1. The eurozone problems are structural, and stem from a monetary and economic integration that was not followed (I’d say accompanied) by fiscal integration (a federal budget to be clear). Hard to disagree on that
2. Without massive debt write-downs, no reasonable solution to the current mess seems feasible. Hard to disagree on that as well
3. Some more inflation would be desirable, to bring down the value of debt. Hard to disagree on that as well.

In a sentence, intra eurozone imbalances are the source of the current crisis. Could not agree more…

Unfortunately, Rogoff does not stop here, but feels the irrepressible urge to add that

Temporary Keynesian demand measures may help to sustain short-run internal growth, but they will not solve France’s long-run competitiveness problems [...] To my mind, using Germany’s balance sheet to help its neighbors directly is far more likely to work than is the presumed “trickle-down” effect of a German-led fiscal expansion. This, unfortunately, is what has been lost in the debate about Europe of late: However loud and aggressive the anti-austerity movement becomes, there still will be no simple Keynesian cure for the single currency’s debt and growth woes.

The question then arises. Who ever thought that a more expansionary stance in the eurozone would solve the French structural problems? And at the opposite, why would recognizing that France has structural problems make it less urgent to reverse the pro-cyclical fiscal stance of an eurozone that is desperately lacking domestic demand? Let me try to sort out things here. This is the way I see it:

1. European woes have deep sources. Institutional developments have led to a suboptimal currency area that endogenously created imbalances; as of today only extreme solutions seem to offer a durable solution: Either we cross the ford towards a fully fledged federal entity, with a federal budget (the United States of Europe, just to be adamant); or we go back where we were a few years ago: a common market, in which each country retains its own monetary and fiscal sovereignty (we could call it the British View).
2. The eurozone structural problems made it fragile, and the crisis exposed them.
3. Disastrous management, and widespread adherence to the Berlin View have imposed harsh austerity to the periphery and to the core alike, worsening the textbook Keynesian demand slump.
4. There is little hope that the aggregate fiscal stance in the eurozone turn positive (thus fighting the recession), if  core countries do not make a u-turn in their fiscal policies

From his Project Syndicate piece I infer that Rogoff would broadly agree with me on items 1-2. But I do not see why this would lead to deem appropriate the fiscal stance Europe is following today. Claiming that we need to sustain aggregate demand, here and now, in no way impacts on the diagnosis of the structural problems of the EU (even if I suspect that I would not have the same solutions as Rogoff for these problems). If anything, given that the fiscal expansion would mostly happen in the core, it would help, not hamper the necessary rebalancing between core and periphery.

The question remains of why we keep observing eminent economists that bash Keynesian policies even when this is inconsistent with (or irrelevant to) their general argument . Barring bad faith, I can’t find any other explanation than an ancestral aversion to Keynes and to its policy prescriptions (a couple of years ago Paul Krugman coined the term of Keynesophobia): whatever argument you are making , just find a way to slip into it a couple of paragraphs claiming that Keynesian policies would not work. This will keep you safe from hell. Could this also explain why a few excel cells were forgotten in a formula?

If that is the case, discussing it is not a job for me…

And here we are. With  timely synchronization, we learn that wages in Bavaria will increase  by 5.6% over the next two years,  maybe triggering a more generalized increase. Or maybe not. While in China they increased 17% in the year 2012.

Even taking into account differences in inflation and in growth, the difference is revealing. China is actually playing the game it committed to. Not only it tries to reduce its dependence on foreign demand; but, domestically, it is trying to boost consumption and to curb investment.

In the meantime Germany is stuck with its small-country syndrome: export-led growth and restraints to domestic demand (both public and private). In spite of recent troubles, austerity remains the course Europe is following (with disastrous results). It is telling that even when partially acknowledging that austerity did not bring the fruits she hoped for, Angela Merkel can only suggest, as an alternative, structural reforms to boost competitiveness. Expanding domestic demand has not, is not, and will not be an option for the German government.

The Berlin View is alive and kicking.

