The ECB gets it wrong on the causes of the Euro troubles (again).

from Merijn Knibbe

On the fourth of November, 2011, José Manuel González-Páramo (JMPG), member of the executive board of the European Central Bank, held a speech in Madrid. It was a sad one. According to this banker

“The economic and financial crisis has led to a severe deterioration of public finances across European countries. Governments which already had significant fiscal imbalances ahead of the crisis exited from the recession with the highest deficit and debt-to-GDP ratios recorded in times of peace”.

These two short sentences imply imply that, according to the top of the ECB, the present problems in the European Union and especially in the Euro-area are in the end not caused by the (run-up to) the credit crisis, banks and reckless lending – but by irresponsible governments. But is this right? Do the facts show this? No. They don’t. If an economist in 2007 had analysed government debt and deficits of EU-countries and had used only this information, while refusing to analyse current account deficits (as the ECB still seems loath to do, by the way) to predict which countries would and wich wouldn’t be in financial trouble in case of a severe economic downturn he or she would have been quite surprised how wrong he or she would have been. Quite a number of countries with low debts and low deficits had (and have) to be bailed out while others with much higher public debts and deficits did not have comparable troubles:

* Countries with high debts in 2007 were Belgium, Italy and Greece – and Belgium and Italy are not (repeat: not) among the countries which experienced a fast increase of their debt.
* Countries like Spain, Ireland, Bulgaria, Latvia, Estonia and Lithuania had low debts as well as deficits – and these had (or have) to be bailed out.
* The total nominal increase of German debt is by the way about twice as high as the total increase of Italian debt
* And countries with high deficits like Poland and Hungary experienced a low increase of government debt (% GDP).

Government deficits and debts of course matter – but much less and in a different way than the ECB seems to think. And implicit guarantees to banks and deficits on the current accounts seem to have mattered a lot more than the ECB still seems to think. A lot of the German and Irish and Dutch increase of debt is due to bailing out banks. And the steep decline of GDP in Spain and Greece, which is part of the explanation of the higher debt/GDP ratio, has a lot to do with the sudden disruption of the flows of capital which financed the deficits on the current accounts. It’s almost as if there is some kind of repressed panic among ECB officials which disables them to admit this – the kind of panic one gets when you find yourself suddenly and to your utter amazement trapped in a Titanic kind of situation – no, this can’t be, we did not hit an iceberg, we’re not going to drown. But we will kick everybody out of the lifeboats.

See graph 1 and graph 2 for government deficits
and the increase of government debt.

Graph 2 only shows non-transition countries with an increase of government debt of more than 15% of GDP, which leaves out Italy. The recent discovery that German debt has been overstated with 55 billions of Euro’s is not yet included in these Eurostat data.

The lessons of these graphs and the mistake of José Manuel González-Páramo are of course that private debts and reckless lending and implicit government guarantees and deficits on the current accounts matter, too. We all know this. We have known this, for quite some time. It’s economics 101. But the ECB doesn’t know it. Sad.

P.S. – I still like my graph on the current account imbalances in Europe better than Krugman’s one. Though his one is indeed simpler (Ockham’s razorblade…). But nevermind – Krugman’s message is the same as mine: there is a weird kind of denial going on, which goes deeper than just covering up past mistakes. It’s a worldview that’s at stake.