Arnold Kling  

Perspective on the Eurozone Crisis

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John Cochrane writes,


The euro was explicitly set up as a currency union without a fiscal union. (And it turned in to one without a bank regulatory union.) That can work, a fact which practically all commentators ignore.

The central ingredient is: sovereigns who can't pay their bills default. The European central bank does not print up euros to bail out sovereign creditors, either directly or via the subterfuge of lending to banks who then buy the sovereign debt.

The euro was explicitly set up this way. The main problem is, when the crisis came, nobody bothered to read the instruction manual.

Actually, my understanding of the instruction manual is that governments were supposed to operate with responsible budgets. People did read the manual--and ignored it.

Which is the primary source of the crisis?

(a) trying to use a common currency when labor is not mobile between countries

(b) governments running unsustainable budgets

I vote for (b). However, you will not see many commentators on the left shouting from the rooftops that (b) is a problem. Instead, they do the opposite when they decry any attempt to rein in deficit spending as "austerity."

A lot of people want you to believe that the progressive agenda is the victim of Angela Merkel and Paul Ryan. But an alternative perspective would suggest that it is the victim of arithmetic.


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CATEGORIES: Eurozone crisis



COMMENTS (10 to date)
Hugh writes:

I think it's (c):

Trade deficits building up over time in the countries with weaker economies. The fixed exchange rate prevented resolution through currency depreciation and the 2008 crisis precipitated the euro's downfall.

Shane L writes:

Ireland had a very healthy debt-GDP ratio, one of the lowest in the developed world, until the construction crash threatened to tear the banks down. The Irish government took on the bank debts and made taxpayers liable for this gigantic debt instead, threatening the entire state. It's quite a different story to the south European countries which had long been struggling with big debts and large social welfare systems.

Here, this has been interpreted by the left as evidence that free markets need greater regulation. Don't necessarily buy their interpretation, but I notice that Europe seems to have an example for every ideology at the moment! Both left AND right are claiming German growth as evidence that they were right all along. Confirmation bias in full flow!

Eelco Hoogendoorn writes:

I agree, countries should be allowed to default. Though it was clear from the beginning this was never the intent, as evidenced by the preferential status of member states bonds, which is not to be weighted against their capital requirements.

Fractional reserve banking with a lender of last resort needs regulation of capital requirements to be any kind of sane. Too bad those same governments are not very vigilant policemen when it comes to credit creation that suits their own short term political agenda.

The behavior of banks is predictable: their appetite for government bonds is artificially inflated, and while the markets full well know this zero risk weighting is a political boondoggle, one might as well expect a cat not to eat the fish you put on its platter because you said so, as to expect the banks not to pile on this 'tails I win, heads you lose' game.

Money is too important an instrument to be left in the grubby hands of government; but that does not seem to be the lesson learned once more.

Aidan writes:

I see two possibilities here:

(a) Kling is ignorant of the differences between legitimately irresponsible countries like Greece and countries that ran budget surpluses like Spain and Ireland (and ignorant of how Keynesians make a distinction between them)

(b) Kling has gone native.

Yeah, I'm going to go with (b).

Yancey Ward writes:

Aidan,

If Spain and Ireland were such exemplary countries, then how have their governments ended up where they are today? A government overspends on the items it chooses to overspend on, whether that be on extensive social benefits or bank bailouts. I am unsympathetic to arguments like yours that basically boil down to excusing the governments because they decided to spend their taxpayer's blood bailing out banks. If you believe as you do, then you must recognize that they should have let the banks default, and as a fall back position, since they decided not to do that, we should now let the sovereign themselves default. Don't you agree with this approach?

Shawn writes:

I understand that the main problem is (b), but I don't understand how the simplest end would not be a default. Why does Greece need to leave the Euro, other than for politics. If your in favor of austerity that should be your position too. If Greece defaults, but keeps the euro, it would be forced to run balanced budgets, as no one would lend them money at reasonable rate. But if the go back to their old currency they can finance deficits by printing money.

For Greece, being on the euro is no different than being on the gold standard, they don't control the value of their currency.

Lorenzo from Oz writes:
governments running unsustainable budgets
What is sustainable depends on your level of income, surely. And if the ECB is driving down the income of everyone in the Eurozone who is not Germany, does not that make any budget problem worse?

The ECB must love Greece. Everyone is having so much fun pointing at its dysfunctions, no one hold the ECB to account.

And, yes, I agree the euro was a bad idea and Greece should never have been allowed in. But this particular crisis is caused by the ECB.

Jon writes:

The unique feature of th euro countries in trouble is that they lied during the application process. Greece was the biggest liar: they were very far from meeting the euro adoption criteria.

Meanwhile countries such as latvia and Estonia who are apply for admission and have already pegged their currency to the euro and honestly meet the admission criteria appear to be weathering the crisis well.

This is the classic cheating in school problem. The cheater think they are Cheating their professors but they are really cheating themselves. I'm very explicit about this to my students: I allow unlimited collaboration kn the homework but they must understand every answer they turn in as theirs. I don't attempt to ascertain whether this is true when gradin the homework (honor code), but when it comes time for the exam they are in their own. I they cheated the rules on the homework, they cheat themselves on the exam.

Ditto for life: cheat in this course; you steal from yourself not from me--when you need to know this material later, I won't be around to help you understand it.

Amazingly no one seems to have spelled this out to them in the past.

Charles R. Williams writes:

The euro would be inconsequential except for the fact that eurozone banking is integrated, eurozone banks were under-capitalized before the crisis, they are regulated on the principle (the lie) that sovereign debt is riskless and European governments operate on the "too big to fail" philosophy with respect to banks.

Given this, the sovereign debts of eurozone countries are meaningless numbers. The liabilities connected with their insolvent banks must be added to get a meaningful measure of public debt - not to mention their exposures to losses in the alphabet soup entities that were created to hide the pea.

Nobody knows the true financial condition of any eurozone country that appears to be sound. France seems questionable to me and even Germany. There is no doubt that this lack of clarity reduces the capacity of eurozone countries to run deficits and support existing levels of debt. This is why we see no crisis in the UK, Japan and the US.

ajb writes:

Charles Williams is right. We don't even know how well Germany is doing. We just know it's had export success. Beyond that, no one understands the true extent of bad debts which means many "surprises" are still possible for the entire eurozone.

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