The Germans Keep Hitting Themselves on the Head with the Austerity Hammer
John Quiggin:
One size fits nobody?: Much recent discussion of the future of the euro... has started from the idea that Europe is not an optimal currency area, and that a ‘one-size fits all’ monetary policy is therefore bound to lead to the kinds of problems we are now observing.... I want to argue that this is not an accurate description of the current state of the eurozone. It’s true that Germany is doing a lot better than the eurozone as a whole, and the peripheral countries a lot worse. So, the optimal policy for Germany alone would be tighter than for the rest of the eurozone.... But when you look at the actual policies of the ECB, including Trichet’s recent threat to raise interest rates, it’s hard to see that this policy is optimal for any EU country, even Germany.... Germany’s recovery has not been that strong, and an expansion based on exports could easily be derailed by the kind of currency appreciation that would follow an interest rate rise, or even a really credible commitment to hold inflation down. And given the difficulties of handing out explicit haircuts, a modest amount of inflation seems likely to be a low-risk way of easing debt burdens without endangering the (largely German and French, and also UK) banks that hold a lot of the debt.
As has been pointed out here on previous occasions, to say that the problem is the ECB rather than the euro is, for some purposes, a distinction without a difference. But in other respects it is critical. If the optimal currency area analysis is correct then a breakup of the euro is probably inevitable and the big question is how to manage it. On the other hand, on the analysis offered here, the ECB must, in the end, be bluffing. Faced with the end of the currency it has been set up to manage, the ECB must eventually back down on everything else, including its inflation targets. The problem on this analysis is how to broker the politics of pushing the ECB towards large-scale quantitative easing and a higher inflation target...
