Yesterday, like many, I was appalled by the ECB announcement that it would stop accepting Greek bonds as collateral for loans. The timing, right after Greek finance minister Varoufakis met Draghi, but before he met German finance minister Schauble, seemed a clear signal: the ECB sides with Germany and EU institutions, and the only possible outcome it expects is a complete rolling back of Syriza electoral promises, and a renewed Greek commitment to austerity and troika-style structural reforms (privatizations plus labour market reform, to say it simply). This would of course be terrible news for Europe (these recipes simply did not work, this is acknowledge everywhere from the IMF to the White House, passing by Downing Street). And terrible news for democracy as well. The signal to voters would be “Enjoy your day at the polls. Then we decide in Brussels, Frankfurt and Berlin”.
Appalling, I said. This morning I have read a different, very interesting interpretation by Frances Coppola. Please read the piece. Is wonderfully written. In a few sentences, it says that the ECB move may not be pressure just on Greece, but on both sides involved, i.e. on Germany as well. In a sort of mega game of chess, by weakening Greece, by pushing it closer to the edge of the cliff, the ECB forces both sides to actively look for a deal, in order to avoid the catastrophic effect of Grexit. Coppola mentions the principle of “coercive deficiency” (famously applied to nuclear deterrence): a weaker Greece makes it run out of options, and hence a deal unavoidable.
Boy, I hope Frances is right! The alternative interpretation, United Creditors Against Greece, would mean the end of the Euro. And it is true that the practical implications of yesterday’s decision are in the end limited. But I remain worried, for at least two reasons.
- The first is that if the ECB were trying (in a convoluted way) to set the stage for a deal, it should push Greece closer to the cliff, while at the same time showing at least some willingness to negotiate. Now, it seems that the ECB is not willing even to grant an extension of maturities. This is at odds with the interpretation of the ECB as setting the ground for a deal
- Second, even assuming the ECB were in fact trying to crate the conditions for a deal, the game would be dangerous indeed, because it relies on Germany’s leaders to be good chess players! Leaving metaphors aside, it seems that Angela Merkel and Wolfgang Schauble are trapped in their own narrative of debt as a morality tale, in which punishment of the sinners is by definition impossible. So the question becomes whether they would recognize that pushing Greece off the cliff would entail huge costs for the EU at large. And even if they recognize it, they may be willing to pay the price “to teach the sinners a lesson”
Difficult times ahead. I am not optimist
As I write the Greek people are voting. I was puzzled in the past weeks by the fear (more in the media than in markets, actually) of a “radical” left win. Puzzled, because the radical and ideological policy makers do not seem to live in Greece, today. On January 20 I wrote a piece for the Greek website Macropolis, where I claimed that we should not expect an Armageddon if Syriza wins, but rather some welcome fresh air. I reproduce the piece here:
It is most likely that from the elections of January 25 will emerge a Syriza-led government, the main uncertainty being how large a coalition Alexis Tsipras will have to gather to obtain a comfortable parliamentary majority. This is seen with a fair deal of preoccupation in Europe. A preoccupation that does not seem warranted. Syriza is no longer the radical party of the beginning, which called for the exit from the euro and for a default on Greek public debt. Today it is party whose program can hardly be defined revolutionary, and whose label of “radical” left is justified mostly by the drifting of other social democratic party in Europe (for example in Italy and in France) towards the center of the political spectrum, and towards a de facto acceptance of the European macroeconomic orthodoxy. Syriza’s leader, Tsipras, as the prospects of victory become more concrete, has further softened his tones and is already actively negotiating with the Commission and with the major countries, in view of a compromise on the key points of his program. However, some of the media and some political leaders around Europe continue to present the Greek elections as an incoming Armageddon, and the possibility of a Syriza victory as the beginning of the end for the monetary union.
