As is probably clear from my earlier post on the expiration of the Bush tax cuts, I am a big fan of Paul Krugman. I have been for a long time (going back to when I was in college reading his academic texts), and after a few bits of regret that he had directed efforts towards public intellectual rather than academic production, I’m fully on the Krugman bandwagon (and why not since he has been right more than he has been wrong.
Last week after a disaster of an interview ostensibly focused on his latest book “End This Depression Now!” (video if you dare) with CNBC’s right-wing Joe Kernan and Milton Friedman devotee Michelle Caruso-Cabrera (Kernan called Krugman a ‘unicorn’), Business Insider’s Joe Weisenthal sat down with Paul Krugman for a series of interview segments including
- Deficits (and why the government should be spending more) [video]
- Very Serious People, [video]
- the Euro crisis, [video]
- how Krugman is the “fastest damn writer in economics”, [video]
- why the Republicans are to blame for today’s “nightmarishly disfunctional political system” [video]
- and why we should stop listening to Alan “Snoopy Snoopy Poop Dog” “Enema Man” Simpson
Krugman is not the best TV guest, looking uncomfortable throughout, but he gets the point across and it should be required viewing for people wondering “what the hell is going on?”. But he gets to some very important points including about the European debt crisis, where he says there are two bad choices for Germany to end the crisis: step up and let the European Central Bank buy Italian and Spanish bonds to stop the death spiral, or leave the Euro themselves.
The problems in Italy and Spain are different from Greece (which lied its way into the Euro to begin with, see November 2004). Italy had high debt but low deficits going into the crisis and even today, when you look at the debt payments excluding interest, the primary surplus. Spain had lower debt and was in surplus before the crisis, mostly because it was getting additional tax receipts from a big housing boom, but is now in deficit, due in large part to the recession caused by the housing bust (sound familiar?).
The crisis in confidence in their debt is caused by a concern that they are uncompetitive, and because they cannot devalue their currency or let a little inflation into their economies, will remain so into the future. If they remain uncompetitive, they won’t be able to service their debt in the future. If they were outside of the Euro, like Iceland is, they could just let their currency devalue and regain competitiveness and start the economic recovery, but they can’t because they are reliant on the ECB, which is controlled by the Germans (whose investments were partially funding the bubble that started the mess).
As it is, they are stuck and it is up to the ECB and the German government who pulls the strings to decide how to resolve the situation. There are two possible solutions that Krugman describes:
- The ECB allows inflation to creep above their “below but close to 2% target” for the Eurozone as a whole, and makes this an explicit promise, backed up by their own quantitative easing program buying Eurozone countries’ debt (including Italy and Spain) to drive down yields on those countries’ bond, to make their debt service affordable. In addition to the help on the interest payments from falling yields, it will also stimulate the Eurozone economy, which is why they must also commit to allow slightly higher Eurozone inflation (which will mean escaping deflation in Southern Europe and 3-4% inflation in Germany). This is costly for Germany because its purchasing power will decline, but the benefit they get is that the Eurozone stays together and Southern Europe has a chance to escape from deflationary hell (Dante, meet Franz, who has wrought many levels of deflationary hell on Southern Europe).
- Germany exits the Eurozone and takes explicit control over its monetary policy. The rest of the Europe, “freed” from Germany’s strong economy, sees its currency depreciate, bringing the changes needed to make their economies competitive again. While simpler to explain, the effects would be more complicated. Germany, without the weight of depressed Southern European countries, would see its currency soar in value, which would hurt severely their competitiveness, which would depress their large export sector. But at that point, with them in control of their own monetary policy, they can let the regions within Germany fight about it (export heavy regions ask for looser monetary policy to depreciate the currency to bring back competitiveness while other regions support maintaining the high value of the currency so that they can buy more suddenly cheap imports, sound familiar?).
Krugman wisely chooses not to handicap the probabilities of these two outcomes, giving a bland 50-50 probability. And I’m going to follow him, since I have no more insight into internal German politics than he does, but I think the fallout for the global economy would be far less with the first choice than with the second (especially since it would probably cause a cascading effect since it would not be an orderly withdrawal).