Not surprising, I said, because in spite of increasing talks about softened austerity, austerity ain’t over. In many countries, government final consumption in real terms (the G in national accounting equations, just to be clear) sharply decreased. And this is, surprise, correlated with subsequent growth:

In plain English, countries that expanded government consumption (in real terms) in 2012, tended to have more growth in the first quarter of 2013. I took away extreme cases (Latvia and Lithuania, that had exceptional exports increase, and Cyprus and Estonia, that had a rough first quarter for other reasons; lighter in the figure), and ran a raw regression (excel! and with only 17 observations! R&R taught me nothing…). The regression shows that one extra euro of public consumption in a given year would yield 31 cents of extra GDP (annualized) in the first quarter of the following year. I know, it has already been said, but it is worth repeating over and over again: austerity is not good for growth…

Two more considerations:

1. The few positive growth outliers (in particular Latvia and Lithuania) had very strong export performances over the year 2012 (around +10%). In general, one may argue that once considered exports, that especially for small countries have a major impact on growth, the effect of government consumption could turn out to be smaller than simple correlation would imply. Well, actually not really. Adding export change (in 2012) to the regressors (once again, do not take this as more than suggestive evidence; 17 observations is really too little to claim robustness), the impact of government spending is only slightly reduced  even if the goodness of fit is improved.
2. I went maybe a bit too fast when I said that the Eurostat press release was not surprising. In fact, the surprise is that growth in Germany has been anemic throughout 2012. After all the alarmist talk about the poor performance of France, and the danger it poses to the eurozone stability, it turns out that its public consumption did not expand more than Germany’s, and that the growth performance is equally bleak (-0.3 against -0.4 per cent). Advocates of the German model should come back a bit later…

Meanwhile a standard (and trivially textbook-Keynesian) monetary and fiscal expansion is boosting growth in Japan, to levels that in Europe would be considered miraculous. More important, besides exports, behind the boom for the first time there is a robust increase of domestic (household) spending. The Keynesian multiplier at work…  If I recall correctly we were told just a few months ago (no wait, it was a few days ago) that Abenomics was a risky bet, and that our wise European leaders were right in putting the house in order. For Japan it is maybe too early to tell, but  for Europe certainly not. At the interval, Abe leads Rehn-Merkel 3.5 to -0.8. I do not see how we could win the game in the second half if we do not change strategy..

I tracked in particular the evolution of private (consumption plus investment) and public expenditure on good and services.

One can distinguish two phases. During the first, 2008-09, the EMU is in synch with the US (and with most other advanced economies): private expenditure falls dramatically as the crisis spills from the financial sector to the real economy; and governments gradually build up a classic Keynesian response, reaching its climax with the stimulus plans implemented in 2009. But the interesting part is the second phase. The figure shows that from the beginning of 2010 the crisis went local. While private expenditure picked up in the US, it kept falling in the eurozone. The Greek crisis and the eurozone response have been depressing the confidence of households and firms.
Looking then at public purchases of goods and services, one may be tempted to say that austerity was much harsher in the United States than in the EMU. The temptation should be resisted. First, because in a few small countries in Europe the drop in public spending was dramatic, and it simply does not show in aggregate figures because of their size. Second, and most important, because the reduction of public demand in the US accompanied the increase of private expenditure. In other words, the United States government fully played the role of supporting aggregate demand when needed, and withdrew only when private demand gained momentum. That is a What-Keynes-Would-Have-Really-Done countercyclical fiscal policy. I would argue that, because of the exceptional levels of unemployment, and of the ineffectiveness of monetary policy at the zero lower bound, the fiscal stance should have remained more expansionary throughout the years 2010-12. It remains nevertheless true that the fiscal contraction in the US only begun once the private sector showed at least some capacity to walk alone.
In the EMU, public purchases of goods and services should have continued to increase to compensate the continuing reduction of private spending; but this did not happen, with the result that fiscal policy ended up being countercyclical. The table below is an apt summary of the discussion so far; it shows the correlation between public and private expenditure in the two periods. Roughly speaking (correlation does not imply causation, ask  Reinhart and Rogoff for details), a negative correlation indicates that fiscal policy may have been countercyclical.

In the US the correlation is negative in both periods. Public spending increased when consumption and investment were falling (2008-09), and decreased when the trend in private expenditure was reversed. In the eurozone, since 2010, private and public expenditure have been moving in the same direction, yielding a positive correlation coefficient. This table alone explains a good deal of why the EMU economy “decoupled” from the rest of the world, and has been flirting with recession since then.
There is more than that. The (mis)management of the eurozone crisis has exposed all the flaws of the single currency while showing an astounding lack of solidarity among member countries, and not indicating any clear solution for the future. The only clear indication has been the stubborn insistence on an austerity that is proving self defeating. This certainly had a negative impact on private sector’s confidence, and contributed to depress its demand.