Let’s see what are the reasons for concern. Regarding Europe, Syriza’s agenda has two key elements. First, in case of victory Tsipras would ask to renegotiate a substantial chunk of Greece’s unbearable public debt, that today is mostly (for around 80%) in the hands of official creditors. Of course, this would mean a loss for creditors to absorb. But, as the Financial Times noted as well, it is difficult to imagine a durable exit from the crisis that has choked Europe since 2008, if at least a part of the debt burden that is stifling the recovery is not removed. The French finance minister has agreed yesterday that some compromise on Greek debt will be have to be found, even if some northern countries are at least as of now inflexible. What seems increasingly evident, in fact is that with the European economy back into deflation the costs, for creditor countries as well as for debtors, of a long stagnation, seem far more important than the loss associated with the debt restructuring. The second key point of Syriza’s electoral agenda is the abandonment of austerity that, albeit less stringent than in previous years, continues to characterize European economic policy In other words, Syriza asks to address the problem of unsustainable debt, so far hidden under the rug, and to finally acknowledge the need for a comprehensive plan to restart the European economy, that goes well beyond the accounting tricks of the Juncker plan. Syriza may seem radical to some German economist. But it is in good company of other well-known extremists such as Paul De Grauwe, the IMF, the US government, and much of the Anglo-Saxon press. The European economy is unbalanced and stuck in a deflationary liquidity trap, Mario Draghi’s faces fierce political opposition, and his arrows are increasingly ineffective; it is therefore increasingly clear that only fiscal policy will be able to get us out of trouble.
On closer inspection, it seems far more radical the position of those who, despite having grossly underestimated the negative effects of austerity, ask for more of the same; of those who insist on advocating supply-side reforms to cope with a chronic lack of demand; and of those who boast having achieved a balanced budget one year ahead of forecasts, when Europe would benefit from a recovery of domestic demand in Germany.
What will happen then, if “radical” Syriza will win the election? Actually not much. Tsipras, comforted by opinion polls among his fellow citizens, does not consider the Grexit option. He will sit at the negotiating table to try to obtain for his country a substantial restructuring of debt, and for Europe change towards a more Keynesian policy. If on the latter objective it is hard to imagine that substantial progress will be made, debt restructuring in some form will probably happen. First, because as we said above, it seems to be an unavoidable event, just waiting for the political conditions to be reunited. And second, because Greece will negotiate from a position of strength. Its primary budget surplus (a proof, if needed, that contrary to widespread beliefs Greece actually did its homework; and painfully so), and the low share of debt held by private investors, around 15%, would allow it not to be subject to market pressures in case of exit and default.
And contrary to some declarations that resemble to pre-electoral tactics (the Greek election game is played in the European arena as well), Greece’s exit from the euro would not arrange its European partners either. First, because it would be accompanied by default, and losses for creditors would be significantly larger than in the case of restructuring. Then, probably more important, because Grexit would have unpredictable contagion effects on other peripheral economies, which not hazardously today look with concern to the increasingly harsh tones used in particular by the German Government. In case of a Syriza victory Angela Merkel will most probably soften the tone and agree to negotiate. It is hard to imagine that orthodoxy will go as far as to push Greece out of the euro.
It goes without saying that the negotiation will be harsh, and that tensions will emerge. But today the ECB is more active in assisting countries in difficulty, and its program OMT, which recently received preliminary clearance by the European Court of Justice, is a good protection against speculative attacks.
To conclude, Europeans should stop worrying and let democracy play its role. A Syriza-led government (possibly forming an alliance with George Papandreou’s To Kinima) would not cause an earthquake. Rather the contrary, it could help stirring things up, and bring within the European debate discussion about measures the need for which is now obvious to all except to those who will not see.
It seems that we finally have our Bazooka. Quantitative Easing will be put in place; its size is slightly larger than expected (€60bn a month), and Mario Draghi, once again, seems to have gotten what he wanted in his confrontation with hawks within and outside the ECB (I won’t comment on risk sharing. I am far from clear about the consequences of that).
And yet, something is just not right. I am afraid that QE will end up like LTRO and all the other liquidity injections the ECB performed in the past. What bothers me is not the shape of the program (given the political constraints, one could hardly imagine something more radical), but Draghi’s press conference. Here is a quote from the introductory statement:
Monetary policy is focused on maintaining price stability over the medium term and its accommodative stance contributes to supporting economic activity. However, in order to increase investment activity, boost job creation and raise productivity growth, other policy areas need to contribute decisively. In particular, the determined implementation of product and labour market reforms as well as actions to improve the business environment for firms needs to gain momentum in several countries. It is crucial that structural reforms be implemented swiftly, credibly and effectively as this will not only increase the future sustainable growth of the euro area, but will also raise expectations of higher incomes and encourage firms to increase investment today and bring forward the economic recovery. Fiscal policies should support the economic recovery, while ensuring debt sustainability in compliance with the Stability and Growth Pact, which remains the anchor for confidence. All countries should use the available scope for a more growth-friendly composition of fiscal policies.
