With European voters voicing their frustration at harsh austerity measures, economic fears are back in the eurozone and any respite from government and central bank intervention appears to be fading.
In a Q&A, Uri Dadush says there is no end to the euro crisis in sight. Dadush analyzes the greatest risks facing the region today and outlines the elements needed to find a way out of the turmoil, including Greece’s departure from the euro.
The need for austerity, however, is not going to change. This is not a philosophy imposed by Germany on the rest of Europe, but a reality that is imposed by the markets. The calls for departures from austerity are responding to massive political pressure and even Germany will need to move some, but in my view these moves will not be particularly consequential economically. If they were, the markets would push countries right back up against the wall.
Europe is in a deep crisis already. It’s unclear if things will get markedly worse in the next six to twelve months, but there are undoubtedly going to be big ups and downs filled with surprises and flare-ups that will compel policy reaction. In other words, while there will be a great deal of strain and volatility in the near future, it’s not guaranteed that things will get a lot worse. They may, but they may not.
The Greek situation may be coming to a denouement. This could take one of two forms. Either there will be a political crisis and Greece exits the euro—not because it wants to or is pushed out but because the country will run out of money—or the voters in the next elections will realize that they are at the edge of the precipice and usher to power a government that can keep things going.
It’s possible that Greece leaving the euro is not as bad as many people fear. It would certainly be very bad for the Greeks in the year or two following, but not necessarily so in the longer term, nor would it necessarily be a disaster for the eurozone. So much preparation and discounting has been done already in the private sector that the debt workout would really become a public-sector affair.
The other country to watch is Spain. It is the focal point of the euro crisis today, even more so than Greece. Spain is a big country facing gigantic imbalances, high unemployment, and major problems in its banking system. A huge amount of fiscal adjustment is needed.
Spain’s crisis is much more dangerous for the eurozone than Greece. Greece is relatively small and its exit is not a deathblow to Europe, but if the situation in Spain deteriorates it is a direct threat to the eurozone’s survival. Spain’s economic failure poses a real risk to Germany, France, and Italy. This means that every possible thing will be done to keep Spain from spiraling downward.
It’s a complicated question. The countries under stress in the periphery have very little choice but to engage in austerity. They can play at the margin, but basically they are doing what they have to do.
The eurozone overall could perhaps shift the balance with less austerity and more progress if Germany took a different line. But Germany’s margin for maneuver is far less than people think. Germany is part of the game and under scrutiny just like everyone else. It is a big economy, but it’s not the size of the American economy and needs to be careful. It is not remotely capable, for example, of bailing out Italy.
Still, Germany can do a little more and not just on its own spending. The main thing that Berlin could do is allow the European Central Bank to adopt even looser policies. Again though, I’m not convinced that the bank can do a lot more. It has already injected over one trillion euros into the European banking system, its balance sheet is greatly expanded, and the interest rate is at 1 percent, so it is not clear if the bank can really influence the economy to the extent that people hope.
The main issue holding back growth in Europe is not enough fiscal spending or demand; it is the fundamental lack of competiveness of the periphery. The euro crisis is not a crisis of demand as there is a great deal of demand in the global economy from emerging markets and others.
The real problem is that small countries in the periphery cannot supply goods at a reasonable price and in the workings of the monetary union they can’t devalue or adjust. Simply inflating the European economy can help at the margins, but without big adjustments in the periphery the situation will not improve enough.
None of this is easy and the politics are frightful, but there are three elements to reducing the risk of turmoil and improving economic prospects.
First, some countries can’t make it and they need to get out of the euro. This includes Greece and possibly Portugal. At this stage, it looks like Ireland can hold its own and stay in the eurozone. These exits—provided they are carefully managed—will help the situation. Europe needs to prepare for their departures and is now quite prepared for Greece leaving, but is not yet ready for Portugal to go.
Second, the eurozone needs to close the internal competitiveness gap. This can happen through higher inflation in the core than in the periphery and structural reforms in the periphery. This process will take many years under the best of circumstances.
And third, the institutional framework of the union needs to be strengthened. The center of the eurozone can be enhanced by coordinating fiscal policy and jointly issuing eurobonds, establishing a common banking authority with real teeth, and implicitly or explicitly supporting the core of the eurozone with the European Central Bank. The third element is a longer-term change, but faster movement toward this goal will increase confidence.
All three are fraught politically, so it’s impossible to be confident that they will occur.
Europe’s economic fragility impacts the global economy in many ways—and all of them are bad. The first is that Europe is not growing. When it’s all added up, we are talking about the world’s largest economy, and when it is in recession everyone suffers.
The second thing is that the euro is much lower in value than it otherwise would be. The markets know that the euro should be stronger. This means that the rest of the world not only faces lower demand from a big bloc, but greater competition and less profits for its exports.
The third way that the situation is bad for the global economy is Europe’s loose monetary policy. Liquidity is spilling over into emerging markets and it is an unhealthy situation. Over time, this is bad news for the economy.
But the most important thing is the uncertainty that the euro crisis creates. This affects everyone from consumers to companies to banks to governments around the world.
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