IN A recent post, Simon Wren-Lewis assigned blame in the euro crisis in a provocative way: it's the core's fault! He clearly wants to provide a counterweight to the opposite story ("It's the periphery's fault!"). However, he goes a little too far.
Mr Wren-Lewis correctly points out that the core countries of Europe, when setting up the euro, did not take proper account of the macroeconomics of a currency union, focusing instead on an inadequate limit on public debt.
When the Euro was formed, its fiscal architecture was embodied in the Stability and Growth Pact (SGP). ... That fiscal architecture was all about containing deficits, and said nothing about using fiscal policy to control domestic demand. To many economists, this was something of a surprise. Much of the academic work leading up to the formation of the Euro had stressed the crucial role that countercyclical policy could play in reducing the consequences of asymmetric shocks in a monetary union. The SGP effectively ignored that work.
Indeed. But even though the SGP ignored this academic work, there was nothing to stop the peripheral countries taking its warnings to heart anyway--as Sweden did. Those peripheral countries that got carried away during the pre-crisis boom could have used fiscal policy or macro-prudential tools to engineer the necessary counter-cyclical policy. After all, there was nothing in the Stability Pact to prevent countries running tighter policy.
After the Euro was formed, interest rates came down substantially in the Periphery. There was a substantial amount of lending by the Core private sector to the Periphery private sector. This led to inevitable overheating in these periphery countries relative to the core. At this point the Core, and the bureaucratic apparatus that was essentially under the Core's control, should have been sounding alarm bells. But instead they continued to follow the flawed fiscal architecture. In the case of Spain, as is well known, the budget deficit looked OK according to these fiscal rules, so the overheating there was allowed to continue. As a result, we got a housing and construction bubble.
So the European “bureaucratic apparatus” is in part to blame for the failure of the Spanish and Irish authorities to stabilise their economies?
Consider a parallel with the sub-prime crisis. Do we hold the low income households who took out mortgages they could not afford responsible for the financial crisis that ensued? … Instead we ask, how can the financial system have allowed this to happen? … I think we should have the same response to the Euro crisis. What was wrong with the fiscal and banking architecture that allowed housing bubbles and the like in the Periphery, and who was responsible for this architecture?
To see what's wrong with this, just ask yourself: what would Spain and Ireland have done if some European bureaucratic apparatus, let alone Germany, had told them to rein in their unsustainable credit, banking and housing booms, and to run massive fiscal surpluses to cool down their economies? Clearly, they would have insisted on their sovereignty, and politely told the others to mind their own business.
It was their choice to implement whatever policy they thought best suited their economies. Blaming the core for the periphery's bad choices means not taking these “subprime” countries seriously.
Indeed, it was their choice to join the euro in the first place. EU treaties oblige most of its members to join the single currency at some point. But this formal obligation has little weight in practice, as Sweden has demonstrated. Countries like Spain could have paid more attention to the dangers of low interest rates and heavy capital inflows in the absence of currency flexibility. It was their choice to trade monetary independence for dangerously low interest rates. It was not the ECB that killed Spain, as Matthew Yglesias recently suggested. Economic suicide would be the more appropriate term.
Of course, one might sympathise with the periphery's predicament. They had to choose between going it alone or joining an ill-designed single currency. Presumably what they really wanted to join was a well-designed single currency. The core is partly responsible for giving them such an unpalatable choice. But it was a choice nonetheless, and Sweden, the UK and Denmark decided differently.
The sad fact is that Europe as a whole underestimated the macroeconomics of the euro -- despite the experience of others and warnings from abroad. All countries--in the core and on the periphery--should have thought harder about the institutions required for macroeconomic stabilisation when they set up or joined the euro. It would be better if we just stop blaming each other, and discuss how to improve the economics of this currency union now and in the future. Mr Wren-Lewis' own research, for instance, has plenty to offer.
Readers' comments
The Economist welcomes your views. Please stay on topic and be respectful of other readers. Review our comments policy.
Sort:
The whole crisis is one big joke. It´s funny to read new Montis statements, how he blaims northern euro countries about their situation. Italians have done nothing to save money. Berlusconi said that paying taxes is stupid. Well, now they ar broke and they think that ewerybody else must save them. In euro area there are 4 economically strong counries, Germany, Netherlands, Finland and Austria and what I think, is that they are not gonna pay everybody elses bills.
IT'S NOT ABOUT BLAME
"The intracies of the World are changing almost as quickly as technology. What was new yesterday is old today. What worked last year doesn't work today. The euro was a great idea then but cirmstances in all 17 euro sovereign countries changed. A good and noble idea of a common market has outlived its usefulness."