And here the answer to a question, even more explicit:
What monetary policy can do is to create the basis for growth, but for growth to pick up, you need investment. For investment you need confidence, and for confidence you need structural reforms. The ECB has taken a further, very expansionary measure today, but it’s now up to the governments to implement these structural reforms, and the more they do, the more effective will be our monetary policy. That’s absolutely essential, as well as the fiscal consolidation side. So structural reforms is one thing, budget and fiscal consolidation is a different issue. It’s very important to have in place a so-called growth-friendly fiscal consolidation for confidence strengthening. This combined with a monetary policy which is very expansionary, which has been and is even more so after our decisions today, is actually the optimal combination. But for this now, we need the actions by the governments, and we need the action also by the Commission, both in its overseeing role of fiscal policies and in its implementing the investment plan, which was launched by the President of the Commission, which was certainly welcome at the time, now has to be implemented with speed. Speed is of the essence.
The message could not be any clearer: Draghi expects the QE program to impact economic activity through private spending. What we have here is the nt-th comeback of the confidence fairy: accommodative monetary policy, structural reforms and fiscal consolidation, will cause a private expenditure surge (“[..] but will also raise expectations of higher incomes and encourage firms to increase investment today and bring forward the economic recovery“). We have been told this many times since 2010.
Unfortunately, it did not work like this, and I am afraid it will not this time either. The private sector signals in all surveys available that it is not ready to resume spending. If governments are not given the possibility to spend more, most of the liquidity injected into the system will remain idle, exactly as it was the case for the (T)LTRO.
The concept of countercyclical policies is so trivial as to become commonsensical: Governments should step in when markets step out, and withdraw when markets step in again. Filling the gap will actually sustain economic activity, and crowd-in private expenditure; more so, much more so, than filling the pockets of agents with money they are not willing to spend. This is the essence of Keynes. Since 2010 in Europe governments rushed to the exit together with markets; joint deleveraging meant depressed economy. How could one be surprised that confidence does not return?
I would like to add that invoking more active fiscal policy within the limits of the Treaties has the flavour of a bad joke. Just so as we understand what we are talking about, the EMU 18 in 2014 had a deficit-to-GDP ratio of 2.6% (preliminary estimates by the Commission, Ameco database); this means that to remain within the Treaty a fiscal stimulus would have to be limited to 0.4% of GDP. How large would the multiplier have to be, for this to lift the eurozone economy out of deflation? Even the most ardent Keynesian would have a hard time claiming that!! And also, so as we don’t forget, at less than 95% of GDP EMU, Gross public debt can hardly be seen as an obstacle to a serious fiscal stimulus. Even in the short run.
The point I want to make is that QE is all very good, but European governments need to be put in condition to spend the money. It is tiring to repeat the same thing again and again: in a liquidity trap monetary policy can only be a companion to the main tool that could be used by policy makers: fiscal policy.
But in Europe, bad economic policy is today considered a virtue.
Tomorrow’s ECB decision on Quantitative Easing is awaited like a messiah (it would be interesting to see what happens if the ECB does not announce QE). We’ll see the shape this takes, but I already argued some time ago that excessive expectations on ECB action stem from the suicidal neglect of fiscal policy, the instrument of choice at times of liquidity traps. Mario Draghi and the ECB Governing Council are given an excessive burden by the inertia of governments trapped in ideology and/or in a crazy fiscal rule.
There will be time to assess the shape and the impact of tomorrow’s decisions. Here I want to focus on one aspect of all this that is not sufficiently emphasized. Even the bolder and more effective Quantitative Easing program would come unacceptably late. The ECB should have stepped in to sustain economic activity much earlier, at least in 2012, when its counterparts launched their own programs; or possibly earlier, given the Eurozone specific sovereign debt crisis. But it did not, mostly because it was politically impossible to take such a decision without the threat of deflation looming on the eurozone.
