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Germany and the €-zone Crisis

Germany and the €-zone Crisis. Jörg Bibow , Skidmore College & Levy Economics Institute, New York World Economic Roundtable, New America Foundation & World Policy Institute, NYC, 12 June 2013. Aim & message. AIM: Explore Germany’s central role in the ongoing Euro-zone crisis

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Germany and the €-zone Crisis

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  1. Germany and the €-zone Crisis JörgBibow, Skidmore College & Levy Economics Institute, New York World Economic Roundtable, New America Foundation & World Policy Institute, NYC, 12 June 2013

  2. Aim & message • AIM: Explore Germany’s central role in the ongoing Euro-zone crisis • MESSAGE: Having misinterpreted its own economic history, Germany is forcing an unworkable policy regime upon Euro-zone • Posing great risk to global recovery • Germany blind to its own vulnerability J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  3. Structure of talk • The “German model” • The trouble with exporting the German model • The key causes behind Euro-zone crisis • Unimpressive pre-crisis performance • Crisis (mis-)management • Conditions for proper crisis resolution • Concluding remarks J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  4. 1. The German model • “price stability above all else” • Lower inflation actually caused growth in Germany in environments of fixed nominal exchange rates • COMPETITIVENESS • Independent Buba as referee: to check labor unions and fiscal policy • DISCIPLINE • Asymmetric MP; no job in stimulating demand • Relying on export engine worked for Germany because and as long as others behaved differently • Easier to balance budget alongside external surplus J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  5. A history of external surpluses J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  6. 2. The trouble with exporting it • Maastricht meant export of Germany model • Meant trouble for Germany because key trade partners now required to be like Germany • Some temporary factors in 1990s • + Interest-rate convergence, “new economy” boom • - “burden” of German unification (“transfer union”) • So Germany became “sick man of the euro” • German response: more wage repression, fiscal austerity, and structural labor market reforms J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  7. Miraculous healing of the sick man J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  8. 3. Key Causes behind €-zone crisis • Deep cause: regime flaws • Cutting the Treasury-CB nexus of sovereign states • Nobody “minding the store” • No proper policy coordination to ensure convergence and cohesion of union • More immediate cause: German misbehavior • How wage repression, structural reform, & mindless austerity in Germany undermined currency union J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  9. 1) treasury-CB nexus rather vital • National treasury strengthened by national CB underwriting of financial system liquidity, just as CB strengthened by Treasury’s “deep pockets” • Treasury-CB nexus vital to safeguard liquidity and solvency of banking system • Euro decoupled member states’ national CB and national Treasury, while ECB not meant to be LOLR and Euro Treasury nonexistent • Strength! Says German model of central banking • CB independence “above all else” (Buba as referee) • Hyper-fears of “fiscal dominance” (Weimar, MEFOs) J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  10. 2) Nobody “minding the store” • No demand management foreseen in good times • “Stability-oriented” monetary policy asymmetric • “Below 2%”: Quick to hike, slow to ease = anti-growth bias • “Disciplined” fiscal policy asymmetric too • “Below 3%”: deficits can be “excessive” but never too small • Policy mix? No, as coordination threatens CBI! • Fiscal stance random, macro policy mix set by ECB • No LOLR foreseen in bad times • “Market-policy domain problem”: common market but no common policy = fragility, as markets “off the leash” and without backstop • Today: Common financial market without “banking union” J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  11. 3) Convergence not ensured • Euro-zone members commit to common inflation rate • ECB: “below but close to 2%” • “Golden rule of currency union”: National ULC trends must be aligned with common inflation norm • As nominal exchange rates eliminated, relative ULC trends determine intra-area competitiveness positions • While € determines extra-area competitiveness • Diverging national ULC trends undermine union • Divergences cumulative, lastingly distort competitiveness positions, causing current account imbalances • And persistent CA imbalances involve debt buildups J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  12. 4. Unimpressive pre-crisis performance • Business cycle • Brief booms, long (domestic demand) stagnations • Remarkably export-dependent for large economy • Growth and policy outcomes • Declining trend growth rate • HICP (headline) inflation mostly above 2% • Budget deficits mostly above 3% • Buildup of massive divergences and imbalances J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  13. Notorious Growth laggard • Lack of domestic demand management • Persistent high unemployment • Budget pressures, so SGP provokes tax hikes • While ECB thinks it is not responsible • Alas, MP and FP shoot each other in the foot! Both missed their magic numbers! • Official blame on “structural problems” • Hence “structural reform” as panacea • Strangely, Germany never had a problem growing on strong export stimuli J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  14. Low growth and “Tax-push inflation” J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  15. Divergence! Europe Converges to Germany’s historical stability norm by mid ‘90s 1980s 1990s 2000s € crisis € launched J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  16. But Germany itself diverges OFFICIALLY, everybody ‘lost competitiveness’ but Germany J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  17. Nasty consequences! • One-size-does-NOT-fit-all ECB policy • Too tight for Germany … domestic demand flat • Too loose for periphery … ‘hello’ bubbles … • Germany turns “über-competitive” • Internally, Euroland seriously unbalanced • Externally, euro exchange rate too weak for Germany, too strong for rest = ASYMMETRIC SHOCK!!! J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  18. Maastricht regime amplifies trouble • As Germany suffocates domestic demand, macro conditions become relatively tighter • Financial conditions, credit, property prices … • More SGP prompted austerity … vicious circle … • While ECB stance becomes too easy for periphery • Financial conditions, credit, property prices … • Fiscal ease as public finances seemingly healthy • Feedback loops sustain & amplify divergences, smoothly financed by liberalized & integrated markets; fragilities build up; supervisors dozing J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  19. Current account imbalances As flows change stocks, debts build up … J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  20. Germany’s “euro trilemma” • As Germany’s CA surplus and NIIP balloon, partners see their position deteriorate • Pre-crisis Germany’s CA surpluses concentrated in EU, and so are financial exposures! • Germany cannot have all three: perpetual CA surpluses, a no-transfer/no bail-out currency union, and a “clean” independent CB • Germany is on the hook! J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  21. 5. crisis (mis-)Management • Fiscal policy • Brief ‘Keynes moment’ in 2009 • Followed by mindless austerity since 2010 • Fiscal support to financial sectors • Guarantees, recapitalizations, deposit insurance etc. • ECB monetary policy • Foolish hikes, delayed easing (i.e. business as usual) • ECB as LOLR to banking systems • Various, culminating in LTROs • ECB as LOLR to governments (indirectly) • SMP, finally: OMTs = Mario’s magic bullet J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  22. Essentially, Official flows replacing private flows as bop crisis unfolds • Private exposures turning into official exposures • Bilateral loans (Greece bailout no. 1 etc) • EFSM/EFSF, ESM • ECB bond holdings (SMP … OMTs …) • Intra-Eurosystem (TARGET2) • Note: So-called ‘bail-outs’ and Buba’s TARGET2 position are NOT new net exposures • Measures just allowed banks to pull out J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  23. Meanwhile, Re-loading/re-sourcing of German external surpluses J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  24. 6. Conditions for proper crisis Resolution? • Crisis resolution - and sustaining EMU - has three parts to it, and one precondition • Rebalancing the currency union • Restoring intra-area equilibrium (transition; flows) • Fair deal on debt legacies • Balance-sheet cleanup (past; stocks) • Fixing (Maastricht) EMU regime • Establish viable EMU regime (future) • Precondition: robust GDP growth J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  25. 1) asymmetric rebalancing = debt deflation J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13 • As convergence to Germany’s historical norm not good enough! • Even France – after staying 2% path – forced into debt deflation

