing.

This is where structural reforms enter. Many German commentators say ‘why cannot other countries do what we did from 2000 to 2007’? But low nominal wage growth in Germany from 2000 to 2007 was accompanied by a recession in Germany! Furthermore, that recession was not so bad as the current Eurozone position, because the ECB was able to do its job and cut interest rates, so inflation outside Germany was above 2%. So from 2000 to 2007 many countries had to experience above target inflation because of low nominal wage growth in Germany, [2] yet many in Germany want to avoid above target inflation while imbalances are corrected.

If your starting point is what happened in Germany from 2000 to 2007, then current German arguments can look incredibly self-centred. They seem to say: we suffered a recession from 2000 to 2007 which led to a beggar my neighbour outcome, now you have to suffer a worse recession to put right the problem we created. But as I have argued before, and which comments on my recent posts and readings confirm, I think the German position is more about ignorance than greed. I also suspect there is a great deal of macroeconomic ignorance outside Germany as well, which is why Germany has been able to impose a recession on the rest of the Eurozone. Take for example this paper by Michael Miebach, who speaks from the left of centre in Germany.

Miebach presents a wide range of macroeconomic fallacies or irrelevant arguments. Germany’s fiscal position is not good (irrelevant in a liquidity trap), its macroeconomic position is not too bad (when it should have above 2% inflation, which probably requires a boom), fiscal expansion in Germany would have only a small impact on the periphery (but what we should be talking about is fiscal expansion in all the main Eurozone economies, which this paper confirms would help the periphery as well as France, Italy etc, and expansion in Germany would benefit countries like the Netherlands), and the old canard about how focusing on demand distracts attention from dealing with structural weaknesses in the Eurozone. But most revealingly we have this:

“Also, how can Germany demand fiscal discipline from other countries if it strips away its own principles at the first opportunity?”

You can only write this if you just do not get the idea of a liquidity trap, when demanding fiscal discipline from other countries is the source of the problem! What makes Germany’s current position unforgivable is not that it is refusing to undertake a significant fiscal stimulus of its own. It is that it is doing what it can to make other countries persist with austerity, and at the same time making it difficult for the ECB to do what it can to offset this. The ultimate problem is that what Germany sees at virtue is pre-Keynesian macroeconomic nonsense, nonsense that is doing other countries a great deal of harm. The best one can say in mitigation is that, in a sort of collective stockholm syndrome, too many in these other countries also mistake nonsense for virtue.

[1] Economists would naturally talk about real exchange rates here, rather than use the term competitiveness, because the latter invites a confusion between firms and nations. The first point to note is that if Germany had its own exchange rate, the impact of low nominal wage growth on competitiveness would be undone through a nominal appreciation. (There are no benefits of a nominal appreciation if everything real is unchanged.) The second point is that a competitive market is beneficial when it encourages improvements in productivity. For a single nation to gain a competitive advantage in a currency union by cutting nominal wages just causes problems.  

[2] Looking at consumer prices tends to mask national differences, because of imported goods. Over the 2000-2007 period average Euro consumer price inflation was 2.2%, and in Germany it was 1.7%. However if we look at output prices (the GDP deflator) we get a clearer picture: average Eurozone inflation was just above 2%, but inflation in Germany was 0.8%. 

125 comments:

  1. the problem with your reasoning is that at one moment you look at the eurozone as a whole and the next moment you look at individual countries. This makes things confusing.

    Either you treat the eurozone as a currency zone just as the Unites States is a currency zone, and than countries or states become irrelevant, the only relevance is to improve the working of it by fiscal transfers and more labor mobility or other currency zone wide policies (assuming this is all politically feasible).
    Or you continue to treat the eurozone as separate countries and than you can argue unsustainable trade flows and competitiveness, but the most likely solution is breakup and go back to own currencies.
    Your ideas about adjusting and balance trade flows and competitiveness between countries are not going to work, you get endless finger pointing at each other, as you acknowledge yourself in the examples in your post, and as all the discussions on this blog illustrate.

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    1. It is perfectly acceptable to think about both the Eurozone as a whole and also to think about its separate parts. As I have tried to point out, the current problems are less to do with national interest and more to do with simple macroeconomic misunderstanding.

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    2. even when disregarding the differences of opinion on economics (which will always be the case), it will still lead to fingerpointing: state A says to B: you should do this,. State B replies: only if you do that etc. With as outcome: mind your own business!

      Let's try to apply your ideas to the USA, after all, why limit it to the eurozone?
      Georgia has almost triple the unemployment of North Dakota.
      http://www.bls.gov/web/laus/laumstrk.htm
      What should North Dakota do? fiscal stimulus? Increase wages? This sounds absurd, this is not how currency unions work.

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    3. The answer, presumably, is not what North Dakota should do, but what the US federal government is doing, and the ECB should be authorising.

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    4. The US has political union, common language, national identity, fiscal transfers and people move and relocate easily.

      When Europe will have those features, let's talk about monetary union again.

      Maybe 500 years from now ? (500, not 50 or 5).

      Meanwhile, let's get rid of the present, crazy, unsunstainable eurosystem.

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    5. The thing is that American States are not biasing the Fed's policy and the US federal government has much more power than the EU has over its members.

      As for his analysis of the EU, he's right. You need German prices to catch up with the rest of the EU. If they all had their own currencies, it would not be a problem, but they don't, so the shift has to be gained from a movement in their respective price level. Higher inflation in Germany, deflation elsewhere ot both is what they need. If this was the US, the Fed would hit pedal to the metal and all levels of government could increase spending -- and some of their states would experience high inflation, the idea being that the inflation is bellow target and has been for YEARS. But it's not the US or Canada. As this is Germany, the central bank can be influenced with very bad results and each has to be convinced on their own to pursue fiscal stimulus. And Germany keeps pushing for idiotic policies...

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    6. to the people pointing out that USA has political and fiscal union, I am aware of that when I posted 08:18
      But that adds to my point: the solution is not trying to balance trade and competitiveness (impossible) but to move to (more) political and fiscal union.
      Full fiscal union is unlikely, but maybe that is not needed.
      There are states in the USA that are much poorer than the rich states, with much higher unemployment, even with political and fiscal union.
      Another solution is increased labor mobility: there are millions that went from Eastern Europe (who spoke different language!) to Western Europe for jobs, more unemployed people in Southern countries can migrate to Northern countries too if they want.
      there is no perfect solution, but dissolving the eurozone going back to 15+ currencies is not perfect either (even when disregarding the economic shock it will first cause).

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    7. "More unemployed people in Southern countries can migrate to Northern countries too if they want": so desertification of 50% of the continent is your solution ?

      There are states in the US which are poorer than the richest, sure. But states 20%+ below the US average (Arkansas, Tennessee and West Virginia) account for just 3% of the total population.

      In the Eurozone is 25% (Portugal, Greece, Southern Italy, most of Spain and several smaller countries).

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  2. ''That is what would happen if the ECB was able to do its job, and Germany would get no choice in the matter''

    what should the ECB do exactly?

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    1. Get Eurozone inflation to 2%! The problem is that is very difficult when (a) interest rates are zero and (b) fiscal policy is contractionary.

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    2. Is there a danger this could lead to things like distortionary house price and other such bubbles that exacerbate inequalities without really increasing the price of goods or employment?

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    3. ''Get Eurozone inflation to 2%! The problem is that is very difficult when (a) interest rates are zero and (b) fiscal policy is contractionary.''

      That's why I am asking.
      What should the ECB do and how much stimulus should the eurozone countries do to get to 2% inflation.

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    4. Note Anon 08.46 and Anon 09.21 are two different people asking two different questions. But would be good to have an answer to both.

      Anon 9.21.

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    5. The ECB just CANNOT bring inflation to 2%. You need expansionary fiscal policy in the Eurozone as a whole. ECB just has to guarantee everybody's public debt. Or better, providing helicopter money.

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    6. No wonder Professor Wren-Lewis remains silent on this as indeed it seems he does not know what he actually wants.

      Here he writes "Get Eurozone inflation to 2%", which at zero interest rates means QE, however in another post he seems to be strongly against QE+tax cuts (which he for some reason equates with helicopter money), and of course he is against tight fiscal policies. So, basically he's against everything, which no doubt is otherwise a quite comfortable position.

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    7. Anon 11/11/14 No idea what you are talking about. The best thing that the Eurozone could do to get 2% inflation is fiscal expansion. If not that, helicopter money. (Why do you think I'm against that?) If not that, QE is better than nothing, but I doubt it will be enough.

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    8. Both helicopter money and QE are unlawful under EU law. The original question stands: what do you think the ECB should do?

      Your answer was that it should achieve the nice end we all desire. That isn't the question. The question is what it should do to get there.

