Saturday, March 2, 2013

The Eurozone Political Crisis in One Picture

. Saturday, March 2, 2013

Some, like Krugman, have argued that the European crisis is a technocratic failure, the result of quasi-religious beliefs in mythical creatures ("the Confidence Fairy") held by Very Serious People in government and the commentariat. If only they would just abandon their heresies and follow the One True Keynesian path, everything would be fine. The optimal policy is obvious and Pareto-improving -- more monetary stimulus, possibly combined with debt rescheduling and the end of fiscal austerity -- so all that is required is the fortitude to implement it.

Others, like me, have argued that the European crisis is a political crisis, the result of a disjunction between the interests of the Eurocore (esp Germany) and the Europeriphery. Rather than postulate cognitive dissonance or willful ignorance (or something more sinister), I focus on distributional issues: either the Europeriphery's creditors are re-paid or they are not; either the Eurozone's macroeconomic imbalances are addressed by adjustment in Eurocore or by adjustment in the Europeriphery. Ultimately these are political questions, and political questions are generally decided by those with the most political power. In the case of the EZ crisis, any resolution must involve the European Central Bank, and the ECB has traditionally been influenced by Germany more than other member nations. There is no Pareto-improving policy -- what helps some countries hurts others -- so this is not a technocratic problem.

Look at this picture (via Niklas Blanchard) and tell me which view best explains the European Central Bank's policy calculus, and thus outcomes in Europe:



Germany is running above its nominal GDP trend; everyone else is below it. That means that further monetary stimulus will increase real GDP growth everywhere but Germany, which will instead experience higher inflation*. Germany does not want that to happen, because Germany does not like inflation. Germany has disproportionate control over the monetary authority of Europe. Therefore, the Europeriphery does not receive the monetary support which they want, because it would cause inflation in Germany.

No parsing of myths necessary; it works without them. Also no moral lesson. Just normal distributional politics.

UPDATE: Fixed some typos and poor wordings, which were both more common than usual (I think) and more egregious, and thus more likely to lead to misunderstanding.

*Added at the same time as typo-fixing: Arguably an increase in German inflation would not facilitate the sort of adjustment which is needed anyway. Higher German inflation would depreciate the real exchange rate of Germany vis-a-vis the other members of the eurozone, thus increasing Germany's competitiveness in export markets relative to, say, Spain. Movement in the opposite direction is needed. Because Spain cannot devalue externally through a fall in its currency, it will have to adjust to a rising real interest rate with an even larger internal devaluation. That means even lower wages, and probably more fiscal austerity.

If I'm right about that it's a potentially very interesting point which I've seen no one else mention.

12 comments:

Emmanuel said...

I'm not saying they're right but that's Germany's argument: sometime ago they started dealing with structural impediments to being competitive, most of all high wages. So they embarked on wage suppression and other measures meant to keep jobs at home and inflation in check.

What the Germans would like now is for the rest to follow. It's not just austerity for the heck of it, but austerity for a purpose which many of their fellow Europeans seem to be unable to identify. To be fair, they are not so "corporatist" in governance to allow fruitful discussions to take place alike in the German example.

arianedewitte said...

Isn't higher inflation in Germany leading to a real exchange rate appreciation that makes German exports less competitive vis-à-vis the other Eurozone countries? After all, one reason why the GIIPS became less competitive was their higher level of inflation, which lead to a real exchange rate appreciation vis-à-vis lower-inflation countries such as Germany.

Sebastian said...

it's unfortunate that your Krugman antipathy apparently makes it impossible to you to benefit from the many smart things Krugman says.
While yes, he's been saying that austerity makes things worse, Krugman's main point has always been about the fact that the Eurozone is poorly set-up as a currency area. For example, he made pretty much the exact point you're making about inflation two years ago:
http://krugman.blogs.nytimes.com/2011/01/18/european-inflation-targets/
and has talked about issues of Euro governance countless times, e.g.
http://krugman.blogs.nytimes.com/2012/06/24/revenge-of-the-optimum-currency-area/

That said, I think your addendum about the problem of German inflation increasing German competitiveness is indeed a very good point.

