Home > debt crisis, Eurozone Crisis, Plutonomy > The ECB’s high wire act

The ECB’s high wire act

from Dean Baker

At this point the sovereign debt crisis in Europe is almost getting boring. We’ve seen the same script played out over and over with country after country. The basic story is the markets begin a run on the debt of a country: Greece, Ireland, Italy, Spain etc.

The troika, the European Central Bank (ECB), the European Union (EU), and the International Monetary Fund (IMF) then demand a series of austerity measures. In addition, they sometimes demand measures unrelated to fiscal policy, such as a lower minimum wage in Ireland or weaker employment protection legislation in Italy, that are intended to weaken workers’ bargaining power. As a quid pro quo, the troika then arranges enough bond purchases or other supports to get through the immediate crisis.

Of course these measures don’t actually solve the underlying problem. If the troika took the steps needed to ensure that the indebted countries got past this crisis, it would lose the ability to demand further austerity and other steps that weaken welfare state supports for workers. The troika is not willing to give up its leverage at this point.

That is why the ECB repeatedly declares its refusal to guarantee support for sovereign debt any time it seems as though the financial markets believe that it is committed to supporting the debt of the troubled borrowers. This insistence by the ECB, coupled with the other policies it pushes to stifle growth, ensures that the crises will continue. The same countries will have to keep coming back for another dose of punishment and new countries will be added to the list as the contagion of slumping demand, deteriorating bank balance sheets, and dwindling confidence spreads.

The negotiating teams at the troika surely must know that the path they are following can only lead to further crises. Their medicine of austerity is irrelevant to the disease that is afflicting the debt-burdened countries.

Most immediately they are suffering from a lack of confidence in their debt. The commitment by the ECB or any other sufficiently deep-pocketed institution (e.g. the IMF, the European Financial Stability Fund or even the Federal Reserve Board or Bank of China) to support the debt would immediately end the crises. If the heavily indebted eurozone countries could again borrow at rates anywhere close to those paid by Germany or the United States, with the exception of Greece, they would have no near-term budget issues.

These countries also all continue to suffer from a shortfall in aggregate demand. This is the continuing fallout from the collapse of housing bubbles across much of Europe. There is no new source of demand to replace the demand that was generated by the bubbles in Spain, Ireland and elsewhere. In this area, the austerity drive directly worsens the problem. The cuts in government spending are not replaced by increased private sector spending. Furthermore, each country’s turn to growth slowing austerity reduces the exports of its neighbors, dampening growth elsewhere in the eurozone.

Then there is the longer term structural problem that costs in southern Europe are out of line with costs in the North, most importantly Germany. Germany continues to maintain a massive trade surplus with the southern European members of the eurozone. The devaluation that would ordinarily occur is impossible within the confines of a single currency.

This leaves differential inflation rates as the only path for adjustment. Ideally this would mean that the northern European countries would run an inflation rate that is somewhat higher than normal. This would allow the southern eurozone countries to regain competitiveness by running low, but still positive inflation rates.

However, the ECB is not going this route. Instead, it is insisting on keeping to its 2.0 percent inflation target for the eurozone as a whole. That means that the southern European countries will be forced to have deflation in order to regain competitiveness. This is an extremely difficult process implying many years of high unemployment. It also means that mortgages and other debts rise in value relative to wages, making households, businesses and the government more heavily debt-burdened through time.

It is almost inconceivable that the ECB and the rest of the troika are not fully aware of the basic facts of the situation as described here, yet they continue with crisis perpetuation policies. This course of action is understandable if the goal is to use the crisis to roll back welfare state protections for workers as much as possible. Presumably once they feel satisfied with the extent of the concessions, they will then take the steps needed to end the euro debt crisis once and for all.

This is a horribly cynical misuse of public institutions. It also runs the risk of backfiring. While it may be the case that no government will deliberately want to incur the costs of defaulting and leaving the euro, the possibility that they will be pushed to this point cannot be ruled out.