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    9. Mark Carney rejects 'helicopter money' plan:
      ''I can’t see any circumstances where I would advocate it, even in the eurozone..... Never mind the Maastricht treaty [ruling out debt monetisation] ...just as [appropriate] policy.''
      http://www.theguardian.com/business/live/2014/nov/12/banks-fined-foreign-exchange-rigging-probe-fca-boe-live

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    10. @SpinningHugo
      QE (buying every asset class in 2° markets from private holders) is allowed by art.18 of the ESCB statute, provided it is done for objectives that are in the ECB's mandate, like price stability, which is the ECB's core duty.
      Art.123 TFEU prohibits the ECB monetary financing, i.e. buying gov bonds in the 1° market from the original issuer.

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    11. @Zoe Keller:

      Yes, but one has to look at volume of QE and how long bonds have been held. If volume is sizeable and bondholders buy GBs only to pass it to the ECB after a brief period, then the whole thing is just a scam to circumvent Art.123 TFEU.

      I predict that such a set-up would be judged ultra vires by the Bundesverfassungsgericht. The EU/EMU is a collection of nation-states not a federal state. When push comes to shove, national constitutions supersede European law. Certain responsibilities have been outsourced to the ECB. If the ECB goes counter to that, the outsourcing can and will be revoked.

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    12. "The outsourcing can and will be revoked": which would end the eurozone.

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    13. I was aware of what I was writing at the time, yes. Germany's membership of the Eurozone is not unconditional.

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  3. The deficit rules have to go, I agree with that. That makes spending programs possible. Engineering a boom-bust cycle in Germany sounds weird to me. Push one country into disequilibrium to let other countries move towards it... This is probably an indication of the defects of the monetary union.
    I don't think that Germany is intent on depressing nominal wage growth of the other countries. That's not the kind of reform that Germany undertook in 2003. It was a flexibilisation of the labor market and a reform of the welfare system. This is what Germany wants other countries to do.

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    1. I would call what you a defect and find weird the realities of a monetary union when you have asymmetric shocks. It is a problems for sure, and this was the big negative in debates before the Euro was formed. Unfortunately those embarking on this experiment tried to deal with this problem by pretending it would never happen.

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  4. Not 100% on topic this, but here goes.

    Simon says, “The right policy when you are in a liquidity trap is to have a fiscal stimulus large enough to get you out of that trap.” Put another way, “When interest rates are zero and unemployment is above NAIRU, have the state borrow and spend so much (or print and spend so much) that not only is unemployment reduced to NAIRU, but borrow or print even more and to the extent that the private sector has to be induced (via attractive interest rates) to lend back its newly acquired excess wealth (state liabilities) to the state, and with a view to preventing the private sector from spending those newly acquired liquid assets.” (And good luck to anyone trying to translate that sentence into German, complete with verbs at the end of subordinate clauses.)

    Anyway, why not just reduce unemployment to NAIRU, i.e. bring the economy up to capacity and leave interest rates at zero? That is, what’s the point of the excess borrowing / printing with consequent interest rate hike? Amongst other things, excess base money or state debt is held by the rich, while it’s the average taxpayer, i.e. the less well-off who fund the interest. I.e. the zero bound tends to reduce inequalities.

    Of course if interest rate adjustments were a FAR MORE PRECISE method of fine tuning than fiscal adjustments, the latter policy would be justified. But I have doubts about that.

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  5. Couple of points:
    1. "...given Germany’s pivotal role in making that happen". Someone very naive would rather conclude that these countries priced themselves out of their export markets through unwarranted, irresponsible real wage growth. Other countries' opposite policies may have worsened the problem but it seems so eminently home-made.

    How come you never reflect on this?

    2.Following from the above, it's only logical if the solution is that these countries reverse such unwarranted wage growth in order to become competitive again. I find it absurd to put the blame on nations which did not choose to consume way above what they produce.

    3. It would be interesting to see U.S. / Chinese / Korean data on real wage growth or unit labour cost in the infamous 2000-2007 years. Are those closer to Germany's or Club Med's numbers?

    4. "...the appropriate macroeconomic position for Germany at the moment is a boom, with inflation running well above 2%." puzzled by this... compared to what? In what context? On what purpose? Are there other moments where stagnation is appropriate? What is the meaning of this sentence?

    5. "Germany’s current position is unsustainable..." this has been said for a number of years, along with "the EZ is certain to break up within months unless X / Y / Z is done", and other mantras and yet nothing of the sort happened. This seems to be just another unreflected statement which is derived from theoretical models with no regard to history, politics, institutions, policy makers and so on.

    6. "German inflation will exceed the Eurozone average until its long term relative competitive position is restored." As above. Will not happen. You yourself state that the ECB is firmly in German hands. Once more a bold statement without any kind of argumentation. Pity.

    7. Absolutely amazing that you wipe issues of structural reform off the table with a wave of your hand. Talk to Italians and French people, many will be full of grief about their disfunctional structures. It's not all fiscal and monetary policy.

    8. Thing is, and I'm going to be very honest here, given that this "it's all Germany's fault" sounds so crazy, and it so poorly and arbitrarily argumented, one can hardly escape the feeling that this is zero percent economics and 100% politics - of the good old scapegoating type.

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    1. 1. Try looking at some data. I discuss here how real wage growth ran below productivity growth in Germany: http://mainlymacro.blogspot.co.uk/2014/09/can-country-be-too-competitive.html

      5. not an 'unreflected statement', but just using basic macroeconomics. Talking of history, show me a country that has permanently run 7% current account surpluses.

      6. Luckily the ECB is not firmly in German hands.

      7. This issue is all about monetary and fiscal policy, and not about structural reforms.

      8. Why crazy? It has nothing to do with politics. Try finding some macroeconomic reasons why I am wrong.

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    2. 5. not an 'unreflected statement', but just using basic macroeconomics. Talking of history, show me a country that has permanently run 7% current account surpluses.

      There are such countries, such as there are countries that run permanent deficits. They tend to be exporters of manufactures and have kept a large industrial base (Germany, Japan, East Asia, Germany and a number of other north European countries).

      These are structural, and only turn when there is a major turns in the terms of trade between industrial goods and commodities (revise James Meade) or when there is an exceptional event that wipes out a lot of your production (a tsunami combined with a nuclear accident and earthquake that hits the capital and kills 30 000 people and hits areas where crucial small supporting industry is located).

      Exchange rate revaluations and expansionary policies may reduce these surpluses, but unless a sustained revaluation permanently wipes out their industrial bases, they will remain surpluses and the decrease in their surpluses will be very temporary.

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    3. 1950 - 2000 German average current account surplus was 2% of GDP. Nobody is denying that Germany is a structural surplus country, just that 8% is insane (and four times the historical average).

      http://www.bundesfinanzministerium.de/Content/DE/Monatsberichte/Bilder_Migration/2009/12/analysen-und-berichte/b03-leistungsbilanz/Abbildung04.gif?__blob=normal&v=3

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    4. Sure 8 per cent is on a high end for a country of its size; however the point about structural balance of payments surpluses and deficits and the ability of macro-economic policy to fundamentally change them is not a trivial one.

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    5. Professor,
      With all due respect, it is you who claim something, i.e. that not Club Med is responsible for Club Med’s difficulties, but Germany.

      So I’d say it’s on you to provide your readers with data that support this claim, and not just data on Germany, but (at least) also on the countries in question, and preferably also on their non-EZ competitors. That would be some most basic scientific diligence in my view.

      But let’s see some numbers then.
      When one googles “unit labour cost Eurozone”, one gets for instance this chart: http://cdn1.alphanow.thomsonreuters.com/wp-content/uploads/2011/10/euro_zone_unit_labour_costs.jpg
      It shows unit labour costs in Greece, Portugal, Spain and Ireland growing some 30-40% between 2000 and 2008, while that of Germany unchanged.

      Then, take this: http://www.ariva.de/unit_labor_costs_by_country_figure_web_ready_png_a665276
      It shows U.S. unit labour cost to UNDERSHOOT Germany’s one in the given period, while in South Korea it is shown to have grown by roughly 10%, i.e. one third or fourth of Club Med’s increases.

      From this, the prima facie conclusion is that Club Med priced itself out, full stop.

      And I’m more than willing to be educated by great minds and accept that things are indeed to be interpreted totally differently, if there are convincing arguments. Problem is, all I’ve seen so far are ex-cathedra statements.

      How do you interpret the above-mentioned numbers?

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    6. "From this, the prima facie conclusion is that Club Med priced itself out, full stop."

      Please allow me to reiterate it: Italy's HCPI has been below 2% since 1991 *4 times*. Is it any wonder that Germans refuse to believe that Italy's price level problems are not the fault of their real wage reduction?

