What are the alternatives to austerity for the Eurozone?

Paul Krugman’s post on the topic was revealing, compared especially to the analytic and rhetorical flourish which he applies to criticizing austerity.  You can’t fault his IQ or his knowledge of the situation, there simply isn’t much convincing to put forward.  Here is Ryan Avent, in a good post but I think it also fails to put forward a workable solution:

What, then, are the alternatives to austerity? Well, first up would be an integration that would help break the diabolical loop now gutting the periphery. Creating a euro-zone-wide safe asset and a euro-zone-wide set of institutions to stand behind damaged banks would help accomplish that. America doesn’t expect Delaware to shoulder the costs of failures of banks headquartered in Delaware. That’s an important contributor to the stability of the American federal system. The euro-zone must recognise that it is the failure to build appropriate euro-zone-wide institutions—equal in scope to the considerations and resources of the central bank—that is contributing to soaring yields around the periphery and creating the illusion of the need for dramatic austerity in places that could do without it.

I call this the “Germany pays for everything and accepts all the risk of moral hazard” approach.  Potential German liabilities could run in the trillions of euros and the “ball and chain” lasts forever.  I know all about Connecticut and Mississippi, but without a common electorate, not to mention a common national identity, I don’t see how this is possible.  Keep in mind that Eurozone-wide deposit insurance in essence serves as an implicit guarantee to the parent national governments as well, for Modigliani-Miller-like reasons.

It is like doing African development policy by suggesting that America send one-third of its gross national product to Mozambique.  Maybe it is moral to do so (though I doubt that), but in any case it is not really a policy proposal.  Lack of a common identity is a constraint, not a policy choice, except at fairly small margins or at moments of extraordinary cultural transformation (hint: this is not one of them , especially when there are seventeen nations involved).

Just to (imperfectly) integrate the relatively small unit of East Germany cost West Germany almost $2 trillion dollars.

By the way, will the periphery nations give much (any?) control over their finances to Germany?  Clearly not, and thus we are back to the idea being dead as a doornail.

There is no common fiscal policy without a common electorate, not for long at least.

Ryan Avent also supports looser monetary policy for the eurozone, as do I.  It’s worth trying.  But keep in mind, the further along is a financial crisis, the more emergency monetary policy takes on a more purely redistributive element.  You end up having to stick the money somewhere quite specific and forget about ever getting it back.  Nominal reflation helps with some problems when done well in advance of crunch time, but right now it is a question of solvency for many of the parties involved.  It’s already ineffective for the ECB to be doing three-year loans to rotten banks at one percent, against very low value collateral, how much more of a boost are we to expect?

Just how much monetary policy needs to be done?  At this point, we’re not talking about a move from price stability to say four percent eurozone inflation (which I would nonetheless favor, and favored all the more a year or two ago), rather much more would be required.  We’re running up against the same constraints which prevent the de facto Eurobonds from taking off.  Revisit the well-known point that in a financial crisis fiscal and monetary policy blur together, and we return to the notion that solutions are based on massive cross-border redistribution.  On top of all that, arguably the deflationary pressures in Greece, and possibly Spain, are already past the point of control from the ECB side, given the ongoing collapse in private lending.

Here is my earlier post, Austerity as a substitute for trust.  Kevin Drum adds related comment.


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