And I get to my point. I just saw a paper by Philippe Martin and Thomas Philippon (here a VoxEU column presenting its main results) that tries to disentangle the impact of different shocks on the crisis, and runs a number of counterfactual experiments. Its conclusion are interesting and commonsensical. The first is that except for Greece, more prudent fiscal policies in the early 2000s would not have been effective in preventing or softening the private deleveraging shock that happened from 2008. Only if more prudent fiscal policies had been coupled with macroprudential policies (i.e., curbing private leverage in the first place), there would have been an impact on the crisis. The counterfactual I found more interesting is the one on the “Whatever it Takes” OMTs program. The authors ask whether the OMT, if implemented in 2008 and not in late 2012, would have made a difference, and the answer is a clear yes. If through ECB insurance spreads had been kept low, peripheral countries would have had the fiscal space to counter the crisis, and unemployment would have been reabsorbed. Interestingly, the authors neglect the impact of the 3% limit on public deficits. Of course, had they introduced a fiscal rule limiting fiscal space, the impact of OMT would have been less glorious.
The way I see it (I am not sure the authors would have the same interpretation), Martin and Philippon show that the roots of EMU problems are institutional. If we had a normal central bank, capable of acting as a Lender of Last Resort, and of insuring the euro denominated debt; if we had normal governments, capable of using fiscal policy as a countercyclical tool, then… well, then we would be the US! The crisis would have hit hard because excessive leverage did not depend on macroeconomic governance, but policy could have been reactive and coordinated, thus leading to a recovery like the one we saw in the US (while I hear those who complain about policy and about the state of the economy in the US, it is undeniable that their economic performance is orders of magnitude better than our own!). Of course, the US also have a system of fiscal transfers that we can only dream of…
So our problem is that we don’t have normal institutions for macroeconomic governance. Macroeconomic policy in the EMU is the result of political skirmishes, and rests more on the diplomatic capacities of Mario Draghi Angela Merkerl, or Alexis Tsipras, than on a clear assessment of problems and solutions. Furthermore, this (mal)functioning yields last-minute decisions, only if under threat (OMT because of speculation on periphery’s debt; QE because of deflation).
We are in the eight year of the crisis, and the trending topics among European elites are QE, and the Juncker plan. The former will likely be a byzantine compromise between Mario Draghi and the German government (as a side note: what about central bank independence, Mrs Merkel? Wasn’t that one of the things that you kept in such high consideration that you did not want it endangered by debt monetization?); the Juncker plan is simply an empty box. And they both come into the picture way too late, as the need for expansionary fiscal and monetary policies was clear at least since 2010.
The new European motto should be too little too late.
The Juncker Commission is now up and running, and it is beginning to give an idea of where it wants to go. Unfortunately not far enough. The two defining moments of the first few months are the Juncker plan, and the new guidelines on flexibility in applying the Stability and Growth Pact. Both focus on public investment.
Public investment deficiency is now chronic across the OECD, and particularly in the EU. Less visible and politically sensible than current expenditure, for twenty years it has been the adjustment variable for European governments seeking to meet the Maastricht criteria, and to control their deficit. Since the crisis hit, private investment also collapsed, and it is still kept well below its long term trend by depressed demand and negative expectations.
Let’s start from the most recent Commission measure. The guidelines issued last weeks, that some countries trumpeted as a great victory against austerity, are in fact just a marginal change. The Commission only conceded that the structural effort towards the 60% debt-to-GDP ratio be relaxed for countries growing below potential, while reaffirming that in no circumstance, the 3% deficit limit should be breached, and that any extra investment needs to be compensated by expenditure reduction in the medium term1.
The Juncker plan foresees the creation of an Investment Fund endowed with €21bn from the European budget and from the European Investment Bank. This is meant to lever conspicuous private funds (in a ratio of 15 to 1) to attain €315bn, mobilized in three years. EU countries may chip into the Fund, but this is not compulsory, and the incentives to contribute are unclear: while the contribution to the fund would not be accounted as deficit (the guidelines confirm it), the allocation of investment will not be proportional to countries’ contributions.