      I will acept though that Germany shares part of the blame insofar as currency union requires close coordination and Germany, as well as the others, did not enough to stay together.

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    7. Anonymous 04:53, your unlabelled chart is wrong or not representing what you claim it is. OECD ULC statistics for the total economy show clearly that Germany was the global outlier.

      ULC increases 2001-2011 were 20% for USA, 27% for Italy, 16% for South Korea, and 3% for Germany.

      http://stats.oecd.org/Index.aspx?DataSetCode=ULC_ANN

      And yes, Italy has a higher structural inflation rate. So what? It was the ECB's job to manage differing inflation rates in different countries. Instead it choose to adopt a policy that only fit Germany. Italy had no independent central bank anymore. How was it supposed to reduce inflation?

      Not to mention the fact that in most Club Med countries - including France - wages grew in line with productivity. Sorry if I am not a big fan of cheating workers out of their fair wages, as you seem to be.

      I don't blame Germany. I don't think such a thing as "Germany" or "Italy" even exists. German industrial elites adopted a policy that favoured them and damaged German workers, as a result of which Germany has seen the fastest increase in inequality in Europe. 20% of German workers are now on low wages, compared to 10% in Italy. 16% of Germans are at risk of poverty even after fiscal transfers. If this is the economy you want, you can have it.

      You want to compete instead of cooperate? Fine with me. Let's restore proper market competition by removing the euro, the greatest impediment to the market regulating itself as it should.

      Italy has been one of the richest countries in the world for the vast majority of the past 2000 years. We're happy to stand on our own, with no handouts from anyone (although it'd be nice if you gave our 74 billion euros which you used to bail out your broken banks via Greece back, thank you very much).

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  6. I admire your persistence, Professor Wren-Lewis, but historically nothing has proven able to make Germans change their mind besides their country being reduced to rubble. I submit Anon 11:54 above as proof, with the stunning ignorance of point 3 - of course wage growth in every other OECD country massively outstripped Germany's - as a particular point in case.

    Germany will keep forcing delflation on Southern Europe until the Euro goes; its economy will then rapidly fall apart, as all surplus economies have to when trade imbalances finally redress themselves, while the "Club Med" countries will quickly surge ahead. How much of the damage done they will be able to fix remains to be seen. Italy is a particularly painful case to watch, given its position as Germany's primary competitor as Europe's second largest high-value maufacturing economy. 25% of Italian industrial output has been wiped out so far. How much more needs to be sacrificed on the altar of failed economic ideologies?

    Please keep writing these posts. They are being translated to reach a wider Italian audience - perhaps if the North remains unwilling, the South will be able to talk some economic sense into the European Commission?

    http://vocidallestero.it/2014/10/31/perche-leurozona-ha-un-problema-tedesco/

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    1. "25% of Italian industrial output has been wiped out so far. How much more needs to be sacrificed on the altar of failed economic ideologies?"

      I sympathise greatly with the Italian people, Hypnos and agree with what you say. Where I disagree with the blogger is that macro-expansion is the answer.

      I think people are ignoring the competitive challenges from East Asia (I suspect that is where a lot of the manufacturing has gone), the huge shock to the periphery of the rapid expansion of the EU to low wage countries without giving proper thought to what that would mean to the old periphery.

      Devaluations are old pre-Euro solutions that were not solutions to anything. Macro-expansion could lead to large distortions in the economy that do not help the people they are supposed or restore industrial bases.

      I really think the only way to go is drop the UK, put the eastern bloc on hold (that would also ease tensions with Russia which is a big problem waiting in the wings) go for full fiscal union of the existing Eurozone, have the fiscal expansion and direct the fiscal transfers to where they are needed.

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    2. "and direct the fiscal transfers to where they are needed".

      But Germany does not accept any kind of fiscal transfer.

      So ?

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    3. I take your point, but if that were the case, than the sectors that should've suffered most should've been the low value added ones such as textiles. And yet what Italy lost was high value manufacturing, such as white goods and cars, where Italy always competed with Germany (or was the primary supplier to German businesses).

      I fully agree with your broader point though: the European internal market should've been the backstop to protect European countries from Asian low cost competition. Instead, it turned into the slaughterhouse. The chance for cooperation and good will has gone. Once this is over, Southern Europeans will have become extremely wary of putting their economic fate in Northern European hands.

      And as an Italian, I can't in good conscience agree to a scheme of permanent fiscal transfers. We have had fiscal transfers towards Southern Italy for the best part of a century. It has gotten us nowhere.

      Nations need to take their destiny into their own hands. Italy is twice the size of South Korea. If they can compete alone on the global markets, so can we.

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    4. "And yet what Italy lost was high value manufacturing, such as white goods and cars, where Italy always competed with Germany (or was the primary supplier to German businesses)."

      Very interesting Hypnos, I did not know that, and this is exactly the sort of discussion that needs to take place. Unfortunately macro-economists tend to only look at macro data and macro-models. But really we have to ask if there was a fiscal expansion, would this lead to a restoration of the industrial base, or rather, lead to distortions in the economy that solve nothing and exacerbate inequalities.

      Who now are the primary suppliers to German businesses? My guess is that it is East Asia and Eastern Europe, and I doubt such production will return to Italy with an AD expansion. If they do it will be like Apple in the US - in a capital intensive, not employment generating form.

      Korea might not be a good example for a few people to follow if they do not like the Euro, especially if you do not like pegged exchange rates and a minimum foreign exchange reserve accumulation policy (US economists think they got where they did with an undervalued exchange rate - that's false).

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    5. "We have to ask if there was a fiscal expansion, would this lead to a restoration of the industrial base, or rather, lead to distortions in the economy that solve nothing and exacerbate inequalities".

      You get it easily if fiscal expansion goes together a real exchange realignment in less competitive countries. Italy would be fine with a 20% reduction in gross labor costs. In a flexible exhange rate environment, it could be achieved by devaluating. In a monetary union, by reducing indirect tax and social costs on labor.

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    6. Marco Cattaneo
      "But Germany does not accept any kind of fiscal transfer.
      So ?"

      - Well, fiscal transfer has from the very beginning a key element of the EU, actually on pretty massive scale.

      One could of course argue for this to be intensified further. The problem there is in my view not so much an inherent German attitude against assisting other EU members. The impediment there would be much more that
      Germans fear - rightly or wrongly - that such transfers would do little good to Italy but would mostly land in the pockets of oligarchs and politicians. All the more so as this is what actually happens to EU-funds in Eastern Europe since they joined.

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    7. "Fiscal transfer has from the very beginning a key element of the EU, actually on pretty massive scale"

      Are you kidding ? fiscal transfers are peanuts in the EU. BTW Italy gives € 16 bln and gets € 8 bln per year. Italy provides net transfers, doesn't receive them.

      "Germans fear - rightly or wrongly - that such transfers would do little good to Italy but would mostly land in the pockets of oligarchs and politicians. All the more so as this is what actually happens to EU-funds in Eastern Europe since they joined."

      There is no trust, fine. No problem. Let's break the wedding then.

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    8. "Let's break the wedding then."

      I approve this message.

      Alternative für Deutschland

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    9. I think there is just a fear that would happen if there was not a proper fiscal framework for these funds in place. It is only right that the German people want to be sure that these funds go to the people that need them and not to oligarchs or housing booms. You know a recovery could actually harm the bottom end the most. House price rises can actually make life more difficult for people at the bottom end, particularly those in arrears. They would be forced to sell their properties. Then what? More inequality, a less broad-based econonmy, the cycle continues...

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    10. "German people want to be sure that these funds go to the people that need them": that would imply a request to control how funds are allocated.

      Instead, there is absolutely no acceptance for the needed amount of deficit spending, regardless of the allocation.

      The monetary union doesn't work. Let's decide upon the most efficient way to get rid of it.

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  7. Dear Sir,

    you write:
    "There are no benefits of a nominal appreciation if everything real is unchanged."

    Here's where I disagree. You seem to restrict yourself to comparing a starting state with an end state. Even if, at the end of the day, the status quo has been maintained, it does not mean what happened inbetween had no effect. In a way, an above comment alludes to the same issue:
    "Germany will keep forcing delflation on Southern Europe until the Euro goes; its economy will then rapidly fall apart, as all surplus economies have to when trade imbalances finally redress themselves, while the "Club Med" countries will quickly surge ahead. [...] 25% of Italian industrial output has been wiped out so far [in the meantime -- me]. "

    If you consider what Hypnos said, it means that Eurozone countries will eventually have to come back to a form of balance. But what happened between the starting point and the end point is not inconsequential. It is of great consequence.

