June 04, 2012
In a column noting the bind in which the euro zone countries fund themselves, Robert Samuelson told readers that:
“Softening today’s austerity would require more borrowing. Who would lend? The ECB? Historically, excessive lending by central banks risks high inflation, though many economists discount that now.”
Given the massive amounts of excess capacity in the euro zone it is difficult to see how additional lending in the euro zone would lead to inflation. The context in which central bank lending led to inflation has typically been when an economy was near its capacity and a central bank continued to lend to keep interest rates down. That is clearly not the situation today.
Furthermore, the euro zone countries should welcome a modest increase in the rate of inflation. The key problem facing the euro zone is the uncompetitiveness of the peripheral economies. The cost of goods and services produced in Spain and Italy is much higher than the goods and services produced in Germany and the Netherlands.
If the euro survives, this gap has to be closed by having lower inflation in the peripheral countries. That would mean deflation if the inflation rate remains low in the core countries. Deflation is very difficult to bring about and will be very costly for the economies affected.
On the other hand, if inflation rises to 4-5 percent in the core countries, then the peripheral countries can regain competitiveness by keeping their inflation rate in a 1-2 percent range. This would be the most painless solution to the euro crisis. Unfortunately, the European Central Bank seems unable to even conceive of this policy path.
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