Matt Yglesias

European Monetary Paralysis

Nick Rowe explains that the Eurozone’s woes go beyond inadequate labor market and fiscal integration, it’s not really even sufficient monetary policy integration:

But the lender of last resort matters more. The US has an effective lender of last resort. The Fed has the political authority to print as many US dollars as are needed. The only effective limits are the risks of inflation and moral hazard. The Eurozone does not have an effective lender of last resort. The individual Eurozone countries do not have their own central banks. The ECB lacks the political authority to print as many Euros as are needed.

Suppose you abolished the US Federal government. So you needed all 50 State governments to agree before the Fed could act as lender of last resort to one of those State governments. And suppose some of those US State governments had as much debt as Greece, or were bailing out their banks like Ireland. Think all 50 State governments would agree on anything? I don’t. (And they all at least speak the same language, and really do all think of themselves as part of the same nation). Think it would matter? I do.

Tim Fernholz’s five positive economic signs for 2011 is fairly persuasive to me, but the big problem is that there are a lot of possibility for new negative shocks. And the shocks coming from Europe, in particular, are potentially enormous. And I’m not at confident that we’ll respond adequately if shocks do come.

Currency Union in the Digital Age

Paul Krugman reviews the debate over the euro. Anyone who’s been following his blog will already be familiar with the argument that currency integration without labor market integration or fiscal integration has a lot of problems. What I was intrigued to learn about were the surprisingly modest benefits:

What about those benefits from monetary integration? Jeff Frankel has a good piece on this: pre-euro work had suggested very large trade gains, but the actual experience has been much more modest — not nothing, but nothing like the high hopes some had for the euro.

If you read Frankel’s piece, you’ll see he doesn’t really have an explanation for it. I wonder if it’s not related to the point I made about the euro and tourism. In 1980, European monetary integration would have had huge practical benefits for international travelers. In 2010 where you can use ATM cards and credit cards just about anywhere, it’s not that big a deal. For larger scale trade the issue would be less the de-cashing of the economy as the spread of computers. In 1980, I imagine it would really have been quite burdensome for many firms to check prices at suppliers in a half dozen different countries each with their own currency. But today even the smallest firm can have a computer and a spreadsheet program—a free online one, even—and do this pretty easily.

In other words, what is and isn’t an optimal currency zone may be dependent on technology, and digitization may be setting the bar higher.

The Latvian Catastrophe

Klaus Regling, chief executive of the European Financial Stability Facility, wants you to know that monetary union without fiscal integration is workable after all and he offers, as an example, Latvia:

Latvia which has a currency pegged to the euro, testifies to the success of this policy. Contrary to commentators who predicted disaster for Latvia early last year unless it gave up its hard peg – in line with advice from the commission – it did not devalue its exchange rate. A real effective devaluation was achieved through severe cuts in nominal income. Today its economy is growing again. Those outside “experts”, who always seem to know what is good for Europe, should take note.

So to be clear about this, the Latvian economy suffered a 4.2 percent contraction in 2008. By way of comparison, in the horrible year of 2009 the US economy contracted 2.44 percent. So that was a very bad recession, much worse than the American recession. At this point, so called “outside ‘experts’” predicted disaster for Latvia in early 2009 unless it devalued its exchange rate. Latvia declined to devalue and its GDP shrunk 18 percent! That’s the disaster right there. Overall GDP growth for 2010 is forecast to be slightly negative again. So, yes, Latvia has returned the growth. But the toll was terrifyingly high.

As ever, there were some “real” shocks involved in this. Some loss in Latvian living standards was inevitable and unavoidable. But the unemployment rate in Latvia is nearly 20 percent. That means a great many able-bodied adults are simply not working, not producing any goods and services for market consumption. That represents a vast loss of living standards that could have been largely avoided in a floating exchange rate regime.

To suggest that this is some kind of success story that illustrates the underlying workability of the system is horrifying.

Bundestag Debate on Eurozone

Quentin Peel has an excellent report in the FT on a recent Bundestag debate that shows the shifting sands inside the German political elite:

German unwillingness to bolster the size of the €440bn eurozone stabilisation fund, or contemplate the issue of jointly-guaranteed eurozone bonds, was in danger of turning the European Central Bank into a “bad bank”, said Frank-Walter Steinmeier, parliamentary leader of the Social Democratic party, and former vice-chancellor.