    You yourself claim above that eventually competitive will have to be restored because Germany must have above average inflation. But, again, the transitory process is not without effects.

    This is the reason why I disagree with your statement above. Yes, eventual currency appreciation will restore balance. But the longer the lag between change in market fundamentals and market perception, the greater the potential gain for a country with a temporarily undervalued currency. This is a potential boon of a currency with repeat appreciations.

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  8. 1. If the 'problem' in Europe is low inflation and weak demand that is attributed to the 'inability' of the ECB to pursue its mandate courtesy of the ZLB-irrespective of the underlying causes (shock[s]) of said 'problem'-why would fiscal expansion be a 'solution'? What stops peripheral countries from spending their newly printed cash on German wares, thus inflating (probably) German prices while still depressing own prices?

    2. The rest of the south of the EZ ie Greece and Portugal, according to the post, should not do any fiscal expansion-presumably because their 'fiscal space' is virtually nil? If so, what happens to the magnitude of unemployment (eg around 26-27% in Greece)? What sort of 'structural reform' is capable of making room for a quarter of the labour force, within a reasonable time frame?

    3. If what's wrong with the EZ is the need for a competitive rebalancing, why would that occur within the zone and not outside the zone, ie if Germany is unstable vis-a-vie the rest of the world, why not re-equilibrate against the rest of the world by devaluing the euro? After all, isn't Germany the biggest exporter of capital flows?

    4. thank you

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    1. "What stops peripheral countries from spending their newly printed cash on German wares?": you only need the periphery to spend a part of their fiscal expansion to reduce gross labor costs, via lower social contributions and taxes on labor.

      Delete
    2. Question: From 1991 to 2013 Italy's hcpi was only 4 times below 2% (and that is including the recent crisis years 2009 and 2013) - doesn't it seem a bit unfair to blame Germany if Italy has uncompetitive wages?

      Delete
    3. I think what's useless is speaking in terms of "blaming".

      The point is not whether Italy is right in blaming Germany, or the other way around.

      The point is that fixing the eurozone unbalances via Southern countries' internal devaluation IS NOT POSSIBLE. It destroys internal demand, puts them in permanent depression and ultimately causes the eurosystem to collapse.

      Delete
    4. I agree and I am not trying to blame Italy at all. In my mind, it is a shared blame. EMU requires constant close coordination between governments as well as setting a common economic policy framework. This hasn't happened to the extent needed and that is why we are here.

      I think the real problem of EMU is lack of trust. Specifically of north in the south. The reason for that is that the south hasnt proven that it can maintain a hard currency on its own and is therefore suspect. A currency union needs that trust. It cannot do without.

      Delete
    5. @ Marco: ok, so the government sectors of the south should-effectively-subsidize their respective private sectors so as to improve unit labor costs in order to boost their net exports? If that's so, how are countries with limited 'fiscal space' expected to do that?

      Also, if subsidizing ulc's is the way to go, why is everybody crying for 'structural reform'? Or is subsidizing ulc's a 'structural reform'?

      To give a crude example of what I had in mind, Greece imports VW's from Germany because it doesn't produce cars and no amount of ulc subsidizing can make amends for that. So, fiscal expansion in Greece would inflate probably a wee bit VW's prices and that's that... Deflation would still be a prominent feature of the Greek economy and Germany would still have price change rates below 2%.

      Am I missing something here?

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    6. @ john
      "Why is everybody crying for 'structural reform'" ?
      I'm not. IMHO nobody knows what structural reform means. You should ask those crying fellows.

      Greece doesn't produce cars, right. It doesn't mean it has not products to export. Reducing labor costs via lower taxes would mightly improve this. It's not "subsidizing". BTW it's precisely what Germany did - lowering gross labor costs while violating the 3% Maastricht limit: deficit spending to finance lower labor costs.

      Delete
    7. @Ano 11.11 06.40
      If trust is not there, the wedding cannot and should not last.
      Let's discuss the most appropriate way to end it.

      http://bastaconleurocrisi.blogspot.it/2013/09/tax-credit-certificates-certificati-di.html

      Delete
    8. "The point is that fixing the eurozone unbalances via Southern countries' internal devaluation IS NOT POSSIBLE. It destroys internal demand, puts them in permanent depression and ultimately causes the eurosystem to collapse."

      I approve this message. And I am fed up by British Econs telling me how we should fix the euro crisis.

      Alternative für Deutschland voter

      Delete
  9. Gunther Kirschner11 November 2014 at 02:04

    I would agree that the excessive focus of fiscal tightening in the eurozone is flawed and the ECB should be able to act as a genuine central bank without the constant threat of legal action. What I don’t understand is why the political leadership in France or Italy has failed so spectacularly in presenting a basis for alternative policies? What I also don’t understand is why the obvious “competitiveness misalignment” in the eurozone is only Germany’s fault. Wages in Spain and Italy increased above productivity growth for many years during the “boom” years. In Italy collective bargaining arrangements still cover more than 80% of all industry. Germany’s trade unions have been putting jobs before wage growth for some time now. They learned this the hard way during the mid-1990s as parts of Germany’s manufacturing base vanished and moved across the border to Eastern Europe.
    For the competitiveness misalignment to become narrower, both sides need to move. Anecdotal evidence suggests that this is happening for instance in the Spanish auto industry where trade unions enabled flexible labor arrangements. It is simply unrealistic to expect some kind of boom in Germany to eliminate competitive misalignments in the eurozone.




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    1. The way to think about it is that what happened from 2000-2007 has to be reversed. That means a (relative to average Eurozone) boom in Germany, and a (relative to average Eurozone) downturn outside - just the opposite of what happened before. That has to happen. But, if your last sentence is correct, this implies that in absolute terms we get at best no boom/downturn in Germany and chronic recession outside.

      Delete
    2. Mainly Macro11 November 2014 02:42

      "The way to think about it is that what happened from 2000-2007 has to be reversed.... That has to happen."

      That is not the way to think about it. The past is the past. What you are saying is: Because other Eurozone countries permitted themselves ridiculously high salary raises, Germany should now implement ridiculously high salary raises.

      Even if that happened, it would not help the other countries out of their recession because most of them do not compete with Germany and vice versa (or do you want to holiday on the sunny beaches of Germany, surrounded by their classical ruins and eating German olives?).

      Delete
    3. to SWL: we have seen the graphs of increased competitiveness gap between North and South, but first it's not clear that this is the actual cause of the problems and secondly, you have not proven that a boom in Germany will solve the problems. You would need to provide a detailed analysis of trade flows before you can make any predictions about your proposed solution.
      Other issues are credit flows to South that will never return , competitiveness of eurozone compared to outside eurozone, and structural low growth and shrinking populations in some countries . It's a complicated problem, your focus on Germany seems unjustified.

      what is your response to this post
      http://fatasmihov.blogspot.nl/2014/11/the-false-rhetoric-of-euro-victims-and.html
      quote
      ''Even compared to Germany where we know that there was a significant internal devaluation via very low nominal wage growth, exports in Spain grew at a similar speed before the crisis and faster than in Germany. Yes, the current account in Spain was on an unsustainable trajectory but it was caused by capital flows supporting excessive imports.''

      Delete
    4. Gunther Kirschner 11 November 2014 02:04

      "I would agree that the excessive focus of fiscal tightening in the eurozone is flawed and the ECB should be able to act as a genuine central bank without the constant threat of legal action."

      This is not possible without full-scale political union. The EU as-is is a collection of souvereign nation-states and the constitutions of these nations trump any federal laws if push should come to shove. And that is how it should be at this point.

      If you want more than that, get democratic legitimation for that in each nation-state. There has no democratic legitimation been given by German voters for a European Central Bank that acts outside of stipulations of the German constitution. Right now, the ECB has merely the legitimation of an outsourced Bundesbank. That's it. If it goes ultra vires, it's legitimation can be, and probably will be, revoked.

      Delete
    5. What happened in 2000-2007 needs to be reversed?
      Problem is that since the beginning of the crisis we have created close to EUR 2 trillion public debt. Your arguments about fiscal stimulus to exit crisis would be appealing if we had 60% debt to GDP, but at 90%+ additional fiscal stimuli could jeorpardize debt sustainability and market perception, particularly if you succeed in generating 2% inflation and need to steer a rise in long term rates to make sure that inflation expectations remain properly anchored

      Delete
  10. Great article Prof.

    It seems to me that we can't get to rational economics until you get past the morality fixation that Germans seem to have created around matters economical. Germany's sense of self worth seems to be inordinately associated with her economic outlook. Virtue is the German way - vice is the Keynesian way. Who benefits from this perversity and who is pushing this morality tale? The conservatives and the business lobby would be my answer.