Richard Michael Abraham www.redii.org
The motive behind Simon Wren Lewis's piece may have arisen from his frustration that, in this crisis, the moral argument is being used by Germans as a substitute for a constructive economic response to this crisis.
The fact is that any intelligent consideration of Europe's (and Germany's) economic welfare has been completely set aside in favour of an exhibition of self serving old wives tales which misrepresent both the current crisis and Germany's own role in it's formation.
The role that Germany herself played in breaking the EMU treaties is not acknowledged.
The role that Germany's particular dependence on export trade surpluses and the role these unprecedented intra European trade imbalances have played in creating both the Southern credit bubble. These trade imbalances first broke and then reversed the momentum towards economic convergence in the eurozone as a whole. In the absence of a full bore fiscal and treasury union it was economic convergence which was the indispensable ingredient for the survival of the single currency. The best predictor of eurozone casualties from this crisis was the deficits they suffered in their trade with Germany - not their own fiscal deficits.
Finally this German promoted revival of economic mediaevalism that insists on applying unlimited fiscal and monetary blood-letting to a set of patients already dangerously weakened by the worst financial crash since 1929.
To be sure there is much blame to go around but Germany's share is disproportionately large.....
It seems to me that you haven't understood this article. Or are you Simon Wren-Lewis himself?
For example, you say "The role that Germany's particular dependence on export trade surpluses and the role these unprecedented intra European trade imbalances have played in creating both the Southern credit bubble."
But you don't say "The role the periphery countries particular dependence on imports and their lack of competitiveness which was a result of insufficient structural reforms, especially during good times ..."
If Germany improves its competitiveness in a globalized world, is it in charge of forcing other peripheral countries to catch up or are the countries in charge of themselves to keep an eye on their own competitiveness and current account balances?
What would have happened if Germany told the periphery to become more competitive so that the imbalances with each other don't get too big and so that the EZ as a whole gets more competitive compared to the rest of the world? You find the answer in the text: "Clearly, they would have insisted on their sovereignty, and politely told the others to mind their own business." And BTW, there is a Lisbon strategy, saying the EZ should become the most competitive area in the world by 2010. It is rather like that: Germany commited to those agreements, reformed and became more competitive, the periphery simply forgot it.
Well the Germans were certainly much nicer to the periphery when they were uncompetitively consuming all of her surplus product. Pity the Germans didn't realise that they were really paying for it all on German loans.
How competitive does that make the German export model?
The price of default is falling for all those unworthy debtors nations and growing for competitive Germany. Let's wait and see
what happens after Germany's savings are destroyed before we award zero sum trade policies and neanderthal austerity policies first prize in the global competitiveness league.
You still don't seem to get it. The Germans did not have any influence on "the periphery when they were uncompetitively consuming all of her surplus product." Moreover, the Germans as well as the periphery agreed to the Lisbon goal of becoming the most competitive economic area in the world. That means that the Germans were never planning to leave the periphery behind but those countries outside Europe instead. And mutual trading is never a zero sum game since increasing imports from one country doesn't prevent exporting more to the same country, increasing the entire trade volume. And the Germans try hard to convince the periphery to catch up, that means they do not aim at having a trade surplus with them but to have increased overall trade. These are not "zero zum trade policies".
But your comment shows a sentiment of deep rooted hate against the Germans. So I guess you just don't want to get it.
@Pacta: "You still don't seem to get it. The Germans did not have any influence on "the periphery when they were uncompetitively consuming all of her surplus product."
Of course they did – they provided the money that funded the consumption. Net exporters of goods are always net exporters of capital. That is how Germany extracted such huge trade surpluses from poorer countries.
Within Europe Spain is poorer than Germany but in 2008, prior to the impact of this crisis, she nonetheless had a trade deficit with richer Germany of $38 billion (equivalent to 3% of Spanish GDP!). This level of deficit was not untypical of the preceding years. Greece had an ‘08 deficit with Germany of $13 billion!
The laws of comparative advantage have therefore been reversed within the eurozone – the richer partner is securing all of the trade advantage at the expense of the poorer partner. Even in the short term this is unsustainable without the massive injection of credit – which Germany provided. A vast vendor financing scheme. This money was not invested it was provided to fund consumption - and that's precisely what it funded.
@Pacta "Moreover, the Germans as well as the periphery agreed to the Lisbon goal of becoming the most competitive economic area in the world. That means that the Germans were never planning to leave the periphery behind but those countries outside Europe instead."