  26. 2) Debt deflation & growth crisis Magnify need for Debt relief • “The more the debtors pay, the more they owe” (I. Fisher 1933). • Real GDP (2013 relative to pre-crisis peak, IMF WEO April 2013) • Greece: minus 23% • Ireland, Italy, Portugal, Spain, Cyprus, Slovenia: minus 5-10% • France: zero // Germany: plus 3% • Even nominal GDP is shrinking! (2013 relative to pre-crisis peak, IMF WEO April 2013) • Greece: minus 20% • Ireland, Italy, Portugal, Spain, Cyprus, Slovenia: minus 1-10% • Unemployment skyrocketing, investment plunging, debt ratios soaring! J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  27. 3) “more-of-the-same” style Reforms mean perpetual austerity • Strengthened SGP cum ‘Fiscal Compact’ • Balanced budgets forever, implies public debt ratio converging to (near) zero • Either private sector has to seize being net saver or ROW tolerate perpetual, large €-zone CA surpluses (=German model) • Banking Union & Macroeconomic Imbalance Procedure • BU concerns future crises (“market-policy domain problem”) • MIP about acquittal of Germany, turning key blunder into virtue (to justify more structural reform) • Structural reform NOT a growth strategy though • As distributional impact further undermines domestic demand … continent-wide … J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  28. As ‘growth-friendly’ consolidation taking its toll, Will Row really put up with ‘germanizedeurope’? J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  29. 7. Concluding remarks • Asymmetric rebalancing by lethal mix of mindless austerity and structural reform = debt deflation • Ultimate cost of crisis & need for debt relief rising • ‘More-of-the-same’ regime reforms counterproductive • Recent shift in strategy, i.e. faster structural reform for delayed austerity, no growth strategy either! • Global tensions? Currency wars, trade wars … • Need for Euro Treasury and spending from center!!! J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

  30. Thank you! Background to ‘Germany and the Euro-zone crisis’ • ‘The Euroland crisis and Germany’s euro trilemma’, • Levy Working Paper no. 721, May 2012, http://www.levyinstitute.org/pubs/wp_721.pdf • International Review of Applied Economics, online version, October 2012, http://www.tandfonline.com/doi/abs/10.1080/02692171.2012.721757 • ‘At the crossroads: The euro and its central bank guardian (and savior?)’, Cambridge Journal of Economics, 2013 • Levy Economics Institute, Working Paper no. 738, November, http://www.levyinstitute.org/pubs/wp_738.pdf • ‘On the Franco-German euro contradiction and ultimate euro battleground’, Contributions to Political Economy, 2013 • Levy WP no. 762, April, http://www.levyinstitute.org/publications/?docid=1740 • ‘Germany and the euro crisis: The making of a vulnerable haven’ • Levy WP no. …, June, coming soon • See my homepage http://www.skidmore.edu/~jbibow/research.htm • At Levy Economics Institutehttp://www.levyinstitute.org/scholars/?auth=20 J Bibow: Germany & Euro-zone Crisis, NYC, 12 June 13

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