Two aspects of the plan raise issues. First, it is hard to see how it will be possible for the newly established fund to raise the announced amount. The expected leverage ratio is very ambitious (some have described the plan as a huge subprime scheme). Second, even assuming that the plan could create a positive dynamics and mobilize private resources to the announced 315 billions, this amounts to just over 2% of GDP for the next three years (approximately 0.7% annually). In comparison, Barack Obama’s American Recovery and Reinvestment Act of 2009 amounted to more than 800 US$ billions. The US mobilized more than twice as much as the Juncker plan, in fresh money, and right at the beginning of the crisis.
To sum up, the plan and the guidelines are welcome in that they put investment back to the centre of the stage. But, as is the norm with Europe, they are too little, far too little, to put the continent back on track, and to reverse the investment trend of the last three decades.
In an ideal world, the crisis and deflation would be dealt with by means of a vast European investment program, financed by the European budget and through Eurobonds. Infrastructures, green growth, the digital economy, are just some of the areas for which the optimal scale of investment is European, and for which a long-term coordinated plan is necessary. That will not happen, however, for the fierce opposition of Germany and other northern countries to any hypothesis of debt mutualisation.
The solution must therefore be found at national level, without losing the need for European-wide coordination, that would guarantee effective and fiscally sustainable investment programs. With Kemal Dervis I recently proposed that the EU adopt a golden rule, similar in spirit to the one implemented in the United Kingdom between 1998 and 2009. The rule requires government current expenditure to be financed from current revenues, while public debt may be used to finance capital accumulation. Investment expenditure, in other words, could be excluded from deficit calculation, without any limit. Such a rule would stabilize the ratio of debt to GDP, and would ensure intergenerational equity (future generations would be called to partially finance the stock of public capital bequeathed to them). Last, but especially in the current situation not least, putting in place such a rule would not require treaty changes, but just an unanimous Council deliberation.
But there’s more in our proposal. The golden rule is not a new idea, and in the past it has been criticized on the ground that it introduces a bias in favor of physical capital; expenditure that – while classified as current – is crucial for future growth (in many countries spending for education would be more growth enhancing than building new highways) would be penalized by the golden rule. This criticism, however, can be turned around and transformed into a strength. At regular intervals, for example every seven years, in connection with the European budget negotiation, the Commission, the Council and the Parliament could find an agreement on the future priorities of the Union, and make a list of areas or expenditure items exempted from deficit calculation for the subsequent years. Joint programs between neighboring countries could be encouraged by providing European Investment Bank co-financing. What Dervis and I propose is in fact returning to industrial policy, through a political and democratic determination of the EU long-term objectives. The entrepreneurial State, through public investment, would once again become the centerpiece of a large-scale European industrial policy, capable of implementing physical as well as intangible investment in selected strategic areas. Waiting for a real federal budget, the bulk of investment would remain responsibility of national governments, in deference to the principle of subsidiarity. But the modified golden rule would coordinate and guide it towards the development and the well-being of the Union as a whole.
Ps an earlier and shorter version of this piece was published in Italian on December 31st in the daily Il Sole 24 Ore.
1. Specifically, the provisions are the following:
Member States in the preventive arm of the Pact can deviate temporarily from their medium-term budget objective or from the agreed fiscal adjustment path towards it, in order to accommodate investment, under the following conditions:
- Their GDP growth is negative or GDP remains well below its potential (resulting in an output gap greater than minus 1.5% of GDP);
- The deviation does not lead to non-respect of the 3% deficit reference value and an appropriate safety margin is preserved;
- Investment levels are effectively increased as a result;
- Eligible investments are national expenditures on projects co-funded by the EU under the Structural and Cohesion policy (including projects co-funded under the Youth Employment Initiative), Trans-European Networks and the Connecting Europe Facility, as well as co-financing of projects also co-financed by the EFSI.
- The deviation is compensated within the timeframe of the Member State’s Stability or Convergence Programme (Member States’ medium-term fiscal plans).
Update: The Court ruled the OMT “Legal in Principle“. The final ruling will be later this year, but it is safe to assume that it will confirm the preliminary one.
Today is an important day for the ECB, as the European Court of Justice will issue an interim ruling on the Outright Monetary Transactions program launched in the fall of 2012. The Court needs to rule, upon demand by the German Constitutional Court, whether the program overstepped the boundaries set by the Treaties to ECB action. The ruling of course may have an impact on furture action by the ECB, notably the decision to launch a round of QE.