    German economic policy is perverse not merely for Germany's unfortunate euro partners but for the average German wage earner. Their incomes have been squeezed and they pay far higher taxes on that income then any of their G7 peers. Real wealth accumulation for the average German is amongst the lowest in the G7.

    There is a real need for the German left to take a hatchet to the faux morality of the dominant German narrative and to describe it for what it really is - an ordoliberal corporatist scam which has depressed the living standards of the largest cohort of Germans as well as devastated the economies of Germany's unfortunate eurozone partners.

    J'accuse....

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    1. Tony Maher11 November 2014 04:26

      If you'll believe that, you'll believe anything

      Delete
    2. Pretty amazing to see you accusing Germans of moralizing when this entire narrative Prof W-L and others are pushing is exclusively centred around putting all the blame for suffering in the South on the Germans, and therefrom derive some kind of ill defined moral obligations.

      And all you have in support is buzzwords like 'rational economics' or 'basic macroeconomics' (as if economics were a homogenous corpus of knowledge rather than a collection of a thousand schools of thought, disagreing in just about everything with each other), and of course the angry southern European population which happily jumps on anything pushing responsibility away from their own elites.

      Delete
    3. Anonymous11 November 2014 05:28

      That is indeed so, and one wishes Prof. Wren-Lewis will take it to heart

      Delete
  11. ''its economy will then rapidly fall apart, as all surplus economies have to when trade imbalances finally redress themselves, while the "Club Med" countries will quickly surge ahead.''

    yeah right.
    Please explain this to me: some Southern countries could have chosen to stay out of the eurozone, so they could continue to ''surge ahead'' instead they tried everything possible to get into the eurozone (and still want to stay in), while at the same time some Northern countries pondered about entering the eurozone, and in the end some decided to stay out (Denmark, Sweden).
    Why is this if being outside the eurzone is such a good thing according to you (and others on this blog)?

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    Replies
    1. Anon 05:32, if there had been a referendum in Italy on joining the euro, the country wouldn't have joined. Don't put this on the Italian people.

      The euro was a misguided project by French and Italian elites, no argument from me there. When this is over, I'm sure we can arrange some suitable punishments for those who misled down this route.

      Essentially, Italian political elites wanted this for prestige reasons; French political elites, because of their abysmal macroeconomic ignorance, thought it would help them restrain a united Germany; and Italian economic elites thought it would help them restrain wage demands from Italian labour (they were right, of course: witness the massive drop in the wage share of GDP across Europe. What they missed was that by killing labour they were killing themselves. They still haven't figured it out, unfortunately).

      As I said above, we are suffering from the fallacy of thinking of countries as individuals, rather than collections of opposing interests. The people who have been ruling Europe for the past 20 years belong to an economic elite that is completely independent of the welfare of the countries they hail from. They are not evil. They simply don't know any better, and have no feedback mechanism to understand what their ideology is doing to the people they supposedly represent.

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    2. "The people who have been ruling Europe for the past 20 years belong to an economic elite that is completely independent of the welfare of the countries they hail from."

      A lot of truth, but careful what you might wish for Hypnos. With the exception of Keynes (who was a heterodox economist), theories that have come out of Anglo Saxon countries are not appealing, both on moralistic and social grounds (their root micro foundations are positively awful) or in terms of their record when implemented.

      Delete
    3. to Hypnos: ok, fair enough. But do you really believe competitive devaluation is the solution? I don't think both Southern and Northern countries want this.
      Northern countries probably can live with a one time adjustment to reverse the increased competitiveness gap that happened in the first eurozone decade.
      But if Southern countries can't improve their structural competitiveness in another way, they will be faced with eternal devaluations. Not good for the living standard of the people in Southern countries, and not good for Northern countries either as to a certain extend they might feel forced to increase wage moderation or take other measures to protect their economies.
      A race to the bottom will help nobody, and eternal competitive devaluation is a race to the bottom.

      Delete
    4. Germany would revalue as much as the Mediterraneans would devalue. It would be a two way street. And it is Germany which in a state of competitive devaluation, so the Southern devaluations would be defensive in nature, not competitive.

      Once equilibrium is re-established, and assuming enough good will is left, we can set on creating a proper economic union that is based around the welfare of the people, not of international financial elites. That would mean keeping floating exchange rates to adjust for differences in inflation rates while enacting policies to push the wage share back up. I'm thinking of unifying labour welfare policies - a single European unemployment benefit, similar work protection rules (actual protection, not flexicurity or other such crap), and ideally wage indexation to inflation.

      It's likely capital controls will be needed as well, but that would be part of a broader push to re-regulate the financial sector writ large. That would help avoid "run on currency" situations through hot money flows, as well, making floating exchange rates much more manageable.

      At that point, the European common market - as the largest market on the planet - would act as a common insurance from external demand shocks for all European nations, and we could start thinking about enforcing our standards on the rest of the world through enlightened protectionism, instead of following the United States in the global race to the bottom (see the TTIP). For example, I'd love to see import tariffs based on environmental regulations, chiefly carbon, so that European manufacturers will stop complaining about competition from countries that have no environmental standards.

      That would slow global growth you say? Well what has global growth ever done for the European people?

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    5. @Hypnos: you are not replying to my main argument: you claim that floating exchange rates will create a new balance and from than on prosperity is around the corner.
      I disagree: I think there is a high chance the Italian political class will not do structural reforms, as simply letting your currency devaluate from time to time to remain competitive is much easier for politicians. As a result, living standards of Italian people will slowly erode.
      You claim it was prestige why Italian politicians wanted the euro, maybe, but I think some were realistic enough to see that devaluations of lira are not a road to prosperity. Italy had already difficulty keeping into the fixed exchange rate mechanism before the euro (that's how Italy got the high public debt).
      Globalization has changed the world, either you make sure your economy remains competitive with structural reforms and innovation, or you join the club of countries that slowly sink with currency devaluations.

      Delete
    6. Your main argument is wrong. Currency devaluations (of which there were not that many; in fact, Germany revalued more than Italy devalued, and the Italian exchange rate was more or less aligned with the economic fundamentals of the country) did not decrease Italian living standards at all. That's a fiction.

      Structural reforms, of course, are also a meaningless shibboleth based on a cultish understanding of economics. What little meaning they have is about removing protection in the labour market to transfer wealth away from workers and towards capitalists. This creates just the kind of permanent demand slump we are in at the moment. Furthermore, labour flexibility decreases labour productivity, since businesses have no incentive to invest in their employees, they can just hire more of them at lower wages.

      Of course, Italy has implemented more labour reforms than Germany, and Italy's OECD labour protection index is now below that of Germany. You might notice it has made no difference to anything whatsoever, because, as I said, structural reforms are a cult, and an excuse to ignore the real problem.

      The way Italy got its high public debt was by divorcing its central bank from the Treasury in 1982. The architect of that reform, Andreatta, said as much in a 1992 interview. Up to that point the central bank had operated to keep interest rates on the debt low by acting as a purchaser of last resort. With that eliminated, interest rates skyrocketed. Italian debt doubled from 1982 to 1992, from 60% to 120%. Again, this was done to supposedly curb inflation (which was due to oil shocks and was only hurting rich people anyway), in obeisance to the cult of neoliberalism of which independent central banks are such an important tenet.

      A proper course of reform after dumping the euro would of course include bringing the Bank of Italy back under Treasury oversight.

      Finally, restoring the currency value to where its meant to be would engender an export boom which would result in rapid productivity increases through a Verdoorn law effect. This is exactly what happened in 1992-1996 as Italy left euro mark 1. Further rebalancing of the currency beyond adjustments for inflation would then not be needed as Italian businesses would regain their lost productivity advantage. Italian industrial clusters of SMEs were already undergoing a transition towards more R&D spending and more high-value added products when the lira joined the euro at an already overvalued rate in 1996. Of course, the consequent drop in export demand killed whatever hope of a successful transition we could have. Structural labour reforms followed (Treu package 1997, Biagi law 2003), putting the last nail in the coffin of Italian productivity.

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    7. @Hypnos:
      ''This is exactly what happened in 1992-1996 as Italy left euro mark''

      GDP growth rate of Italy was close to zero during that period.


      '' Italian debt doubled from 1982 to 1992, from 60% to 120%. ''

      Italian debt/GDP grew from 90% of GDP to 120% of GDP in just 5 years between 1990 and 10095, this was because Italian government tried to continue to peg lira to European exchange rate mechanism. Without this, the lira would have devaluated significantly (this makes it even more surprising Italian politicians wanted to join the eurozone, as the experience before 2000 had shown them it was not sustainable).