This was the story with the IMF and Argentina in 2001. The Argentine government did not intend to default on its international debts and break its peg with the dollar. However, the extreme demands of the IMF eventually left it with no choice, as it became impossible for a democratic government to impose further austerity.

The consequences of a disorderly default by one of the eurozone countries would be much greater for the European and the world economy in today’s environment than was the case with Argentina’s default in 2001. We all share an interest in avoiding this sort of calamity. Unfortunately there is little reason to believe that the troika negotiators will be any more competent in tempering their demands than were their IMF predecessors a decade ago.

See article on original website

  1. shivz
    January 22, 2012 at 3:14 pm

    Dean says, “The commitment by the ECB or any other sufficiently deep-pocketed institution to support the debt would immediately end the crises.”
    Assume that this is correct, namely, ending the crisis by such commitment. But, should it, in Dean’s opinion, be given with some strings attached? And if so, what should they be?

  2. January 22, 2012 at 5:18 pm

    It’s all “accounting”, i.e. playing with figures.
    This is getting boring. Isn’t it time to play another game?

  3. Podargus
    January 22, 2012 at 7:02 pm

    So,just what are the “costs of defaulting and leaving the euro” ? Compared to the benefits of returning to a sovereign fiat currency ?

    Whatever the motives of the “troika”,and I doubt if they are pure,the EMU is fundamentally flawed.The chances of fixing these flaws is just about zero so the whole cock up is just a failed experiment.

  4. askod
    January 23, 2012 at 12:59 pm

    “So,just what are the “costs of defaulting and leaving the euro” ? Compared to the benefits of returning to a sovereign fiat currency ? ”

    For a country with a structural current account deficit and great oil dependency – Greece, Spain, Portugal, Italy – a quick balancing of the current account would happen. In effect the new currency would fall, making imports expensive which would hurt them because they need to import oil and have no options in the short-term. Attempts to handle this through rationing would go against EU regulations and could lead to loss of EU funds and voting rights in the Council.

    For a country with a structural current account surplus the consequences would not be so bad, which is why the attacks are targeted against countries with a structural current account deficit even when their debt is in line with the Maastricht criteria (like Spain) and not countries that has a greater debt/GDP but a structural current account surplus (like Germany).

    That being said, with their central bank supporting attacks against them, I would say that the best course for a country under attack is to default sooner rather then later because austerity is already killing their economies. While I am dreaming of sanity, investigating their own central bank manager (who sits on the ECB board) for high treason and attempts to subvert the EU treaties would also be a great step.

  5. January 25, 2012 at 12:21 pm

    I recall in the early days of the EEC having my own debate with Jean Monnet’s friend Pierre Uri (as one of the main draughtsmen of the Rome Treaties) to the effect that trade liberalisation was likely to have disastrous impacts on many European peripheral areas and therefore we should include mandatory provisions to alleviate such trends. But Uri was then totally against burdening the original Treaties with anything so “contentious”. Much later on Brussels created their Regional Policy Directorate but all such policies were never adequately related to each countries’ national public sector supply systems or indeed to the above overall trends – which continued especially in Southern parts of the EU. Obviously the ineffectual nature of this superficial response was then exacerbated by the Lisbon Treaty and adoption of the Euro – plus the unwillingness of EU countries to observe common convergence criteria. And while the inevitable collapse is now obviously less serious for those countries retaining their own currencies they, too, cannot escape the generality of the wider collapse. People like myself – now Octogenarians! – feel this deeply because we had hoped for a more effective national and European response. But we then had to witness the ineffectual nature of public audit at EU (and at many national levels including our own) and also the erosion of the democratic control of public capital as the new blind faith in markets took hold. Sad!

    • Dave Taylor
      January 26, 2012 at 3:20 am

      Sad indeed, Des. I’m old enough to remember the good intentions, but the road to hell is paved with good intentions. The sad fact is that executives like Uri have their own agenda. There was a sad story on television yesterday of a historic building in a conservation area being partially rebuilt in modern instead of matching bricks. The issue was, should the failure to do what was intended just be accepted as water under the bridge, or should the rebuild be pulled down and the original intentions honoured?

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