The belief that all the member states of the broader eurozone economy 90% of whose economic activity occurs within its own borders could all be like Germany i.e, net contributors to supply with no-one contributing to net demand is a truly fantastic German superstition. The fallacy of composition operates here – there cannot be a eurozone economy in which all member states simultaneously enjoy a net trade surplus.
Let us keep this short – the list of indictments against Germany in this crisis follows:
1.) The persistent and wilful German misrepresentation that all this was about Southern fiscal indiscipline. Germany breached the debt and deficit rules 7 times in just ten years. Spain and Ireland did not and even Italy had a far better record of pre crisis fiscal discipline than did Germany.
2.) The reality is that poor private lending decisions from the core were as much to blame as irresponsible private borrowing from the core.
3.) The German insistence that Southern austerity was the only recipe for recovery. Austerity is the means by which all economic adjustments are forced onto the shoulders of the poorest members who have been deliberately been driven into greater poverty amid a sea of unemployed. This is not help it is a crime against humanity.
4.) That current account imbalances were the product of intra eurozone trade imbalances which meant the core ended up exporting excessive cheap credit to the periphery.
5.) Within the eurozone, Germany only contributes net supply not net demand. Germany’s suppressed wages and suppressed domestic demand (engineered via punitively high rates of marginal taxation) has not resulted in trade surpluses with its near east trade partners because they have effectively countered Germany’s internal devaluation by responding with an external devaluation of their own. They have allowed their own currencies to depreciate thus diminishing the volume of German imports and increasing the volume of their own exports to Germany. They have a modest but growing net trade surplus with Germany precisely because they still have their own currencies. For their part the poorer Southern periphery are locked into the euro and they have contributed over a $ 1.5 trillion to Germany in trade surpluses in the post euro 2000 to 2008 period. It has been a deliberate policy of structural mercantilism that has driven the eurozone apart. It has been Germany’s ability to export her unemployment to the southern periphery that lies behind the periphery’s devastated public accounts and which is now being returned to Germany as peripheral debt that cannot and will not be redeemed. The euro has therefore been a lose lose contract for both parties – win lose trade deals always end in tears.
6.) Making the periphery pay through debt deflation in order to indirectly rescue core banks was not an act of solidarity but an act of oppression.
But the minority of core and periphery politicians and journalists who were capable of understanding the economic theory behind the inherent flaws in the Euro from the outset did not mind a crisis, because it could be used to blackmail their electorates into a political union. That such a union could not be democratic, and that most of Europe would be reduced to poverty they simply did not care - and many of the europhiles (including all political leaders in all major European parties) still don't!
You are completely right!
I cannot figure out if the blackmail will work, however, and what will be the outcome; a strong euro union (German style) or a weak euro union (GIPSI style). Right now Germany looks to have the upper hand, but they might have to cave in at some point and then the gates are open. Either way, very many people will be very unhappy about the end result. Wonder if it will hold.
I am pretty sure though, that the world leader, super-power, ultra-competetive EZ that seems to be the dream outcome will not happen.
Matthew 7:18 >>
A good tree cannot bear bad fruit, and a bad tree cannot bear good fruit.
If fault is to be apportioned, should not the major part of blame be placed on lenders who confused country risk (which arguably becomes greater in a currency union, as the governments have one less policy instrument)with currency risk that disappeared?
You can't borrow too much unless someone lends you too much.
You can't borrow unless you make the decision to go to an office and sign papers agreeing to borrow.
You can't get drunk unless you drink too much.
Perhaps we need to shut down the credit markets and make everyone pay with cash.
That might shut up bampbs' whining.
NPWFTL
"certain countries went on a borrowing binge" because certain other countries went on a lending binge...
Can´t have one without the other.
It is important to call attention correctly to the origins of the cross-border credit bubble, as banks recycled export surpluses under the distracted (im)prudential supervisin of the national central banks, followed by a cross-border credit crash.
Incoming and outgoing tsunamis of hot money, as seen from the periphery.
Now we have to save the banks immediately and to rebalance intra-Eurozne competitiveness as well
Spanish economist Jesus Huerta de Soto offers a brilliant defense of the Euro at mises.org/daily/6069/An-Austrian-Defense-of-the-Euro:
“…that the euro has ended up acting de facto as the gold standard, disciplining citizens, politicians, and authorities, tying the hands of demagogues and exposing pressure groups (headed by the unfailingly privileged unions), and even questioning the sustainability and the very foundations of the welfare state.”
“Moreover, the above ends up affecting the revenues of each public sector, and thus, of its credit rating. In fact, under the present circumstances, in the euro area, the current value in the financial markets of each country's sovereign public debt has come to reflect the tensions that typically revealed themselves in exchange-rate crises, when rates were more or less fixed in an environment of monetary nationalism.”