Kindred Winecoff said...

Emmanuel, yes I think that's broadly correct.

Ariane, I see your point, I think: German inflation feeds into wages (and other inputs), thus increasing the (nominal) cost of production. Since the nominal exchange rate b/t GER and ESP is fixed adjustment can't happen through that mechanism. More likely it will affect rates of employment: Germany's loses employment and Spain gains it. Is that right now?

Sebastian, but *my* main point is that framing this as an OCA problem (or as a problem which can be solved using economic tools) is completely missing the point. European integration has always been a political project, not an economic project and not a "governance" project either (the term implies technocracy). So pointing out to me that Krugman has repeatedly written about OCA does not impress me at all. (And I knew it.) Krugman will often tack on some caveat at the end to the effect that politics matters in determining economic policy, he's missed the crux: these are political crises, not economic crises.

Krugman is frequently enlightening on matters of macroeconomics, and sometimes even on international economics (although he doesn't write about that much). But when discussing politics he is almost all heat and no light. To him, the "optimal" policy is usually obvious; if policymakers don't enact it then they are either dumb or mendacious. This comes out in the first link you provided: higher German inflation is just a better policy concession than Spanish deflation.

My goal is to (in some small way) change that framing entirely. There is no optimal policy. All policies benefit some and harm others. Krugman denigrates those who protest policies that he proposes when they would harm them. I think that's inane. He explains political outcomes by reference to the cognitive failings of Very Serious People, the Fed Borg, etc. rather than point out that distributional politics involves competing interests; when interests compete there is no "right" answer.

Krugman routinely writes that "economics is not a morality play" when criticizing something he disagrees with, but frequently writes about economics as if it were a morality play when advocating for his own preferred policies.

Anonymous said...

From my reading of Krugman he (mostly) attacks specific individuals and organisations for being sloppy/idiotic, rather than analyses why certain policies have been implemented..there’s a difference there, I think

Kindred Winecoff said...

Anon, if by "specific individuals and organisations" you mean (at varying points) the G-20, IMF, OECD, the Fed, the ECB, the Bank of Japan, Latvia, China, the entire discipline of macroeconomics, the leadership of both major US political parties, and almost every prominent pundit on either side of the Atlantic... then I agree: he can be very specific in his targets. It's just that there are a lot of them.

He does like Argentina tho, for some reason.

That's not what annoys me. What annoys me is that he *does* speculate as to why those groups/individuals choose some policies over others. And when he speculates, he does not tend to point out that, say, when rich Germans advocate a policy that would benefit them at the expense of poor Greeks, *that does not make them evil or insane*. It just makes them interested.

Put another way, I am no tougher when criticizing Krugman's sloppy takes on politics -- which have dominated his op-ed page for years -- than he is on the sloppy economic claims of others. I have used no stronger language towards him than he has used towards others. I do not think I exaggerate Krugman's positions: he's constantly talking about Confidence Fairies and Bond Vigilantes and VSPs and etc. (Which is strange anyway, since the Confidence Fairies and Bond Vigilantes have definitely materialized in Europe!) I'm merely pointing out that there are other explanations for political outcomes, including the simplest one.

If I spend more time on him than others it is because he is the most prominent pundit on political economy in the world.

Sebastian said...

I think one problem is that you spend all your energy on an uninteresting strawman version of Krugman rather than on the real Krugman. I think you're right that Krugman isn't always great on PE, but then you say thing like: "since the Confidence Fairies and Bond Vigilantes have definitely materialized in Europe"
when Krugman keeps harping on about how the US isn't comparable to Greek and lessons from Greece and Southern Europe aren't applicable to the US.

