September 04, 2013
The countries of southern Europe (Spain, Italy, Portugal, and Greece) have enormous trade imbalances with the countries of northern Europe, most importantly Germany. This is the core problem facing the euro zone economies. In order to limit the size of these imbalances, the European Central Bank (ECB) and the European Commission (EC) are demanding that the southern countries sharply reduce their budget deficits. This has thrown these countries into severe recessions with double-digit unemployment. (Yes, the immediate issue is the budget deficit, but this is an outgrowth of the trade deficit.)
Using complex economics, it is possible to determine that in order to reduce the southern country trade deficits, it will be necessary for northern countries to see more rapid inflation, thereby raising the price of their output relative to the price of output in southern Europe. However the New York Times see this prospect as a serious problem. A story discussing Germany’s relative prosperity told readers:
“But a closer look at the [growth] numbers shows a big gulf between growing, northern-tier countries like Germany, Austria or Finland and southern countries like Spain, Italy and Greece, which continue to contract, albeit at a more moderate pace than before. The divide makes for tricky navigation by the European Central Bank, which will hold its monthly monetary policy meeting on Thursday, as it tries to promote growth in the ailing countries while heading off inflation in the healthier ones.”
Of course if the purpose is to address the imbalances in the euro zone then the ECB should be promoting more inflation in northern Europe rather than trying to head it off.
This piece also uses the pejorative term “handout” to describe assistance from Germany and other northern European countries to the crisis countries. This money is allowing the southern countries to maintain payments to German banks and also to maintain their ability to purchase German exports. If Germany and other northern European countries provided less support for the southern countries it is more likely that they would opt to leave the euro zone and default on many of their debts. This would both cost Germany much wealth and lead to a sharp reduction in its exports.
It is also worth noting that Germany’s growth has not been quite as impressive as this article implies. Since the beginning of the downturn in 2007 its growth has been virtually identical to growth in the United States. While it does have lower labor force growth, and therefore lower potential growth, the main difference in outcomes has been due to the fact that Germany encourages employers to keep workers on the payroll in a downturn, even at shorter hours, rather than laying them off. In other words, labor market policy rather than growth explains Germany’s relative prosperity.
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