I think it is important to clarify once more that QE and the OMT (welcome to the wonderful world of EU acronyms) are not the same thing. If Mario Draghi manages to rally the Governing Council behind him, QE will consist of a vast program of sovereign bond purchases, in order to try to lift the European economy out of deflation. A European version in short, of what was done three years ago by the Fed and other major central banks in the world.
The OMT responded to a very different need, notably the need to defuse speculation on sovereign debt markets and to protect peripheral countries (at the time Spain and Italy) from the risk of default. The summer of 2012 was very difficult, as economic and political problems in Greece caused investors to flee from peripheral countries and spreads on sovereign bonds to increase at unprecedented levels. After the “whatever it takes” speech in July (But there is another message I want to tell you. Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough), the ECB in September engaged almost unanimously to step in the market for sovereign bonds and, if necessary, to stretch its mandate by acting as a lender/buyer of last resort for countries in trouble.
With the OMT program, the ECB commits to buy unlimited amounts of sovereign bonds of countries in trouble that request assistance, thus de facto transforming itself into a lender of last resort. In exchange for ECB protection countries need to engage in a program of fiscal austerity and structural reforms. In other words with the OMT program the ECB offered insurance in exchange for reforms and austerity. A deal that would entail the loss of a good deal of sovereignty. It is not by chance that Spain always refused to apply for the program, in spite of heavy pressure, and that as of today no country ever used it. At the time the OMT program was wrongly interpreted as a clumsy attempt to implement quantitative easing in the Eurozone. It was instead clear, since the beginning that, as with any insurance scheme, its success would be measured precisely by the fact that the ECB would not have to intervene on bond markets.
So we need to be clear here. The European Court of Justice today and in the next months will not be deciding on QE and macroeconomic management. It will be deciding whether the EMU has the right to rely on an insurance mechanism that all countries have . It will be deciding whether EMU governments borrow in their own currency, or in a foreign one. A major decision indeed.
Two weeks ago I received a request from Prof Sinn to make it known to my readers that he feels misrepresented by my post of September 29. Here is his very civilized mail, that I publish with his permission:
Dear Mr. Saraceno,
I have just become acquainted with your blog: https://fsaraceno.wordpress.com/2014/09/29/draghi-the-euro-breaker/. You misrepresent me here. In my book The Euro Trap. On Bursting Bubbles, Budgets and Beliefs, Oxford University Press 2014, and in many other writings, I advise against extreme deflation scenarios for southern Europe because of the grievous effects upon debtors. I explicitly draw the comparison with Germany in the 1929 – 1933 period. I advocate instead a mixed solution with moderate deflation in southern Europe and more inflation in northern Europe, Germany in particular. In addition, I advocate a debt conference for southern Europe and a “breathing currency union” which allows for temporary exits of those southern European countries for which the stress of an internal adjustment would be unbearable. You may also wish to consult my paper “Austerity, Growth and Inflation: Remarks on the Eurozone’s Unresolved Competitiveness Problem”, The World Economy 37, 2014, p. 1-1, http://onlinelibrary.wiley.com/doi/10.1111/twec.2014.37.issue-1/issuetoc, in which I also argue for more inflation in Germany to solve the Eurozone’s problem of distorted relative prices. I would be glad if you could make this response known to your readers.
Professor of Economics and Public Finance
President of CESifo Group
I was swamped with end of semester duties, and I only managed to read the paper (not the book) this morning. But in spite of Mr Sinn’s polite remarks, I stand by my statement (spoiler alert: the readers will find very little new content here). True, in the paper Mr Sinn advocates some inflation in the core (look at sections 9 an 10). In particular, he argues that
What the Eurozone needs for its internal realignment is a demand-driven boom in the core countries. Such a boom would also increase wages and prices, but it would do so because of demand rather that supply effects. Such demand-driven wage and price increases would come through real and nominal income increases in the core and increasing imports from other countries, and at the same time, they would undermine the competitiveness of exports. Both effects would undoubtedly work to reduce the current account surpluses in the core and the deficits in the south.
