Wednesday, August 17, 2011

Economic Change for Europe

Europe faces a fundamental problem. They have created an economic setup where the chance of economic recession is vastly increased. The Eurozone has a very limited solution for preventing economic stagnation and unemployment. They remain focused on an ideal of low inflation and lose sight of what is really important.

For example, Italy has a primary budget surplus (i.e. after debt interest payments they don't have to borrow) Italy has also made long term plans to raise retirement age inline with average life expectancy. Yet, despite facing high unemployment and spare capacity, they are being forced into cutting spending threatening lower economic growth.

Greece, Ireland, Spain and Portugal are all being forced to implement spending cuts at a time when the economy needs exactly the opposite.

Yet, despite fiscal austerity, countries in the Eurozone face no alternative for boosting growth.
  • There is no chance to devalue and restore competitiveness
  • There is no chance to print money and pursue quantitative easing.
  • There is no ability to cut interest rates
  • The lack of monetary independence means countries in the Euro face fiscal crisis
The Eurozone act as if the only important thing is low inflation and reducing budget deficits.

Eurobonds

Eurobonds are a suggested mechanism for sharing risk of borrowing. Instead of individual countries issuing their own bonds, their would be one Eurozone wide Eurobond. This would enable countries to benefit from greater security of Euro fiscal solvency. It would reduce interest rate costs and give countries more time to deal with structural deficits.

Eurobonds could definitely help. They would prevent the rising debt costs faced by countries threatened with deteriorating credit ratings. Eurobonds would prevent countries being forced into spending cuts when it could harm the economy.

Eurobonds will definitely be unpopular in Germany (Germany will face higher interest rate costs as a result). There are also real issues such as moral hazard and countries having less incentive to cut deficits. See: Pros and cons of Eurobonds

Also Eurobonds are not a panacea, but they would help mitigate the fact countries without independent monetary policy can more easily face credit shocks. But, it still leaves much to be done.

ECB

So far this year, the ECB has already raised interest rates twice. This is despite economic slowdown across the EU. Yesterday, Germany posted growth figures of 0.1% for Q2 2011. The ECB need to lose their irrational fear of inflation during a prolonged slump. They should go for growth.

See: EU Money Supply growth slowdown

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