Jürgen Trittin, co-leader of the Green party in the German Bundestag, said the chancellor was regarded throughout the eurozone as a “Teutonic savings-monster” whose actions had aggravated the crisis. He accused her of “disorientation”, and being driven by fear of the popular press. [...]

[Steinmeier] spelt out his three-point programme, outlined in an opinion article for the Financial Times on Wednesday, calling for a debt-restructuring for Greece, Ireland and Portugal, combined with a debt guarantee for the rest of the eurozone, and increased funds for the EFSF. He also backed the idea of issuing eurozone bonds in the medium term, combined with much closer political and fiscal co-ordination amongst the member states.

The price of integrating Europe in an unbalanced way that ran so far ahead of public consciousness has been criminally high. But I do think we see here that the basic calculation that forging ahead with a single currency would drive deeper integration is happening. Leaving aside the policy ideas here, what you’re seeing is a European policy debate. It’s not Germany versus some other country. And it’s not a simplistic “Europhiles versus Europhobes” debate either. It’s a real disagreement about the best way for Europe to proceed, like how Democrats and Republicans argue in Ohio about national policy.

Haircutting the Eurozone

Barry Eichengreen has another good column on the Eurozone debt situation making the point that for countries such as Spain, Portugal, Greece, and Ireland to successfully implement a strategy of “internal devaluation” (i.e., wage and price cuts) they almost certainly need to restructure their external debts. That means coordinated action, and it means some kind of backstopping function from the government of Germany, the ECB, etc:

Now we get to the hard part. All of this requires leadership. German leaders must acknowledge that their country’s banks are dangerously exposed to the debts of the eurozone periphery. They must convince their constituents that using public money to provide sweeteners for debt restructuring and to recapitalize the banks is essential to the internal devaluation strategy that they insist their neighbors follow.

In short, Europe’s leaders – and German leaders above all – must make the case that the alternative is too dire to contemplate. Because it is.

Something that really comes through spending time in Germany and talking to members of the German press (and just scanning their papers) is that mass consciousness of “European” issues is just very low across the board here. I’ve asked a bunch of people if they think people understand the circular flow of debts and how it is that much of this money is owed back to German institutions, and nobody seems to think the answer is yes. If you look at the serious newspapers like FAZ and the Suddeutscher Zeitung, none of the featured articles on their websites this morning related to these European questions. So while leadership is certainly needed, it also doesn’t seem incredibly likely. I think European elites thought they were doing something very clever in the 1990s when they sort of built up EU institutions by stealth. Part of what’s happening now, though, is that the continent is paying the price for having built a set of political institutions that’s totally at odds with public awareness.

Juncker Slams Merkel

While the US has been obsessing over tax cuts, there’s increasing European discontent with German Chancellor Angela Merkel’s lack of real ideas about how to put the Eurozone on sounder footing. These tough cross border hits from Luxembourg Prime Minister Jean-Claude Junker are a sign of the times:

Juncker told German weekly Die Zeit in an interview that Berlin had not even properly looked at his proposal, which was aimed at helping weaker eurozone members raise money, before deciding to oppose it.

“Germany’s thinking was a bit simplistic on this,” he said. “They are rejecting an idea before studying it. This is very strange. This way of creating taboo areas in Europe and not dealing with others’ ideas is a very un-European way of dealing with European matters,” he said.

Merkel responded by urging for “calm” ahead of next Friday’s summit of EU leaders, where discussions will focus on creating a permanent crisis mechanism for the eurozone and what the chancellor called “narrow” changes to EU treaties.

The issue behind the issue is that Germany is currently enjoying the most rapid 12-month period of GDP growth since reunification so there’s no great sense of urgency here. And the issue behind the issue behind the issue is simply that like in most European countries, the German public is not particularly engaged with “European” politics as such. Newspapers have 4-5 times as many people covering the German parliament as they do covering Brussels. In America people care about their parochial interests, but there’s a very real feeling of a national community and people who pay attention to politics pay attention to Washington. In Europe, especially in the larger countries, not so much.

