June 19, 2012
The NYT had two pieces today discussing the euro zone crisis, both of which implied that additional funds to support the peripheral countries will have to come from Germany and other core countries. Actually, this route would be problematic because at some point even Germany’s credit would be called into question.
The key to restoring the euro zone to stable growth would be to have the European Central Bank (ECB) back up the debts of the euro zone countries. This would immediately restore the market’s confidence in their debt and sharply reduce interest rates. The only risk from going this route is higher inflation.
Of course higher inflation is a necessary part of the solution to the crisis. The peripheral countries must regain their competitiveness relative to Germany. This can only be done by having prices rise less rapidly in the peripheral countries than in Germany. Since it is not plausible to envision prices declining in the peripheral countries (there is no precedence for such price declines) then prices must rise more rapidly in Germany.
For this reason, the guarantee of peripheral country debts by the ECB would accomplish both major tasks needed to end the crisis. It would immediately end the risk of a default by these countries and also set in motion a process that could restore their competitiveness. And, it would be largely painless for numerate people in Germany and other core euro zone countries.
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