“Therefore, at this time, the leading role is not played by foreign-currency speculators but by the rating agencies, and especially by international investors, who, by purchasing sovereign debt or not, are healthily setting the pace of reform while also disciplining and determining the fate of each country.”
“Today, with the euro, the recourse to an inflationary tax has been blocked, at least at the local level of each country, and politicians have suddenly been exposed and have been obliged to tell the truth and accept the corresponding loss of support. Democracy, if it is to work, requires a framework that disciplines the agents who participate in it. And today in continental Europe that role is being played by the euro. Hence, the successive fall of the governments of Ireland, Greece, Portugal, Italy, Spain, and France, far from revealing a democracy deficit, manifests the increasing degree of rigor, budget transparency, and democratic health that the euro is encouraging in its respective societies.”
“…in wishing (halfheartedly) that the eurozone would "get its economy in order," and yet self-interestedly omitting to mention that the financial crisis originated on the other side of the Atlantic, i.e., in the recklessness and the expansionary policies pursued by the Federal Reserve for years, the effects of which spread to the rest of the world via the dollar…”
“…without an autonomous monetary policy, the different governments are being forced to reconsider (and when applicable, to reduce) all their public-expenditure items, and to attempt to recover and gain international competitiveness by deregulating and increasing as far as possible the flexibility of their markets (especially the labor market, which has traditionally been very rigid in many countries of the monetary union).”
“Thus, the fatal error of the ECB consists of not having managed to isolate and protect Europe from the great expansion of credit orchestrated on a worldwide scale by the US Federal Reserve beginning in 2001.”
“On a worldwide scale, the survival and consolidation of the euro will permit, for the first time since World War II, the emergence of a currency capable of effectively competing with the monopoly of the dollar as the international reserve currency, and therefore capable of disciplining the American ability to provoke additional systemic financial crises that, like that of 2007, constantly endanger the world economic order.”
“Thus, the fatal error of the ECB consists of not having managed to isolate and protect Europe from the great expansion of credit orchestrated on a worldwide scale by the US Federal Reserve beginning in 2001.”
I'm not sure about that.
An alcoholic can always find a drink.
Sounds like a poor attempt to blame the Fed for their expansion of gov't jobs and pensions to their cronies, amongst other things.
"A key obstacle was that the cajas didn’t have shareholders; they were controlled by a mixture of politicians and depositors."
"But the failure of governance at others was of epic proportions. Isabel Cambronero, a professional dancer appointed to the control committee of Caja de Ahorros del Mediterraneo, bailed out and later auctioned, said nobody ever told her there was a crisis. Other ex-board-members tell of meetings in New Delhi and Chicago. Huge pay packages and golden handshakes were the norm."
http://www.economist.com/node/21556953
NPWFTL
Regards
Read the whole article. He has plenty of criticisms for governments, too.
…that the euro has ended up acting de facto as the gold standard, disciplining citizens, politicians, and authorities, tying the hands of demagogues and exposing pressure groups (headed by the unfailingly privileged unions), and even questioning the sustainability and the very foundations of the welfare state.”
I am trying to find evidence of all of this disciplining going on. A country that can't borrow because it has gone bankrupt has hardly been "discipled".
Bankruptcy is the discipline that the Euro imposes.
fundy,
It wouldn't load.
I hope it didn't call for laws or rules to prohibit actions by individuals and corporations, or to impose actions on individuals and corporations.
Those would be regulations.
And you are against regulations.
NPWFTL
Regards
You misrepresent me. I am for the rule of law. I'm against the state micromanaging the economy, which has everywhere and always has led to disaster.
Mr Wren-Lewis has to be a blast at AA meetings.
"It's not my fault I'm an alcoholic, it's the fault of the people that make booze!"
NPWFTL
Regards
But the core countries knew that the success of the project depended on the responsibility and fiscal prudence of Greek and Spanish politicians. And yet they entered the EU freely and with their eyes open. So it's _their_ fault.
But wait... the periphery countries knew that the core countries knew all that, so it's _their_ fault for going ahead. But the core knew that the periphery knew that the core knew all that, so it's _their_ fault.
You get the point: assigning total blame to any one party because they knew the risks is an oversimplification. The blame is shared in some unknown, mixed proportion. The problem that SWL identifies is that too many assign 100% blame to the periphery countries and 0% to the architects of this fatally flawed project, not to mention the politicians who signed off on it.
