Sunday, November 27, 2011

It isn't too complicated

Mysterious Europe

What I have never understood, and still don’t understand, is how European leaders think this is going to work out. What’s the plan? Or lacking a plan, what’s the story with a happy ending?

As I see it, the underlying eurozone story is pretty clear and simple. After the creation of the euro, investors developed a false sense of security about lending to peripheral economies; this led to large capital flows from the core to the periphery, and corresponding current account imbalances:

These capital inflows also caused a boom in the periphery that raised costs and prices dramatically compared with the core:

Now all of that has to be unwound. So how is that supposed to happen?

It seems obvious that spending cuts in the periphery have to be offset by spending increases in the core, and also that a way has to be found to make the required real depreciation in the periphery feasible. But eurozone policy is for austerity everywhere, and a low inflation target for the area as a whole, which means crippling deflation in the periphery.

So where is the story about how this is supposed to work?

As far as I can tell, European policy makers aren’t even thinking about scenarios. They’re just repeating the old slogans about stable prices and fiscal responsibility, with no narrative at all about how pursuing those virtues can be consistent with European recovery.

Even a few months ago I regarded a complete euro crackup as highly implausible. Now I’m having trouble finding a plausible story about how the thing survives.

In other news, Jean-Claude Trichet is the new chairman of the Group of 30. My congratulations. True, I have said some harsh things about his policies — but as Tessio said, it was only business.