Adjustment Asymmetries

Enlightening analysis of the European situation from Nick Rowe:

Keynes worried about this asymmetry, but Bretton Woods never really resolved it. It’s one of the reasons that Bretton Woods fell apart. Countries that ran chronic balance of payments deficits sometimes were forced to devalue. I can’t think of a case where a country that ran a chronic balance of payments surplus was forced to revalue. Because they weren’t forced to do anything. (Though one of the reasons Canada chose to adopt a floating exchange rate in 1950 (pdf) was to allow the Canadian dollar to appreciate, which might be a partial exception?)

And I think that very same asymmetry is at work in the Eurozone right now. Germany should adjust one way, with higher prices, higher spending, or by leaving the Euro. And countries like Ireland and Greece should adjust the other way, with lower prices, lower spending, or by leaving the Euro. But Germany can choose to adjust. Ireland and Greece are forced to adjust.

And Germany doesn’t seem to want to change course; there are plenty of disagreements in Germany politics but fundamental support for an export-oriented economic model is across the board. So someone else will, in the end, have to adjust.

Europe Needs Looser Money

Ruining everything

I’ve written about the need for looser monetary policy in the United States, but the situation is even worse in Europe. For one thing, as Ryan Avent points out looser money would help the European periphery regain competitiveness:

But the key to a relatively painless internal revaluation is inflation in tighter markets. And it’s here that the European Central Bank could play a particularly useful role. Were the ECB to adopt a looser monetary policy, we would expect inflation to pick up first in the markets with the least excess capacity, and that would obviously mean rising prices for Germany.

The situation is kind of bitterly amusing. The Germans hate the idea of paying for bail-outs across Europe. They want peripheral countries to buckle down, slash their deficits, and accept as much of the pain of adjustment as they can. But the best thing Germany can do to facilitate this process is to allow the ECB to pursue a monetary policy that makes internal adjustment easier—by increasing inflation in Germany. And that’s maybe the one thing Germans hate more than writing cheques to the Irish government.

But it’s hardly all about inflation. Looser money would spur higher real output in Ireland, Spain, Greece, etc. all of which would make the deficits in those countries smaller. By contrast, it’s not really clear what the “German” solution is supposed to look like—if debtor countries are going to borrow less, then either saver countries need to consume more or else world output needs to fall.

Emerald Twighlight

A few links on Ireland. One from Niam Hardiman does a great job of explaining what’s actually happening. Here Barry Eichengreen loses his cool. Tyler Cowen is pithy: “Fiscal union was, is, and will remain a fantasy. The best the eurozone could have done was to abolish national banking systems and have a truly European banking market. It’s too late for even that, though.”

Speaking of the last point, it was observed to me yesterday that in a curious way the creation of the Euro didn’t abolish the Eurozone national central banks. Normally, a country’s “lender of last resort” and a country’s “monetary authority” are the same institution—the central bank. But that’s not the case for Europe. The lender of last resort for Ireland is the Central Bank of Ireland, but the Central Bank can’t print money. Consequently, the Eurozone national central banks (In Ireland, Portugal, Spain, etc.) can actually be subject to runs and liquidity crunches. Which is just to say that Europe doesn’t even have monetary integration in the way we would normally understand it.

Last point would be that as best I can tell public statements from German politicians and commentary in the German press seems to be creating a bit of a dream world in which “irresponsible” Irish business activity is to be contrasted with “prudent” German business activity, and Germans are properly resentful in a nationalistic way about being asked to “bail-out” said Irish. In reality, the Irish government is in crisis because Ireland’s banks are in crisis. Ireland’s banks are in crisis because they invested too much money in property ventures that have gone bust—that’s irresponsible. But the nature of the crisis is that Irish banks owe a lot of money to various creditors, a great many of whom are French and German banks. Which is just to say that French and German banks made, through the intermediary of the Irish banking system, a bunch of irresponsible investments in Irish real state. That’s the exact same thing as what the Irish banks did.

The Demand for Dollars

(cc photo by LateNightTaskForce)

The trouble in Europe seems to be getting worse, with debt fears spreading somewhat beyond even Spain to Belgium and Italy.