And still no turning point in sight…

Austerity partisans had a couple of rough weeks, with highlights such as the Reinhart and Rogoff blunder, and Mr Barroso’s acknowledgement that the European periphery suffers from austerity fatigue.
In spite of the media trumpeting it all over the place, and proclaiming the end of the austerity war, it is hard to believe that eurozone austerity will be softened. Sure, peripheral countries will obtain some (much needed) breathing space. But this is neither a necessary nor a sufficient condition for a significant policy reversal in the EMU.

The problem is that there is no sign that core countries like Germany will finally let their domestic demand expand. And yet, this is what is needed. Look at the following figure, comparing the EMU and the US performance from the peak of the crisis to the latest available data (the last quarter of 2012):

What is this figure telling us? Many things, actually; but I’d like to point out just three:

1. The first is that while the US have recovered and are now above their pre-crisis GDP level, the EMU is still more than 3% below its level of January 2008. We are not going to see the pre-crisis level of activity for at least 2 or 3 years, as the Commission just revised downwards its (negative) growth forecast for 2013 (not surprising, and bound to be further revised, as the readers of this blog may know).
2. Domestic demand is down almost 6%, mostly because of investment (-19.1%).It makes no sense claiming otherwise: this is a Keynesian (sorry for the bad word; should I rate this post R?) aggregate demand deficiency crisis. On the contrary, in the US, robust consumption growth has compensated for the equally dramatic drop of investment, and as a result domestic demand is also above its pre-crisis level. As a sidenote, the dramatic decrease of investment makes one wonder what will be left of the EMU capacity to produce, once aggregate demand resumes.
3. The only two engines of growth, today are public consumption (!) and exports, both at around +4% with respect to the pre-crisis peak ; they compensate, unfortunately only partially, the dramatic drop in domestic private demand. Further reducing government spending, as will most probably keep happening, will lay the burden of recovery only on the external component. It is worth repeating that this small-country-syndrome, in the second largest economic bloc of the world, can only spell disaster. It is impossible to conceive a long-term reliance of our prosperity on demand coming from the rest of the world, as proponents of the “Berlin view” would like us to believe.

It seems very hard not to read from this figure that the EMU needs to seriously boost domestic demand, if it wants to break free from the recessionary spiral that is afflicting it since 2008. And once this is agreed, then it becomes clear why this talk about softened austerity at the eurozone level is pure nonsense. The eurozone is compressing public expenditure, while the private sector, downbeat or financially constrained, keeps expenditure stagnant. Countries that can afford it (hint: their longest river is called Rhein…) should increase their domestic demand. Not because they need to save those sinners in the periphery, but because of their size. No expansion of eurozone aggregate demand can happen without a reversal of policies in Germany.

Whether rebalancing will happen through higher wages (much needed), or increased public spending, is not for me to say. But unless Germany accepts to act as the locomotive of European growth and increases its domestic demand, giving one extra year for budget consolidation to Greece, Spain or Italy, will not end austerity. It ain’t over…

If I were Krugman I’d be thrilled to be challenged by arguments that basically vindicate my points…

As a side note, of very minor importance: Mees faithfully reports the outraged tweets that followed Krugman’s remarks on cockroach ideas. It jumps to the eyes that while Krugman challenged the ideas and not people at the Commission, the response was a long sequence of personal attacks. Probably he is easier to label as unimpressive than his arguments…

• Austerity did not work. Portugal is in a recessionary cycle. The economy will shrink by 2.3 per cent this year, more than twice as much as the previous government forecast (and the slowdown of exports to the rest of the eurozone, is not helping).
• Austerity is self defeating: the deficit-to-GDP ratio widened from 4.4 per cent in 2011 to 6.4 per cent last year, and is forecasted to be 5.5 per cent in 2013. Far above the target of 3 per cent that the government had agreed with the Troika. My guess is that it will be even larger than that.
• The magic wand of confidence is not magic. The budgetary cuts did not boost private spending, and expectations remain gloomy. The Financial Times article cites the Portuguese daily Público writing “Portugal has entered a recessionary cycle. People have no reason to believe the future will be any better. The [adjustment] programme has failed and has to be changed.” So long for the confidence fairy…

Is this surprising? Not at all. Austerity is likely to be recessionary and self-defeating, when a number of conditions are met. (a) Monetary policy is at the zero lower bound, and cannot compensate the recessionary effects of budget cuts with interest rate reductions. (b) Trading partners are also in a slump (and/or they are also implementing austerity measures), and hence exports can not substitute for decreased domestic demand. (c) The private sector is deleveraging, and subject to a credit crunch. This is pretty much a description of the current situation in the eurozone. Can anybody not blinded by ideological faith in expansionary fiscal contractions, believe that austerity today is not self-defeating? And yet, today we were  given the opportunity to read the  statement by the European Commission on Portugal. It is so incredible that it is worth reproducing it in its entirety:

The European Commission welcomes that, following the decision of the Portuguese Constitutional Court on the 2013 state budget, the Portuguese Government has confirmed its commitment to the adjustment programme, including its fiscal targets and timeline. Any departure from the programme’s objectives, or their re-negotiation, would in fact neutralise the efforts already made and achieved by the Portuguese citizens, namely the growing investor confidence in Portugal, and prolong the difficulties from the adjustment.