      History has shown latin countries often suffered from high inflation (probably the reason European Southern countries wanted in the eurozone). Devaluating your currency increases inflation. It may increase exports for a while, but this effect wears off, and than you need to devaluate again. This is not good economic policy, but will slowly hollow out living standards of the population.
      I think that if Italy would exit the eurozone, it risks ending up as Argentina, I guess we disagree.

      Delete
  12. Professor, I greatly admire your patience in explaining these issues despite the fact that most people either can't or won't understand. I think you provide a valuable service to those who actually want to understand.

    As for actually convincing the politicians, that seems pretty hopeless to me. Assuming no political solution, can you comment on what you see as the most likely denouement?

    You suggested that no nation in history has persistently run current account surplus on the order of 7% of GDP. How does it usually end when such countries refuse to re-balance? Depression? War? Trade protectionism? Currency devaluation (which I guess would mean the exceptionally difficult job of leaving the Euro).

    To me it seems like the most likely outcome here is stagnation, deflation, and depression until a majority of Eurozone states either force the ECB to take real action or take unilateral action through fiscal policy. Unfortunately, considering the situation in Greece, it seems like a great deal of pain is required before a country can begin to consider other options.

    Thanks.

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    1. Prof. Wren-Lewis,

      You suggested that no nation in history has persistently run current account surplus on the order of 7% of GDP. How does it usually end when such countries refuse to re-balance? Depression? War? Trade protectionism? Currency devaluation (which I guess would mean the exceptionally difficult job of leaving the Euro)."

      Please, prof. Wren-Lewis, answer that question!

      Delete
  13. The legend of the Agenda 2010 is this: Once upon a time, when The Economist referred to Germany as the “sick man of Europe”, courageous Chancellor Gerhard Schröder stood up against popular opinion and did what was necessary: shoveling painful reforms down the electorate’s throat. The Germans, unwilling to appreciate the good that was done to them, voted Schröder out of office. The Agenda 2010 turned out to be a political disaster, but paved the way to economic success.
    If your economic vision tells you that rigid labor markets were chiefly responsible for Eurosclerosis, and more flexible labor markets would pave the way to growth and employment, and you flexibilize labor markets and observe a relative economic success a few years down the road. Then, naturally, you prescribe the same medicine to troubled countries, and you do so with great confidence.
    The German position is based on false macroeconomic ideas and thinking, and has less to do with national interest.
    Much of the German orthodoxy ignores that things other than the Agenda 2010 may have contributed to the relatively good performance during the crisis. For example, the absence of a credit boom meant that German firms and households entered the crisis with healthy balance sheets, and the various institutions in support of INTERNAL flexibility have helped stabilizing employment and consumption.

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    1. Enno Schröder

      "...the various institutions in support of INTERNAL flexibility have helped stabilizing employment and consumption."

      Couldn't the crisis countries introduce such institutions? Wouldn't the result be the same?

      Delete
    2. Indeed, Anonymous. I think it is very important to separate nominal wage restraint, fiscal contraction and institutional reforms. I've tried to point that out here that the nominal wage restraint began in 2000, but the institutional reforms came after 2003. (The idea that Germany saved itself to prosperity is a myth, which, unfortunately, many german policy-makers believe themselves.) After the financial crash, the German model of temporary part-time work to preserve jobs received much attention. The cash-for-clunkers program of the Obama government was an imitation of the german Abwrackprämie. The introduction of mini and midi jobs are another example of the german labor market flexibility. The unions in Germany are also relatively strong, so it's not like german orthodoxy is some kind of mortal enemy to left-of-center thought. During this discussion, it seems to me as if german policy is morphing into some kind of amalgamation of right-wing evil.

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    3. Anonymous: Couldn't the crisis countries introduce institutions that support internal flexibility?
      The wage-subsidy schemes for short-time work do exist in other countries, but they haven't been used as much there, presumably because the downturn was perceived to be permanent.
      I don't know about the extent of working time accounts, how widely they are in use internationally.
      In any case, the ability of firms to adjust working time on a firm level helps in temporary downturns, but we must not forget that the debt and expenditure paths of Greece, Spain, and Ireland were in fact unsustainable, and some sort of adjustment was in fact necessary. What is unfair and also unnecessary are the policies which shift the onus of adjustment mainly onto wage laborers.

      Delete
  14. "The wage-subsidy schemes for short-time work ..."
    A lot of bad public policy and mistaken public opinion is based on lack of knowledge among the EU member countries, which is particularly damaging to the weaker countries which cannot protect themselves from policy mistakes made elsewhere in Europe.
    Wage-subsidies for part-time work would hardly work in a country like Portugal which has just raised the minimum wage to 505 euros, and which has no budget for any subsidies. About 40% of the unemployed in Portugal have exhausted their unemployment protection already.
    But policy mistakes are everywhere.
    A new cash-for-clunkers program will help to promote automobile imports...
    President Hoover's ghost is alive and well and living in B.....

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    Replies
    1. What would work than for a country like Portugal? With a minimum wage of 505 euros, exiting the eurozone would mean an even lower purchasing power, they might end up with wages lower than China. Is that the solution?

      Delete
  15. These kind of arguments can be construed as German bashing.

    Perhaps it's a better idea to open up the discussion on what acceptable inflation rates are and what costs come at heavy-handed inflation fighting.

    The 2% number is entirely arbitrary. Meant to be enough to prevent a liquidity trap. (Oops.)

    What level of inflation is high inflation? 5%? 6%?

    Clearly 4% will not lead to the Weimar Republic.

    I think this Friedmanite monetary ideology needs to be tempered with some inconvenient facts.

    What caused big inflation spikes in the 1970s? Real wages had been growing for decades. The unions were at their peak power. So forget Homo economicus and the dangers rational expectations being wound up. The reason an oil supply shock could cause a big inflation spike back then -- when it can't now -- is because the power of labor has been busted by 40 years of inflation-fighting and declining real wages.

    Trying to figure out inflation while ignoring real wage growth and the strength of labor is like trying to figure out the atom by ignoring Planck. It's just bad science that isn't going to work.

    Here are some graphs of money supply and real GDP in the US that show the 2% inflation target went too far and is an underlying cause behind the collapse of the Western economy:

    Tight-money inflation targeting was very long-run 'unneutral'

    Fed interest rates causing big recessions since 1973


    The Fed stomping down unemployment from 1973 to 1992 -- the dot com and housing/derivatives bubbles doing the rest (aka "stagflation is a fallacy")

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  16. Prof. Wren-Lewis,
    the new report of the German Council of Economic Experts is out. It's a pretty unhealthy mix of ordoliberalism and neoclassical RBC modelling. In colloquial terms, this council is known among the german population as the "Wirtschaftsweisen" (translated literally: the sages of the economy). It's in the news today because the lone Keynesian on the council, Peter Bofinger, has publicly opposed this report.
    http://www.spiegel.de/wirtschaft/unternehmen/bofinger-wirtschaftsweiser-stellt-sich-gegen-gemeinsames-gutachten-a-1002479.html
    The english Wikipedia page on the Council, http://en.wikipedia.org/wiki/German_Council_of_Economic_Experts , is outdated. Wolfgang Franz is no longer the chairman, it's Christoph Schmidt now. Franz has been replaced by Volker Wieland. Wieland also wrote a couple of papers together with the well-known American monetarist John Taylor, yes THE Taylor. These papers opposed any kind of fiscal stimulus, and rejected any kind of positive impact of it. If you ask for my opinion, two hacks found each other there. (Yes, Taylor has gone off the deep end in the past couple of years, in my opinion.) Another member of the Council is Lars Feld, THE german ordoliberal. I just thought I'd let you know, since you seem rather interested in german economic policy.
    It has to be pointed out though, that the Council has lost much of its relevance. Probably related to Schäuble's distrust of economics (and economists). The minimum wage law and the retirement reform became law this year in spite of their warnings.
    This, I think, is the english link to their report: http://www.sachverstaendigenrat-wirtschaft.de/273.html?&L=1

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    1. "It's a pretty unhealthy mix of ordoliberalism and neoclassical RBC modelling."

      This does not sound good.

      Delete
  17. Professor, a question: The perception that Germany has bailed out the eurozone at great cost is a central issue in the resolution of the euro crisis. But my impression is that most of the bailouts were done based on loan guarantees, not cash contributions from countries.

    If that's right, do you know how much Germany has actually had to put up, and how that compares with what recession among its trading partners has cost in terms of growth?

    Thanks

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  18. Germany's critics just don't get it - wilfully I suspect. I don't think that the Germans would object to 2% inflation if it happened, say, because of a rise in oil prices. What they are concerned about, and rightly so, is risk management. Germany already has a level of public debt that leaves little margin for unexpected crises. They are reluctant to acquiesce in any policy that involves increasing that debt. And the Germans understand that ECB balance sheet expansion effectively increases German exposure to potential increases in debt should these policies lose money, especially when the next two largest ECB shareholders are in even greater debt than Germany, and would struggle to pay their share of such losses.

