Martin Feldstein, a conservative economist, argues (ht Mark Thoma) that a rapid fall in the value of the euro can “save Spain”. His argument, which applies for all the peripheral countries including Italy and Greece is that:
“The increase in peripheral country net exports would also raise their gross domestic product and so reverse their recessions that were caused by higher taxes and cuts in government spending. That would make it politically easier to achieve the needed fiscal consolidations. And shifting from recession to growth would raise business incomes and employment, reducing the volume of bad loans and mortgage defaults now hurting the banks.
Furthermore, the devaluation in the euro, which is already happening could be sped up by looser monetary policy:
“The decline of the euro can therefore occur without specific action by the European Central Bank. But a further shift by the ECB toward a looser monetary policy would speed the euro’s decline.”
Think of Spain as facing a three-level problem. The topmost level is the problem of the banks; set that aside for now. Below that is the problem of sovereign debt. What makes the debt problem so serious, however, is the underlying problem of competitiveness: Spain needs to increase exports to make up for the jobs lost when its housing bubble burst. And it faces years of a highly depressed economy until costs have fallen enough relative to the rest of Europe to achieve the needed gain in competitiveness.
The issue of competitiveness basically comes down to the fact that it had a huge real estate bubble which inflated prices in the country until 2007 and then, since Spain has no control over its own monetary policy or the value of its currency, it was unable to make the changes the way most countries do: looser monetary policy which stimulates the economy and a devalued currency, which adds stimulus by making exports more competitive.
And it is not just Spain, but all the peripheral countries that had recessions in excess of Germany’s since that country has defacto control of the monetary policy for the whole Eurozone and by and large makes changes to suit its own economy’s needs, the rest of the Eurozone be damned. That has created a cascade of problems from Greece with various cop outs for why those countries deserved what they got (Ireland had to bite the bullet in taking on bank liabilities as sovereign debt to win confidence with the markets, Greece lied to get into the Euro and spends too much, Portugal was, well, I’m not sure what the reason they would give why Portugal deserved to get thrown into the fire).
However, the cases of Italy and Spain present different challenges. They are, for one, much larger. Spain is about 8% of the
Eurozone European Union’s economy, Italy is about 12% so between them they represent one-fifth of the Eurozone European Union’s economy. Italy also has a $2.6 trillion bond market, the third largest in the world. If it melted down it would cause much greater chaos than the already large impact of the Greek tragedy.
These countries entered the Great Recession in relatively good shape: Spain had a surplus and even now Italy has a small primary (i.e. before interest payments on the debt) deficit even though Italy has a lot of debt. So the moralizing is not as easy for why these countries deserve the fate of Greece, Ireland (?) and Portugal (??). Even Germany’s Finance Minister who is wrong on basically everything said that Spain’s debt is not unsustainable, although he resorted to just saying markets were wrong (ignoring the root problem of inaction on a European level to end crisis of confidence in European debt markets that requires ECB action).
So, at the end of the day, we have two economists who agree on very little agreeing that the main issue in Europe is a lack of competitiveness in Southern European countries, and that devaluation (aided by monetary policy) could help speed up the devaluation by loosening monetary policy. They largely agree, I think, that the ECB has to buy Spanish and Italian bonds to prevent the spikes in interest rates we see now, although I think they would disagree on whether the ECB should target higher rates of inflation in Germany and how the Eurozone will ultimately prevent future crises. However, now, the case is in for why the ECB must act is pretty well resolved, except within the ECB and the German Finance Ministry, which is why the crisis will continue to live another day.
UPDATE: The ECB President Mario Draghi is saying:
- YIELDS DISRUPTING POLICY TRANSMISSION ARE IN ECB REMIT
- ECB WILL DO WHATEVER NEEDED TO PRESERVE THE EURO
This presumably (unless it is just another head fake) is the ECB acknowledging, at last, what everyone else has realized for quite a long time.