This is something people need to keep in mind when they think about QE2 and the fact that the real problem with current monetary policy is that it’s not loose enough. One thing you’re seeing as all this plays out in Europe is that the Euro is declining in value relative to the dollar. The dollar could go up for two kinds of reasons. One would be that foreigners are increasing their demand for US-made goods and services. They could be saying “I don’t want these Italian financial assets, I’m going to go buy a Boeing jet.” But obviously that’s not what’s happening here. Instead people are concerned about the increasingly rickety-looking European monetary system and want to get their hands on dollars as such.

The right response to this is for the Fed to be doing monetary stimulus—printing more money. This can take a number of forms. Buying longer-dated Treasuries seems to be what the FOMC is most comfortable with, but in a lot of ways I think it would be better to just create the money and send it to people. There are some questions about exactly how you would organize such a “helicopter drop” but I’m confident it could be worked out. And working those problems out would, among other things, have the advantage of improving the politics of monetary stimulus. Cut the banks out of the transmission mechanism and illustrate the fact that the point is to increase the amount of money that people have.

Spain and Bank Runs

Paul Krugman explains why Spain likely neither will nor should leave the Euro:

Should Spain try to break out of this trap by leaving the euro, and re-establishing its own currency? Will it? The answer to both questions is, probably not. Spain would be better off now if it had never adopted the euro — but trying to leave would create a huge banking crisis, as depositors raced to move their money elsewhere. Unless there’s a catastrophic bank crisis anyway — which seems plausible for Greece and increasingly possible in Ireland, but unlikely though not impossible for Spain — it’s hard to see any Spanish government taking the risk of “de-euroizing.”

I suppose one issue is this: Having read this column, if I had a Spanish bank account I’d now be looking for feasible ways to minimize the amount of funds in it. And once everyone starts hedging against a bank run, your bank run is under way.

The larger question posed here is whether it really makes sense to be running separate national banking systems parallel to a single continent-wide monetary authority. A regulatory system that works fine until there’s a problem doesn’t really work at all.

Ireland Bailout

A couple of brief points on this. One is that just as with any other time there’s a bailout, it’s always worth emphasizing that though “Ireland” gets some benefit from this, the real winners are those who lent money to Ireland and will now be repaid. Specifically, people lent to Irish banks without doing due diligence on the soundness of the enterprises and without recognizing that the Irish banking sector was too big for the Irish government to bail out. Then the Irish banks got their government bailout and now Ireland is (inevitably) being backstopped by the broader European Union. The political economy of this all works because at the end of the day there’s a lot of German and other “core” banks holding that debt.

Felix Salmon says the package here is actually small relative to the size of the problem. And Ireland as a country is small relative to the size of, say, Spain. It seems to me that there’s simply no way the key vulnerable EU members can repay their debts under currently predicted growth. And there are no policy options available to them that would get growth levels up to something workable.

I guess to put a positive spin on the European policy trajectory, if you keep kicking the can down the road long enough then it’s always possible a “positive shock” of some kind will emerge from abroad. And what’s the alternative anyway to can-kicking? But I get the sense that even more so than on our side of the Atlantic, dialogue around policy options is hobbled in the EU by a reluctance to admit that any major pre-crisis steps may have been mistaken.

Do Small Countries Need Banks?

One question posed by the ongoing meltdown in Ireland is whether, assuming the Euro survives, it really makes sense for Ireland to have banks at all. Of course Irish people will still want to lend and invest. But that could be accomplished by letting German banks open branches in Ireland. Access to banking services is an important policy priority, but it seems to necessarily entail government exposure to bad bank risk management. The normal best way to try deal with that is through regulation, but a small country in a currency union with much larger countries could deploy the ultimate regulatory solution—no banks! Let someone else do the regulating and the bailing out.

Giving up your ability to conduct monetary policy carries a heavy price, but for a sufficiently small country it should open up the chance to free ride on someone else’s banks.

Peace in Our Time

I was up at Yale talking international law and global governance. When folks like me start waxing eloquent about world peace and cooperation, it’s easy to dismiss us as utopian. Look how far we are from that end-state! It’s unimaginable. And I point them to this point about France and Germany:

Yes. Let us give thanks that the most brutal and blood-soaked border in the world is quiet–a border inhabited on both sides by those bloodthirsty peoples who have been numbers one and two in terms of the most effective killers of foreigners for centuries.

