Justice DeLayed...
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Could We Please Have Better German Policymakers?

Martin Wolf:

Martin Wolf - Ireland refutes the German perspective: If any good can come out of the Irish disaster it is via the realisation that the classic German perspective on the problems of the eurozone is mistaken... that the core problems of the eurozone are those of fiscal incontinence and economic inflexibility and so the right solutions are fiscal discipline, structural reform and debt restructuring. Ireland, however, is not in difficulty because of fiscal failings, but because of financial excesses; Ireland has needed rescue, notwithstanding its astonishingly flexible economy; and an emphasis on restructuring of debt has, predictably, triggered a crisis.

These realities should make Germany rethink. Will it? I doubt it.

Ireland is nothing like Greece. Back in 2007, Ireland’s net public debt was just 12 per cent of gross domestic product.... Spain, too, had net public debt in 2007 at just 27 per cent of GDP.... It was not the public but the private sector that went haywire in Ireland and in Spain. In the low interest rate environment caused principally by chronically weak demand in core European countries – Germany’s real domestic demand was a mere 5 per cent higher in 2008 than in 1999 – asset prices and credit exploded in several peripheral countries, particularly Ireland. An expansionary monetary policy has to work in much this way, somewhere. Moreover, until November 2007, spreads of Irish and Spanish public debt over German levels were next to zero. Nor is it surprising that private suppliers of credit failed to discipline the boom: they caused it.

Then came the “Minsky moment”.... [T]he Irish government rushed to guarantee its banks. The combination of the guarantees with huge fiscal deficits caused by private sector retrenchment – the Irish private sector will run a financial surplus of 15 per cent of GDP this year, according to the International Monetary Fund – has caused an explosion of public indebtedness. But this calamity is the consequence of the crisis, not its cause....

Now consider the solutions. Ireland is certainly not lacking in flexibility. On the contrary, its unit labour costs have collapsed... the fall in wages and prices worsens the overhang of euro-denominated indebtedness. Under pressure, Ireland has also imposed fiscal retrenchment. But deflating an economy suffering from the collapse of an asset price bubble often fails to work....

At best, reliance on fiscal disciplines and sovereign debt restructuring is sure to generate massively pro-cyclical policy. At worst, it will generate serial depression and default among member countries.... The crisis is a huge challenge for Ireland, which should surely convert unsecured bank debt into equity rather than force its citizens to bail out all the improvident lenders. But the Irish case also shows that the German view of how the eurozone should work is mistaken: fiscal sloppiness is not the main problem and fiscal retrenchment and debt restructuring are not the sole solutions. One cannot learn from history if one does not understand it.