As for the specifics of German policy makers, whether what they're doing is in the best interest of the German economy is an economic question, no? Sure, short term more inflation in the Euro Zone would cost Germany at the benefit of the Southern countries. But if that leads to the breakdown of the Euro zone, that short term benefit will almost certainly be outweighed by the costs - which means it's a foolish choice. Of course, Krugman could be wrong about this and this is why I think your addendum was actually the more interesting part of your post.

I think this is a general problem of the strong version of rational choice PE*. One of my favorite examples is the support of business for Menem's 1990s policies in Argentina, which did benefit them in the short term, but in the medium run destroyed much of them and a good chunk of their political power along with it. I don't think there is an easy RC explanation for this. Individual greed and corruption go some ways towards and explanation, but that brings you pretty close to Krugman-type causes.

* I think that's also why Dani Rodrik is so disenchanted with the strong RC version of PE. I think Dani is wrong about PE in general and there are alternatives, and they're not necessarily constructivism, but that's a discussion for another day.

Kindred Winecoff said...

My addendum might be interesting if it wasn't wrong. Pretty much backwards, actually. I'm not sure what I was thinking.

Krugman is right to point out that the US isn't Greece. But (IIRC) he doesn't have a real great explanation as to why. The answer is that the US is embedded at the core the structure of the global economy (and political system) while Greece is in its periphery. Most relevant is having the biggest influence on the global monetary system -- because the dollar is in high demand globally, the US isn't likely to face a rapid, massive rise in inflation -- and the global "safe asset" financial system -- high demand for safe assets keeps US borrowing costs down, so no rapid spike in interest rates either. The US, in other words, is not the proverbial "small open economy" ubiquitous to modern saltwater macro. Krugman has said some of this but not, I think, in any systematic way. Not in the systematic way that he accuses the whole Federal Reserve, say, is trapped by common delusion. In any case it doesn't seem to be at the core of his thinking, and it's not what he spends most of his time on.

But if the US isn't Greece then Greece isn't the US. Greece has no choice but to engage in austerity, either through internal devaluation or external devaluation: either leaving the euro or gaining control of the ECB. The latter isn't happening, so it's either internal devaluation or leaving the euro. Either one is a form of austerity, although the distribution of austerity is somewhat different. So when Krugman rails against the Austerians he's just wasting air: some form of austerity has to happen, and for political reasons it's going to mostly be borne by Greece not Germany.

So if you surf over to Krugman's blog this second, the first post will be a comparison of highly-indebted EZ countries (eg Greece) with the UK during the 1930s. This is just as inappropriate as comparing Greece to the US today: the UK in the 1930s controlled the most significant global reserve currency and had the globe's largest financial market and very large gold reserves. Moreover, the UK's debt/GDP ratio was steady during the entire 1920s (at a relatively elevated level b/c of WWI) and then declined during the entire 1930s before spiking during WWII. That's not Greece's present situation.

A few posts down Krugman compares depressed EZ economies with the US in the 1930s, saying they've followed Hoover-esque policies. His evidence is a statistic estimating the primary fiscal balance if these countries were operating at full employment. But the primary fiscal balance isn't the problem! It's the interest rates that are the problem. Greece and Spain (and basically everyone but Germany... even France, to some extent) *are* facing the Bond Vigilantes, and Krugman is suggesting that they just ignore them. He says nothing about Germany, the ECB, or anything else in the post.

So I don't think it's a straw man. He's actually writing this stuff. Almost every day. I've tried to deal seriously with his arguments on many occasions (you can use the search bar in the top right corner if you like), but sometimes it's just easier to use Krugman's own short-hand against him.

Anyway, your point about Argentina brings up one of the things that is important about Europe: there *is no* "best interest of the German economy". A grinding recession in the EZ hurts some in Germany, but benefits others (relative to feasible alternatives anyway). And not necessarily just in the short run. It isn't very clear that Germany would be worse off outside the EZ, or if Greece was outside of it, or if the ECB pushed for a faster recovery, or if some kind of debt forgiveness program was enacted (it already has been). Some in Germany might be better off but others wouldn't be. So talking about what's right for "Germany" doesn't really work, even though I do it all the time too.