This is a diagnosis that we share But the agreement stops around here. Where we disagree is on how to trigger the demand-driven boom. Mr Sinn expects this to happen thanks to market mechanisms, just because of the reversal of capital flows that the crisis triggered. He argues that the capital which foolishly left Germany to be invested in peripheral countries, being repatriated would trigger an investment and property boom in Germany, that would reduce German’s current account surplus. This and this alone would be needed. Not a policy of wage increases, useless, nor a fiscal expansion even more useless.
Problem is, the data speak against Mr Sinn’s belief. Since the crisis hit, capital massively left peripheral countries, and yet this did not fuel domestic demand in Germany. Last August I showed the following figure:
It shows that after a drop (in the acute phase of the financial crisis) due to a sharp decline of GDP, since 2009 domestic demand as a percentage of GDP kept decreasing, in Germany as well as in the rest of the Eurozone. The reversal of capital flows depressed demand in the periphery, but did not boost it in Germany. Mr Sinn is too skilled an economist to fail to see this. The reason is, of course, that the magic investment boom did not happen:
What basically happened, I said it before, is that adjustment was not symmetric. Peripheral countries reduced their excess demand, while Germany and the core did not reduce their excess savings. The result is that, if we compare 2007 to 2014, external imbalances of the periphery were greatly reduced or reversed, while with the exception of Finland the core did not do its homework:
The conclusion in my opinion is one and only one: We cannot count on markets alone, in the current macroeconomic situation, if we want rebalancing to take place. In the article he suggested I read, Mr Sinn states that a 4 or 5 per cent inflation rate would be politically impossible to sell to the German public:
Moreover, it is unclear whether the German population would accept being deprived of their savings. Given the devastating experiences Germany made with hyperinflation from 1914 to 1923, which in the end undermined the stability of its society, the resistance against an extended period of inflation in Germany could be as strong or even stronger than the resistance against deflation in southern Europe. After all, a rate of 4.1 per cent for German inflation for 10 years, which would be necessary to allow the necessary realignment between France and Germany without France sliding into a deflation, would mean that the German price level would increase by 50 per cent and that, in terms of domestic goods, German savers would be deprived of 33 per cent of their wealth. If the German inflation rate were even 5.5 per cent, which would be necessary to accommodate the Spanish realignment without price cuts, its price level would increase by 71 per cent over a decade and German savers would be deprived of 42 per cent of their wealth.
This shows all the logic of Ordoliberalism: It is impossible to sell inflation to the the German public, because this would deprive them of their savings. This argument only makes sense if one subscribes to the Berlin View that the bad guys in the south partied with hard earned money of northern (hard) workers. Otherwise the argument makes no sense at all, as high inflation in the core for next few years simply compensates low inflation in the past. Should I remind Mr Sinn that the outlier in terms of labour costs is not the EMU periphery, but Germany?
Also, I find it disturbing that, while acknowledging that inflation in Germany would be needed, Mr Sinn rejects it on the ground that it would be a hard sell. The role of intellectuals and academics is mostly to discuss, find solutions (or at least try), and then argue for them. All the more so if this is unpopular, because it is then that their pedagogical role is most needed. All too often public intellectuals abdicate to their role, and simply follow the trend. Should we all argue in favour of a euro breakup only because public opinion is less and less favorable to the single currency?
Finally, a short comment on another bit of Mr Sinn’s article:
And although the core countries would suffer [from high inflation], the solution would not be comfortable for the devaluating countries either. They will unavoidably face a long-lasting stagnation with rising mass unemployment and increasing hardship for the population at large. People will turn away from the European idea, and voices opting for exiting the euro will gain strength. Thus, it might be politically impossible to induce the necessary differential inflation in the Eurozone.
I don’t really see his point here. But let’s take it for good, just for the sake of argument. I think it is too late to worry about support for the euro in the periphery. It is hard to see how “excessive” inflation in the core would impose more hardness than seven years of adjustment, ill-conceived structural reforms, and self-defeating austerity.
So Mr Sinn, thank you for your mail and for the reference to your paper that I have read with interest. But no, I don’t think I misrepresented you. The core of your argument remains that the burden of adjustment should rest on the periphery’s shoulders. And you failed to convince me that this is right.