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    1. Germany needs 2+% inflation. And the idea that Germany should be worrying about their debt is ridiculous.

      Delete
    2. However, any solution that leads to substantially more unemployment in Germany is a non-solution because the German public will not accept it.

      Delete
    3. More demand in the Eurozone would create more employment and the South, not less employment in Germany.

      Delete
    4. "the idea that Germany should be worrying about their debt is ridiculous"

      Why? You are supposed to be a rigorous academic; I would expect you to do better than that.

      The problem with the expansionists is that they have no theory at all as to how much debt is enough, so how can they argue with Germany's apparent choice now that the present level is enough?

      Delete
    5. Tim Young14 November 2014 10:23

      Quite right. SWL has repeatedly refused (by not answering such questions) to give numbers.If you can get him to give some, I will congratulate you.

      Delete
  19. I am a German and I think you are talking BULLSHIT Mr. Professor Mainly Macro. Ja ja die Pferde wollen eben nicht saufen .... haben im Süden ja lange genug (auf deutschen) Kredit gesoffen.
    .
    We need to end this failed Euro experiment and let all the southern states have their fucked up currencies again. This will throw them back to the poverty they were in before the Euro enabled them to borrow huge amounts without ever paying it back.

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    1. Yes, please, please kill the euro my dear angry German! I can't wait to go back to the pre-Euro Italian poverty of being richer than the French and the British.

      Italy GDP per capita as % of German GDP, 1996: 97%. 2013: 78%.

      What incredible prosperity this wonderful currency has brought us!

      Delete
    2. Dear Hypnos, if I look around even in the deepest south of Italy - most everyone is driving around with a new Audi or is proudly showing off his/her new RnineT BMW motorcycle (which I have not seen once in "poor" Germany). Even Porsche is selling SUVs in Bari with great success.
      .
      20 years ago they did not even have an Ikea market south of Milano!
      .
      Your "low interest rate credit driven prosperity" of the last 15 years is parked in your garage, is installed in your house or has been spent by yourself or your parents on trips around the world where "middle class Italians" in times of the Lira were seldomly to be seen.
      .
      As to your GDP ratios I have a different interpretation to those but I do not want to embarrass any one, because I actually like Italy and the Italians a lot. I even bought a Ducati. That did not help much I suppose.
      .
      We need to end the Euro experiment because -as anyone knows who studied Mundell- Europe is not an optimum currency area. Italians rather sit warm and sunny with mom and dad (receiving a pension from being german "Gastarbeiter") than go off and work in the dark and cold north as their parents once did.

      Delete
    3. "Italy GDP per capita as % of German GDP, 1996: 97%. 2013: 78%.

      What incredible prosperity this wonderful currency has brought us!"

      Correlation does not necessarily mean causation.

      Delete
    4. Let's do a real time experiment: Italy to reintroduce its currency.

      Delete
  20. It is the rude and angry German again: Of course we could also tax the rich million- and billionaires in the south ... but then again, that is not up to us poor Germans to do or to decide.
    .
    So in the endgame we will pay for the 15 year long southern shopping spree approximately 500 Billion when the system collapses some day in the far or not so far future.

    The German persective runs like this:
    http://www.focus.de/finanzen/boerse/experte-walter-kraemer-im-interview-deutschland-haftet-jetzt-schon-mit-mehr-als-500-milliarden-euro_id_4268024.html

    ReplyDelete
  21. Now you may resume your ivory tower +2% or maybe only + 1,75% or 2,347% inflation discusssion. You might also want to elaborate on the base money multiplier - ha ha ha what a useless crap all this macroeconomics is. Old models with no new insight!

    And only to make that clear - I am not the professor mentioned in the link above, just some angry German.

    ReplyDelete
    Replies
    1. Anonymous13 November 2014 16:45

      No need to be rude when one is right.

      Prof. Wren-Lewis's macroeconomics is indeed not very convincing, even if many macroeconomists share it. And a view of the world according to which Germany is morally obliged to become as uncompetitive as the crisis countries and to rob its savers and poor through unnecessary inflation is distinctly odd.

      One can be aware of that and yet be polite.

      Delete
  22. Mainly Macro13 November 2014 15:50
    Germany needs 2+% inflation. And the idea that Germany should be worrying about their debt is ridiculous.

    Anonymous14 November 2014 00:14
    However, any solution that leads to substantially more unemployment in Germany is a non-solution because the German public will not accept it.

    Hi Anonymous, would the German public accept a solution that would lead to greater growth because their customers are not in recession?

    ReplyDelete
    Replies
    1. "would the German public accept a solution that would lead to greater growth because their customers are not in recession?"

      Absolutely! But where is it?

      Delete
    2. "Hi Anonymous, would the German public accept a solution that would lead to greater growth because their customers are not in recession?"

      If it leads to substantially higher unemployment, then no. Talk in here is of undoing the years 2000-2007 but I don't see ANY willingness to going back to 2000 in Germany. If unemployment crosses 3.5 million and it can be traced back to the Euro, the AfD will soar.

      Germany (and its voters) does NOT want to experience the unemployment it had back then.

      Delete
    3. Anonymous14 November 2014 15:23

      You are quite right.

      SWL's wording was singularly unfelicitous when he said in
      Mainly Macro11 November 2014 02:42:

      "The way to think about it is that what happened from 2000-2007 has to be reversed"

      Perhaps he might correct that.

      Delete
  23. @ Fellow straggler14 November 2014 04:09:
    More growth now = more debt = less growth in the future.
    It is that simple, just the Keynesians do not get it and hope to inflate every structural problem away!
    .
    Germans will some day learn that it makes no sense to go off to work when -at the end of the credit line- your goods and services are not being paid for or you are being taxed because you are stupid enough to live in Germany because the south simply does not want to pay what is needed to keep their byoyant bureaucracies alive without constantly going into a fiscal deficit.

    ReplyDelete
    Replies
    1. What if don't finance growth with debt, but with newly-issued money ?
      What if it's not inflationary as we are in a liquidity trap (and we are fighting deflation, not inflation) ?

      Delete
  24. Dear Marco: The new issuance of base or central bank money will not work, because the banks will not extend any more credit to the defaulting southern private sector.
    We are going to go through a decade of deflation because bank assets in the south are decaying, leading to huge provisions for bad debt and ultimately write offs. If this goes on (and it will go on) we will see bank closures, bank runs and thus a destruction of "the money" created by banks. In such a scenario (where there is no good creditor in the south left to be found anymore) more central bank money creation will only lead to rising house prices and bond and stock market prices.

    The south had a grand "dolce far niente party" during the last 15 years now it is time to get sober.
    .
    I have an idea for "robin hood helicopter money" though. The southern politicians should tax the rich 20% of their state with a one-off-30% tax on their total net-assets and distribute it to the poor 40% of the southern states through personalized checks.
    .
    The "oh so well Bologna educated but sadly poor" young people would be give the choice to trade in those helicopter money checks to apply for an apprenticeship ("Lehre") in a german company and pay them room and board for the 2 1/2 or 3 years spent in Germany. It is their choice then to either get a new flatscreen, a new gamepad, phone and / or used Fiat with a tire as flat as their future or a chance to learn a new language and the real skills and work ethos required to be succesful in the global economy.

    ReplyDelete
  25. Correction: The sentence ".... where there is no good CREDITOR in the south left to be found.... " is correct if read like this: ".... where there is no good DEBTOR in the south left to be found.... ".
    Sorry I sometimes mix that up when translating.

    Greets the angry German

    ReplyDelete
  26. Why do we need “Robin Hood helicopter money” created through one – off taxation of the wealthy caste in the south and give it to the poor who will gladly spend it instead of investing it on the stock market:

    Creating inflation is ultimately stealing from the poor and giving it to the rich.
    This process is greatly propelled if the central bank issues new central bank money
    and
    the bankers do not know what to do with it because there is no solvent debtor out there anymore, so they invest it on the stock market
    and
    the corporate leaders don´t either know what to do with their free cash flow or massive bond offers at 0,5% interest rate other than to use it for share buy back programs. At least that raises earnings per share and secures the bonusses of the corporate leaders - the real fat cat´s in our modern society - no risk just fun!

    But all of this “money creation” will not help the "poor" in the real economy because the poor have no assets that will rise in value. They hold (and mostly struggle) with the debt – it is as simple as that.

    Oh, if you now argue that the wealthy will then run away and hide. Don´t worry running away is almost impossible when the OECD kills the privacy of bank accounts in 2017 and the taxation is being levied based on “nationality” rather than “place of residence”.