Sebastian said...

I'll respond in more detail later, but you simply have Krugman wrong on what he thinks Souther Europe's options are:
"My argument against austerity policies is addressed to countries that still have the choice. Spain and Greece had no option but to comply with Germany’s demands or run the risk of running out of funds." (from Sept. 2012)
http://www.presseurop.eu/en/content/article/2648061-paul-krugman-euro-shaky-construction

And I think the UK comparison hits on something that we've debated before here (I sometimes post as Latinamericanist) - Krugman makes a very isolated point: Ollie Rehn is a fool for saying that Keynes wouldn't have been a Keynesian with 90% debt/GDP ratios when Keynes clearly was, well, a Keynesian. I think that for Krugman that point illustrates that Ollie Rehn has no conception of economic history, not that UK 1930 and Greece 2013 are suitable analogies.

Kindred Winecoff said...

I think that Krugman interview (which I don't think I'd seen previously) says a lot about the issue I have with him. Take this: "But it nonetheless served to justify a general dogma of austerity and the belief in its universal application. And all other points of view were rapidly excluded from the ensuing debate which proved to be highly conformist."

Krugman seems to have decided to do exactly the opposite: rail against austerity in a dogmatic fashion, in the hopes of increasing the legitimacy of fiscal expansion where it was possible. So while he says that he knows that Greece/Spain have to have austerity, he spends far less time mentioning that than he does attacking austerity-as-ideology.

(Even in that interview he implies that austerity is only necessary b/c of "Germany's demands", the implication being that if Germany thought differently austerity could be avoided everywhere in the EZ. But that's not true. High inflation in Germany to boost Greek competitiveness is just a redistribution of austerity from Greece to Germany. Massive ECB purchases of peripheral sov debt redistributes the debt burden from the periphery to the core. Etc.)

The thing is, when I look out into the world I don't see a "general dogma of austerity and the belief of its universal application". The right/left battles in the US and Europe are less about the effect on the output gap and more about who picks up the check. Germany doesn't want to pick up Greece's tab. The GOP doesn't want to pay for programs which will not benefit their core constituency. There may be a few people out there who believe in "expansionary austerity", but not many.

So I think Krugman frames the problem completely wrongly.

As for Keynes, who knows what he would think were he alive today. He's notorious for his inconsistency and for changing his mind over time (and for having no taste for politics). He famously said that he was the only "non-Keynesian" at the Bretton Woods Conference. It doesn't really matter, but it is possible that Keynes would look at the UK today -- which has by far its largest deficits in the postwar era, some 9% of GDP per year still -- and say "Yeah, that's not austerity".

Nicholas Martin said...

Interesting point. But what about the early 2000s, when Germany went through a serious recession? My understanding is that ECB-set interest rates (IR) at that point were too high for Germany (tho' still to low for e.g./esp. Spain), seriously exacerbating the German recession. How would that fit with your model of a German-dominated ECB?

(Note:

1) I don't know whether early 2000s IR really were too high for Germany. It's just what I've generally picked up -- maybe this conventional wisdom is wrong?

2) You could always argue, I guess, that in the early 2000s the ECB set IR as low as was realistically possible in order to help Germany, accepting the negative effects this had on the periphery as the necessary price. One could try to argue this, but would have to come up with some very good objective standard for measuring what were the lowest "realistically possible" IR, or else the overall argument [ECB mainly focuses on Germany in setting IR] becomes effectively non-falsifiable.

Would be genuinely interested in your thoughts on this.)

United States Financial Crisis said...

I think the problem of the eurozone is deciding to share the same currency but not the same laws. This had resulted for some countries like Greece, Cyprus, and Spain to take advantage of this and spent all of their money with the thought that the stronger countries like Germany would bail them out

The Eurozone Political Crisis in One Picture
 

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