Who am I talking about? The Germans and the French, of course

It is now 65 years and 9 months since an army crossed the Rhine River bearing fire and sword. This is the longest period of peace on the Rhine since the second century B.C.E., before the Cimbri and the Teutones appeared to challenge the armies of the consul Gaius Marius in the Rhone Valley.

The story behind why worrying about a “big blowup in Europe” now is a worry about bank defaults rather than the wholesale destruction of major cities is a long and complicated one. But what’s clear is that it couldn’t have happened without the rise of liberal sentiments on the continent and the construction of liberal institutions to go along with them. France is still France, Germany is still Germany, and the continent still has various problems. But the problem of war has been abolished, just as it has on the US-Canadian border, between the United States and Japan, and in other portions of the globe. The trend worldwide has been toward fewer cross-border wars and fewer and less deadly internal conflicts as well. Working toward further reductions—toward peace—is by no means futile.

Why We Need More Money

I saw this on the FT earlier today:

Münchau is, quite clearly, correct. Only fiscal integration can make this work. Equally clearly, that’s not going to happen. So if you look at these headlines and respond, what you’re going to do is become more inclined to have dollars. In light of the chaos, money and money-like instruments looks better than less liquid assets and dollars look better than euros. Which means the United States needs a more expansionary monetary policy in response.

Germany and China

David Shorr writes from Seoul, South Korea that we should pay more attention to Germany’s trade surplus:

Germany is one of those countries that sells stuff rather than buying. Here’s the point about Chancellor Merkel’s statements: she talks a lot about Germany’s exports as a a success of their competitiveness and not very much about needing Germans to buy more. As with China, Germany is quite happy to chug along with export-led growth, thankyouverymuch. This begs the question — if Americans become less profligate (and households have already shown they can reduce consumer debt — then who will pick up consumer demand where we left off?

I think it’s wrong to put China and Germany in the same box here. The reason is that if you look at the Eurozone as a whole (or the EU-27 as a whole, or various other broader metrics) the overall surplus is pretty small as a share of GDP. Germany is (along with Sweden and the Netherlands) the export-oriented part of Europe sort of like how the Seattle or New York City areas of the United States are the export-oriented parts of our country.

That’s not to say the relationship between Germany, the Eurozone, and the world is unproblematic. On the contrary, it’s a total disaster. The Irish situation is a mess, and the Eurozone-wide growth rate is abysmal which means there’ll be more trouble ahead for Greece, Portugal, Spain, and Italy soon too. When the Euro was proposed, skeptics posited that the labor market wasn’t nearly integrated enough to make it work, but most European leaders forged ahead anyway. The result is an urgent problem, but it’s a very different one from the China situation.

Europe Under Pressure

Bad as the American economy is doing, the picture in Europe is really a good deal bleaker as this Rebecca Wilder chart indicates:

Germany is having more of a classic rebound recovery than we are (and their kurzarbeit plan worked pretty well to help people weather the storm), but it’s from a much sharper downturn. And much of the rest of the EU is looking disastrous. When the single currency area was formed, skeptics warned that it would prove unworkable amidst this kind of crisis to yoke very dissimilar economies together into one monetary system. And as Ryan Avent observes there’s little indication that the main Euro-area governments wants to take the steps that would be necessary to make the system work:

Something clearly has to give. Policy changes are pushing Europe toward a very long period of stagnation if not an outright return to recession. Workers are underemployed and furious. Core and periphery have seriously diverging views on the direction policy should take. And markets continue to pressure indebted nations to make cuts they may not actually be able to make.

Either the ECB must seriously soften its stance, or Germany and France must suddenly become much more generous to struggling euro zone economies, or the euro zone will face its toughest months yet. If no exit valve for the building pressure can be found, then pressured economies will begin heading for the exits.

It’s worth recalling that America’s recovery turn a turn for the worse starting with a period of concern around Greece and the Euro. We finally got a single decent month of jobs numbers, but people shouldn’t forget that there are still tons of problems lurking in the global economy.

Trading Places

There’s a well-known stylized fact wherein GDP per capita in the United States is higher than in the many Western European economies but GDP per hour worked is higher in Europe. But Reihan Salam notes that this now seems to have changed.