    Cheers to the rich in the south from the angry German!

    ReplyDelete
    Replies
    1. <<<... other than to use it for share buy back programs. At least that raises earnings per share and secures the bonusses of the corporate leaders ...<<< and it works like this:

      http://www.zerohedge.com/news/2014-11-15/do-you-believe-miracles-european-earnings-edition

      Delete
  27. Some more interesting reading on this subject from the US of A who are -as always- ahead of us:

    http://www.zerohedge.com/news/2014-11-09/broken-model-eurozone

    http://www.zerohedge.com/news/2014-11-10/deflation-vs-inflation

    http://www.zerohedge.com/news/2014-11-11/fed-won-americas-01-are-now-wealthier-bottom-90

    http://www.zerohedge.com/news/2014-11-09/system-terminally-broken

    http://www.zerohedge.com/news/2014-11-09/and-biggest-source-equity-demand-recent-years-according-goldman-sachs

    http://www.zerohedge.com/news/2014-11-08/gold-economic-freedom

    ReplyDelete
  28. "The new issuance of base or central bank money will not work, because the banks will not extend any more credit to the defaulting southern private sector."

    I'm NOT talking about EXTENDING CREDIT. I'm talking about REDUCING TAXES and stop cutting welfare expenses. That would trigger a powerful recovery, immediately.

    ReplyDelete
  29. Dear Marco, you know that it is hard to reduce taxes that are not even collected.

    But even if the south was paying all their taxes correctly, it still is not enough to keep your humongous bureaucracies well pampered. To keep functioning Italy needs one well paid bureaucrat for 6 to 10 of friends and family he is taking care of.

    This system is not sustainable and even less so if you lower taxes or cut welfare costs. You will just pile up more and more public debt and in the end blame everyone else but yourself.

    A powerful recovery will set in if you tax your rich and give it to the poor. Italy´s private sector is not poor at all but the public sector has written too many uncovered cheques on your own future.

    Since the Italians love their government bonds the first round of "taxation" could just be to cut the bond repayment from 100% to 70%. This will free up new room for public expenditures (to be "helicoptered" to the poor even further south) and -via the magic multipliers- create a boom yet unseen in southern Euroland.
    .
    Then you need not even call it "additional taxes" it is just an "adjustment to the repayment schedule" for all italian bearers of Italian government debt. This policy promises fast results, has a fixed schedule and is easy to implement. What more could you wish for?

    ReplyDelete
    Replies
    1. "It is hard to reduce taxes that are not even collected.".

      Tax collected in Italy are 48% of GDP. It's probably the highest rate in the Eurozone. Way too high.


      "You will just pile up more and more public debt".

      Not if you have your currency and finance deficit spending with money.


      "The first round of "taxation" could just be to cut the bond repayment from 100% to 70%. This will free up new room for public expenditures."

      And reduce private expenditure as every owner of government bonds (ie almost everybody in Italy) will immediately be poorer.

      Delete
    2. <<And reduce private expenditure as every owner of government bonds (ie almost everybody in Italy) will immediately be poorer.<<

      Dear Marco, these people are poorer already, because your failed state will default on its public debt.

      Lucky for the italian political elite nobody has told them that yet. But on some not so distant day someone will need to come forward with this ugly truth.

      Just to add: Us germans will make sure that you don´t cheat yourself out again by begging the ECB to buy those crappy italian bonds at face value.

      The angry German

      Delete
    3. Of course this italian mad man ruling the ECB is not to be trusted.

      He might even buy german government bonds at 200% of face value just to make sure that the italian bonds don´t drop to 50% and grinn like the cheshire cat on his wit producing this "new unconventional measure".

      And that is why the ECB must never ever be allowed to buy huge amounts of government bonds at all be it on the primary or secondary market.

      Delete
  30. Dear Marco, if you suggest that Italy returns to its own currency, say the "Lira nuovo" I am fine with you. You may then let the Banca d´Italia print all the "Lira nuovo" you want.

    But even with the "Lira nuovo" please forget "deficit spending". You have done this for the last 60 years now and all that is left is a huge pile of public debt.

    Italy will never be able to "outgrow" or "inflate their public debt away". There is no easy way out after 60 years of happy deficit spending and piling it in the private bank accounts of those that happened to be in power.

    Be it inflation or taxation it all comes down to taking buying power from one part of italian society and giving it to the other part of italian society.

    You should be happy that your poor people have not understood yet, that they are being betrayed by their own leaders creating inflation instead of taxing the rich.

    Of course the "evil north" and especially us Germans (credit selling you all those desirable goods) now make up the perfect scapegoat but as you and I know that misses the point and is all but fair. So yes please return to the "Lira nuovo" and continue what you had been doing before entering the Euro.

    Someday your poor people will end their siesta and look at the grand palazzos, the infinity pools, the private marinas, the motor- and sailing yachts, the Ferrari and Bugatti collections and the speedboats of those that were lucky enough to someday have been in political power (to plunder the honey pot of your beautiful country).

    ReplyDelete
    Replies
    1. Obviously you recommend actions to reduce inequality then, like the ECB printing €3000 euros to every citzen, and reducing Germany's current account surplus(speedboats, OMG) as it is so unfair then.

      Delete
  31. I might add that after Italy has returned to the "Lira nuovo" we would kindly ask you to repay your Euro debt in ..... Euros please, what else?

    Pacta sunt servanda.

    The angry German

    ReplyDelete
    Replies
    1. Maybe, if you pay us back for all the German banks bailed out and the cost of high unemployment and austerity due to obsession with balanced budgets.

      Delete
  32. Oh yes, the siesta seems to be over.

    I have just read in a big german newspaper about the strike at the stainless steel plant in Terni where the workers occupied the motorway A1 for some 4 hours on all 6 lanes.

    In this article a worker is quotet saying:
    "We are skilled and mobile, the (german) owner of the plant is providing good training and if we had miss Merkel and not mister Renzi in Rome, we would be much better of, because we are delivering good craftsmanship."

    I can tell you that in germany many would like to buy the new Alfa 4C (the Ferrari for the poor German), which is manufactured in Italy. The demand here in Germany is so big, that you can´t even get a testdrive because the Maserati plant can not build enough of the chassis.
    Trouble is, this chassis is not made of (stainless) steel but carbon fibre.
    Now then mister Renzi it is up to you, your industry leaders and your unions, to bring supply and demand for labor into equilibrium. Chances are good, you just need ideas that go beyond "ok I´ll call the mad man in the ECB and let him print some more money".

    The angry German

    ReplyDelete
  33. By this chance an Alfa 4C with an electric drive would also be a very nice "innvation from Italy".

    But as I observe from the maker of these wonderfully designed italian motor scooters, they just don´t get it and continue building their scooters with stinking gasoline engines.

    Meanwhile electric scooters are produced in China and sold via the internet in germany. Someday the italian management will be woken up by their workers because nobody wants to buy the stinkers anymore.

    Then management might say:
    "Oh electric drive was way beyond our core competency in the past 10 years (where we could have easily invested gradually and build the new electric-skills needed, but we didn´t because we loved our "history" so much that we were always celebrating it with prosecco, good red wine and formidable food on our big wine estates).
    The jobless? Well - that´s obviously the Chinese doing that to us (where really they mean "them poor jobless" and not "us in the management now retiring to our wine estates").

    ReplyDelete
  34. OK no more opposing views then I guess now we got the germany argument right, do we ?

    The angry German

    ReplyDelete
    Replies
    1. A believer like SWL is not easily converted. He'll be coming back. Keep your eyes peeled.

      Delete
  35. Let's suppose (i) very expansive fiscal policies in France, Italy, and Spain; (ii) a boom in Germany, as argued by Prof. Wren-Lewis. Then, would not this lead to French, Italian and Spanish inflations to rise above 2%, due to a significant growth in the aggregate demand? Which inflation should, in that case, be reached by Germany, once her partners are above the target?

    That's to say: will it make sense to add up at the same time two macro-instruments like a Latin fiscal expansion and a German boom? What if Latin expansion drives to a Latin boom? (Spain's GDP is already growing, it could be accelerated, but if inflation rises, there will be losses in competitivity).

    I sympathize with Prf. W-L argument, but I find unclear the proposed cycle.

    Thanks

    ReplyDelete
    Replies
    1. Try thinking about the Eurozone as a whole first, and then the countries within it. We need general fiscal expansion to get overall inflation to 2%. If we overdo it (which is hardly likely), the ECB will be very quick to raise rates to correct this. Then within the Eurozone, German inflation needs to be above 2%, and outside Germany below 2%, to correct competitiveness imbalances. If that does not happen automatically (which it probably will), then the degree of fiscal stimulus in each country can be adjusted accordingly.

      Delete
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