(Although: you really think Spanish politicians should have/could have counteracted massive capital inflows by fiscal policy? How would that have worked? Fire all the teachers so that the unnecessary housing boom wouldn't produce too much inflation? Have the police arrest subcontractors and prevent them from installing drywall? And how long would a politician last who voluntarily increased unemployment for vague macroprudential reasons. At least a central bank can cite inflation concerns when they take actions that increase unemployment, and they're independent to boot. Yup, I'd score this for SWL: the core thought politicians could/would take on the job of a functioning central bank, and that predictably didn't work.)
"... you really think Spanish politicians should have/could have counteracted massive capital inflows by fiscal policy?"
.
Switzerland just did. Duh.
I don't really think Switzerland did. The National Bank has fixed the exchange rate to the Euro, which amounts to a heavy dose of monetary expansion; so in theory fiscal policy should strive to compensate that by running a large surplus. Don't count on it to happen.
The Swiss actions here are a really something interesting to watch. The way they nailed the currency appreciation was remarkably well done IMO. And they seem to be effective at not allowing the tsunami of cash pouring over them to leak into and corrupt the entire economy.
.
Too bad Spainyards aren't Swiss.
I agree more with the column than the above comment, because I think the column is correct in pointing out, (As I think MrRFox does) that monetary policy could be effective, and (implicitly) the periphery countries CHOSE to give that up when they joined the Euro zone.
The lack of action by the central European countries is frustrating but one must consider that it was a written reality that they should not be bailing out other countries. Even if the warning seemed crazy... it had some truth to it.
I think the mistake some might be making, is that blame can be diminshed by apportionment. The core is stupid, and the periphery is stupider.
"It would be better if we just stop blaming each other, and discuss how to improve the economics of this currency union now and in the future."
Hear Hear
So what's stopping you?
Well obviously it's not me personally, as just a general sort of citizen, who is in a position to do much about any of this – 'hear hear' is just a figurative expression for expressing agreement with a statement or speaker. (i.e. I am responding to the writer saying I think he has made a good point)
What's your point supposed to be?
The EZ and the rest of the world are in need of some good ideas on how to get past this thing. Seems that you recognize that. So, why not get the ball rolling and propose some? A lot of us already have, and I for one would like hear your ideas and those of any others who haven't discussed it to death already.
Well, for starters someone is going to have to tell the German population we are in a situation of having to choose a 'least bad' option – leaving aside for a moment the discussion on just what is ultimately and pragmatically 'least bad'.
Something will have to be done, and, whatever it is, it will entail trade offs that people – likely German people in particular – aren't going to like (which in itself I really don't blame them for).
It will have to be explained why something must be done and why the alternatives are only worse. In Germany you don't feel the presence of the crisis like you do elsewhere, so opinion hasn't been prepared for bad news of this kind.
The government of the day doesn't seem too keen on delivering this sort of prepatory message ('the Euro falling to pieces would be worse' etc.), so someone has to float such ideas to the public, perhaps the media?
And what is the "least bad option", as you see it?
Well that is precisely my point with 'leaving aside for a moment the discussion...' as I don't pretend to know which it is or have the resources to inform myself to the standard of the various chancelleries, central banks etc. who will have to take these decisions – though every proposal I have seen involves some kind of trade off, so trade off there will have to be.
In one way or another a trade off (whichever option is gone for) is likely to involve something German public opinion won't like.
So one thing that has to be done, is to prepare German public opinion.
I don't see anyone doing this, and our politicians, despite their protestations to the contrary, just don't seem able to get out in front of this.
One can debate about which strategy is the best/least bad – based on its various merits, arguments etc. – but one needs to pick A strategy.
If they have they haven't told us what it is.
The Euro was always seen as primarily a political project with its economic effects being mere details to be worked out by technicians.
The architects expected the periphery to become more like the centre but had no explanation of how this wss to be brought about.
I think they thought it would be a gradual pressure – not so unlike what is happening now, but not so calamitous and severe – that would gradually push towards the logic of greater union.
It would be sort of a creeping thing, not this lurching debacle we are witnessing now.
This is what I mean about failure to think the thing through: how was joining a common currency supposed to pressure Greece to become more like Germany short of by way of a "lurching debacle?"
Well how much does it really matter now?
Reliving battles from the past through hindsight about the errors of others might have a certain sporting allure, and sure there is perhaps a need to adjudicate responsibility at some point, but when we are in a boat trying to not end up on the rocks, primary concern is what to do in the here and now, I should think. This is not a sporting or an academic exercise.
Basically, we do know they thought it would work other than how it has (i.e. they f****d up, if you prefer) – and now we are where we are.
Now what?