The Commission therefore trusts that the Portuguese Government will swiftly identify the measures necessary to adapt the 2013 budget in a way that respects the revised fiscal target as requested by the Portuguese Government and supported by the Troika in the 7th review of the programme.

Continued and determined implementation of the programme offers the best way to restore sustainable economic growth and to improve employment opportunities in Portugal. At the same time, it is a precondition for a decision on the lengthening of the maturities of the financial assistance to Portugal, which would facilitate Portugal’s return to the financial markets and the attainment of the programme’s objectives. The Commission supports that such a decision be taken soon.

The Commission will continue to work constructively with the Portuguese authorities within the parameters agreed to alleviate the social consequences of the crisis.

The Commission reiterates that a strong consensus around the programme will contribute to its successful implementation. In this respect, it is essential that Portugal’s key political institutions are united in their support.

To summarize, the Commission is happy that the Portuguese government chose to ignore a ruling of its constitutional court (“welcomes that…”); it threatens to cut funding if the Portuguese government does not follow its prescriptions (“it is a precondition for a decision…”); it is in a state of denial on confidence (“the growing investor confidence…”); it recommends that democratic discussion does not take place (“it is essential that key political institutions are united in their support…”)

This goes beyond my wildest thoughts. I checked, and nobody moved April fool’s day to April 7th. This is for real, and it needs no additional commenting…

Inflation expectations for the euro area continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2% over the medium term. At the same time, weak economic activity has extended into the early part of the year and a gradual recovery is projected for the second half of this year, subject to downside risks. Against this overall background our monetary policy stance will remain accommodative for as long as needed.

If words actually mean what they mean, Draghi informed us that (a) inflation, and inflation expectations, are in line with forecasts and objectives; (b) at the same time, economic activity is weaker than expected, and the future recovery is at risk; (c) the ECB is willing to have an accommodative monetary stance.
Two considerations: first, the king is naked; it was obvious from the very beginning that the recovery in the second half of the year was not in the cards. I already discussed the systematic bias in official forecasts. It turns out that simply saying to markets that things will go well, is not sufficient to make them act accordingly. The confidence fairy, as Krugman calls it, is nowhere to be seen. I would add that this systematic bias risks making EMU institutions less credible, and hence further weaken their capacity to anchor private sectors’ expectations…
And then the puzzle: if inflation is under control, and if economic activity is weak, and if the ECB deems accommodation to be needed, why, why on earth are rates kept constant? Should we remind to Mario Draghi what is written in article 127 of the Lisbon Treaty?

The primary objective of the European System of Central Banks, hereinafter referred to as “ESCB”, shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union.

Among the general policies that the ECB should support there is growth and employment. And lowering the rates today would certainly not lead to “prejudice to the objective of price stability”

Why is the ECB so frightened to send the signal to markets that it is ready to boost economic activity? Is there an hidden agenda we are unaware of?

• The outlook remains negative (while the rest of the OECD countries are doing better)
• There is still room for monetary accommodation
• This monetary accommodation may not benefit the countries that need it more, because the transmission mechanism of monetary policy is still not fully working
• The Cyprus incident shows that there is a desperate (this I added) need of a fully fledged banking union
• EMU countries need to continue on the path of fiscal stabilization, even if automatic stabilizers should be allowed to fully play their role, even at the price of missing nominal targets

To summarize, the OECD depicts a mixed picture in what concerns macroeconomic policy, notably in calling for more monetary easing (it is difficult to disagree, even if I am unsure there will be major effects), and abandoning the mantra of nominal targets.

