by Olivier Jeanne, Peterson Institute for International Economics
and Arvind Subramanian, Peterson Institute for International Economics
and John Williamson, Peterson Institute for International Economics
Op-ed in the Financial Times
May 25, 2011
© Financial Times
The narrative in Europe on the recent crisis has taken the form of a morality play, pitting the profligate periphery (particularly Greece and Ireland) against a responsible core (Germany in particular). This narrative has become so entrenched that it has allowed Germany to play a decisive role in shaping the response to the crisis, and to emphasize that belt-tightening and reforms by the periphery are the key components of that response. Adjustment by the prodigals and (some) financing by the prudents is the mantra today.
This picture is undoubtedly true, as far as it goes: Greece, Ireland, and Portugal followed unsustainable policies and were living beyond their means. But it is not the whole truth: The euro is good for Germany, especially German exports, because it is weaker than the deutsche mark would have been—precisely because it includes countries such as Greece and Ireland. The key question is this: "Where would the deutsche mark have been before the crisis and today if there were no euro?" The fact is that the German economy would not be purring along at 4 percent growth in the absence of the euro.
It is worth remembering that Germany cares deeply about exports too and has always been concerned about losing exports to other countries. In one of his early works, the development economist Albert Hirschman reviewed the history of policy discussions on German trade since the late 19th century and noted that exports were viewed as vital for the country's economic dynamism. Current arrangements, in effect if not design, sustain that dynamism.
If these benefits are explicitly recognized, it can help to rebalance the narrative in a way that allows for a bigger German contribution to resolving the crisis. This might take two forms that would aid respectively Greece's growth and its debt burden.
The experience of the hyperinflation of the Weimar era has left Germans with a visceral need for price stability, which the world is aware of and takes as given. But the country has joined a monetary union, and a fact of this is that the central bank should and does target low inflation for the whole monetary area. This means that when others have to gain competitiveness (as everyone knows Greece does), the stronger partners such as Germany must expand demand and accept somewhat more inflation than they would like.
Greece is at present getting the worst of all possible worlds: It is incurring the political and economic costs of austerity without gaining investors' confidence that there is light at the end of the tunnel. It is on financial life support and on its way to becoming a ward of Europe. Yields on Greek paper suggest a default is near certain, which cannot but dampen investment in the country. This protracted uncertainty about its financial situation stems in part from Germany (and France) being unwilling to come clean on the toxic Greek assets on the balance sheets of their own banks.
An easy way to give Greece additional support is to endorse the "blue bond" recently proposed by Jacques Delpla and Jakob von Weisacker, of the Bruegel think tank. They argued that European Union (or euro area) countries should pool a portion of their national debt (perhaps up to 60 percent, though it need not be that high) as senior sovereign debt that would benefit from a joint and several guarantee. By giving other countries a euro asset they would want to hold, this could establish the euro as a true reserve asset and thus lower Europe's collective cost of borrowing. Reducing the cost of servicing a substantial proportion of Greek debt would be a real help to Greece.
Paul De Grauwe has recently proposed modifying blue bonds in a way that would guarantee Germany (inter alia) would benefit financially. This would vary countries' contributions to the cost of servicing blue bonds, so countries with lower debt/gross domestic product ratios would contribute less. This meets a very understandable German objection to the simple blue bond proposal.
Larger self-interest, especially in keeping the euro project alive, argues for Germany endorsing the blue bond proposal. But bigger German contributions—more aggressive expansion of domestic demand, and accepting national inflation greater than in the whole euro area—would also repay Greece for its contribution to German competitiveness, exports, and growth.
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