Current account deficits in Europe (5 charts)

from Merijn Knibbe

TRICHET WAS WRONG – KEYNES WAS RIGHT

It’s enlightening to read the autobiography of Alan Greenspan. In it, he argues that, by and large, increases in private debt and deficits on current accounts do not matter as (financial) markets and (financial) innovation will take care of it. In this post, I showed that the ECB shared (shares?) such a vision. Does every able minded economist agree with this? No. It turns out that, according to a recent find, back in 1944 a British economist by the name of J.M.K. argued, in a little place called Bretton Woods,

“that imbalances in trade are next to impossible to resolve in a fixed exchange rate system without surplus countries accepting that they have as much of an obligation to do something about them as the offending deficit countries.”

This was probably inspired by events in the twenties, when France did not want to reflate. Anyway, the lead of this economist is nowadays followed by the European Commission, which has designed a MIPS, a Macro-Economic Imbalances Scorecard, which does not only show a whole bunch of variables like private debts and current accounts (therewith negating the Greenspan/Trichet happy clappy market vision!), but which also uses ‘attention thresholds’ for these variables, which act as a warning system. The thresholds for the current accounts are -4% of GDP for deficits but also +6 for surpluses! As it’s the rich, high wage countries which have the surpluses this approach still is somewhat imbalanced – but for the time being it can do, as it concedes the existence of disequilibrium.

We now know that the ECB should have looked at these variables (see the graphs) – but they didn’t, following the lead of people like Greenspan. Though it’s true that the imbalances increased very, very fast, taking them more serious might, given their size (-25% of GDP in some cases) have led to better policies. The ECB did not do a good job.

Technical detail: The MIPS thresholds are included in the graphs, it however uses the three-year moving average as a metric (no doubt on German request). I use a four quarter moving average. Never mind the numbers of the graphs, they were intended for a larger post but that started to become a kind of book, so I split it up.

The GIPS: yes, the threshold might have worked. Mind the speed of the developments.

 

‘Greater Germany: things started to go wrong when Germany, with a larger economy than all the other countries combined, also started to pursue a ‘high surplus’ policy and started to get a sizeable surplus after 2003.

France, Italy, UK: as we will see in a subsequent post, this was not just about competitiveness, but also about (consumer) demand which increased faster than in Germany

Other transition countries: did devaluation play a role, in the autumn of 2008 (Poland, Hungary). Slovenia and Slovakia however had already adopted the Euro.

“Bell” and Romania: victims of unrestricted flows of capital and asset bubbles. Whoever had the idea that ‘even’ 10% of GDP deficits on the current account are acceptable? By now, money has left these countries while (mortgage)debts stayed behind.