But the interesting part is what came later. The assessment recognizes that the eurozone as a whole does not have a serious debt problem, as shown by this figure (taken from the presentation)

Furthermore, and more important, the OECD recognizes that the eurozone rebalancing so far happened mostly (only, I would say) on the periphery side, and mostly through a reduction of imports induced by the recession. The core surplus countries barely adjusted:

Then the question came natural, and I dared to ask: If the eurozone as a whole is not in a situation of public finances’ distress; and if the adjustment so far fell on the shoulders of peripheral countries, does that mean that the OECD would go as far as suggesting that Germany and other core countries, that have the room for manoeuvre, should implement expansionary policies? The answer by the presenter was intriguing:

• The major role for fiscal policy should be through automatic stabilization
• Germany and other core countries should implement structural reforms aimed at boosting domestic demand (such as reforming the services’ sector, thus triggering more investment
• And then, if there is room for further action, we’ll see…

Maybe because we have been flooded with bad news, lately, and we desperately need to think differently; but I like to see that “we’ll see” as a leak in the dam.

There is no need for me to repeat what has been understood everywhere except, as usual, in Berlin, Frankfurt and Brussels: the tax on deposits breaks an implicit pact between governments and depositors, and fragilizes the banking systems of the whole periphery of the eurozone.

Here I just want to cite a few paragraphs from an excellent piece by Nick Malkoutzis: I just added some emphasis here and there:

what’s happened over the past few days and what’s likely to happen in the days and weeks to come has little to do with numbers. It is much more about perceptions. Even if a financial meltdown is averted in Cyprus this week, the decision to tax depositors there in order to reduce the eurozone and International Monetary Fund contribution to the island’s bailout has sown the seeds for a future eruption. The Eurogroup’s decision on Monday was a clear attempt to correct a mistake, while steadfastly refusing to admit one had been made. [...]

The back-pedalling and hand-wringing has been an embarrassing spectacle but it has also laid bare the unedifying eurozone decision-making process and the lack of stature amongst its decision makers. The only two plausible interpretations for the Eurogroup approving such a self-destructive decision as taxing all bank deposits is a complete disregard for the consequences (doubtful) or an utter underestimation for the effect it would have (more plausible).

The latter suggests that one part of the eurozone is now completely out of step with the other, unable to understand its challenges, its concerns and, ultimately, its reality. Only a core group of decision makers with no sense of the fragile state of societies in the periphery, which have been battered by deepening economic crisis and uncertainty for months on end, would favour a policy that creates a precedent for governments to grab people’s savings without second thought. [...]

even if savers in Greece, Spain, Portugal and Italy don’t panic, the idea of a deposit tax and the way it was adopted has released something poisonous in the air. It is difficult to see how these citizens will be able to trust the system – be it their governments, banks or eurozone partners – in the weeks to come. Belief in countries where the economy is contracting and unemployment growing is already vitreous and planting fears about a possible deposits grab in the future could shatter it completely.

Some will argue that the numbers involved in Cyprus are not that big, that small depositors will not lose a lot. This misses the point. Again, it’s not about the numbers, it’s about perceptions. Cypriot savers [...] have witnessed supposed partners back their country and its new president into a corner with almost underworld-style ruthlessness. The European Central Bank, essentially their central bank, threatened to cut off funding to Cypriot lenders, to cause their collapse, which would bring economic disaster. In these unprecedented circumstances, what basis is there for a relationship of trust between Cypriots and the eurozone? [...]

Others will argue that it is unfair to expect Germany or other eurozone taxpayers to keep footing the bill for bailing out member states. This also speaks of different perceptions of reality in the euro area. It ignores the fact that taxpayers in countries that have been bailed out are also paying a price. In fact, if one looks at the eurozone today and chooses any of its main economic indicators, it is abundantly clear who is footing the much higher cost for these rescue packages.

This emergence of parallel lives is the illness spreading to the heart of the single currency. How can the eurozone’s two parts understand each other when their realities are growing further apart? How can one side decide for the other when it’s not experiencing the depression, polarization and incertitude of its counterpart? In this two-tier construct, how can those on the upper deck assimilate the warnings from those below that the vessel is sinking, when their feet aren’t even wet?
That’s why Cyprus is about so much more than just numbers.

There is really very little to add to this. Except maybe that Nick Malkoutzis is even too nice to Germany. It is interesting to notice that most of the time, in battered countries, Germany’s banks are among the top creditors. In this particular case, the exposure of German banks is 5.8 billions, exactly the amount that the tax should levy. Certainly a coincidence, but still…

I remember, a few years back, Joe Stiglitz accusing the IMF and the American treasury of imposing unnecessary austerity to crisis countries, in Latin America and in East Asia, with the objective to buy time for their banks to minimize their losses (or often times to cash their profits). The resemblance with the current situation in Europe, is worrisome. Very.