He sort of deploys this to a polemical end, but what’s happening basically is that America now has higher unemployment than France, Germany, etc. for the first time in a while. But during the course of the recession, American productivity has surged and European productivity has tended to slump. So suddenly we’re the ones who are highly productive when working who don’t actually work that much.

Of course with hours worked distribution matters a lot. There’s a big difference between 1,000 people each working 1,800 hours a year and 900 people each working 2,000 hours a year while the other 100 are unemployed. The traditional US-European dynamic involved both a “more vacation” element and a “more unemployment” one.

The Pain in Spain

When Spain beat Germany in the World Cup, I tweeted that Germany was going to double its resolve to destroy the Spanish economic with deflationary monetary policy. And it’s really worth checking out this eye-opening chart from Stephen Gordon which shows the extent to which Spanish people are bearing the burden of economic pain in Europe:

If Spain were an American state (call it “Florida”) then the collapse of its economy would spur large net fiscal transfers that help bolster and stabilize its economy. What’s more, the labor market linkages between Spain and other states would be pretty tight, letting people move from place to place. Consequently, in the US all the regions of the country are pretty closely packed on the 45 degree line.

Alternatively, if Spain were an independent country, then the collapse of its economy would spur massive devaluation. Everyone would get suddenly poorer and less able to buy imported goods. But tourists from Germany and the Netherlands would flock in to pick up good deals, Spanish wine sales would boom, and I might be able to afford some jamón ibérico de bellota.

Instead, Spain is having its monetary policy set basically according to Germany preferences and German needs even though conditions are very different. And fiscal transfers won’t be forthcoming. Some people tweeted back at me that the Spanish government is doing an okay job of destroying its economy on its own. But it really isn’t. Before the crash, the Spanish government was running budget surpluses. And it’s simply not possible for your economy to prosper if your monetary policy is set by people who aren’t even trying to create conditions that are appropriate for growth.

Bologna Comes to Utah

To the best of my knowledge there are precisely two people in the United States of America interested in the “Bologna Process” of higher education integration currently occurring in the European Union. Luckily for you, I am one of those people. To make a long story short, the higher education systems of the different EU member states have traditionally been structured differently, and the powers that be decided they needed to create some kind of system of comparability so that a Finnish degree could be compared to an Italian or Belgian one. This is dull on its own terms, but it has the pretty radical implication that colleges and universities are going to have to submit to some kind of measurement of actual teaching and learning rather than just saying “yep, so-and-so definitely took a class!”

The other person interested in this is Kevin Carey, who reports that similar metrics-based reforms are coming to Utah, the rare conservative state that also has a good government innovative streak:

With a grant from the nonprofit Lumina Foundation for Education, physics and history professors from a range of Utah two- and four-year institutions are applying the “tuning” methods developed as part of the sweeping Bologna Process reforms in Europe. Led by William Evenson, a former professor of physics at Brigham Young University, faculty members developed a comprehensive account of what physics students need to know and be able to do at the associate, bachelor’s, and master’s degree levels. “The B.S./B.A. student should demonstrate the ability to use statistical mechanics to define the entropy from the density of states and connect this form to the 2nd law when expressed as ds = dQ/dT >= 0,” for example. Other requirements include extensive laboratory, research, and communications skills.

[...]

“The process builds in accountability,” Evenson told me. “Once you’ve defined the outcomes, you can ask, ‘Are the programs really doing that?’ If a student finishes and can’t do what’s advertised, they’ll say, ‘I’ve been shortchanged.’ Transparency makes it easier for students, parents, and policy makers to make the right choices.” Tuning works only if it’s faculty-driven, Evenson stressed, rather than imposed from the outside. And tuning doesn’t mean that different colleges and professors will all start teaching exactly the same way—only that they will teach with shared, public goals in mind.

These are process reforms, but they’re essential to substantive reforms in the way higher education is done. Modern information technology clearly makes it possible to attempt any number of new approaches (whether DIY U-ish or otherwise) but it’s difficult to apply innovative teaching/learning experiences to a marketplace dominated by credentials and vaguely defined branding. A new university is almost by definition not a prestigious one, even it’s really good at teaching students. Developing real criteria for what you’re supposed to be learning gives innovators a chance to actually reap rewards from doing a good job.