BARCELONA – The countries on the so-called “periphery” of the eurozone (Greece, Spain, Portugal, Ireland, and perhaps some others) need to carry out complementary adjustments that are often discussed separately but actually need to be tackled jointly.
Indeed, to restore these economies to health, three distinct types of adjustment are needed: between the eurozone and the world, between the eurozone’s periphery and core, and between debt and income in the heavily indebted peripheral countries, particularly Greece.
The solutions in each case are as clear as their implementation is complex. First, in order to relieve pressure on the peripheral countries (at least in part), the eurozone must export some of the needed adjustments through a significant depreciation of the euro, which is already taking place. This is the adjustment between the eurozone and the world.
Second, to regain competitiveness, the adjustment between the eurozone’s periphery and its core requires closing the inflation differential that built up during the pre-2008 capital-flow bonanza.
In countries like Greece and Spain, this amounted to roughly 14% of GDP following the launch of the euro.
Last but not least, the adjustment between debt and income may be helped, over time, by higher overall eurozone inflation. But it is becoming increasingly clear that bringing the debt burden in line with the distressed countries’ payment capacities requires, at least in some of them (particularly Greece again), an ordered process of debt restructuring.
So far, European policymakers have chosen to do precisely the opposite on each front. They have tried to talk up the value of the euro, though currency markets have dismissed this as mere political rhetoric, and are rapidly bringing the euro closer to equilibrium.
Likewise, the European Union has tried to dispel doubts about the imminence of Greek and other sovereign-debt restructurings by putting together a reasonably large stability fund (and throwing in €250 billion of still non-existent IMF commitments).
This was designed not so much to shield the peripheral countries from a market run as it was to “bail in” private lenders.
Predictably, lenders saw through the announcements and understood the unfeasibility of the underlying fiscal cuts. Bloomberg reports that, in a recent survey of global investors, 73% call a Greek default likely.
In these circumstances, postponing the restructuring only perpetuates distrust of European banks with opaque sovereign exposures, and of financial markets in general – in much the same way that uncertainty about exposure to collateralized debt obligations led to a confidence crisis in late 2008.
Why not use the much-heralded stability fund as collateral for a European Brady bond plan that puts an end to the sovereign debt saga?
It might sound extreme, but it certainly would be more efficient than a slow hemorrhage of EU funds, which would lead to an official and multilateral debt hangover that could only deter junior private lenders.
Such a plan would also clarify, once and for all, the size of the contagion to EU banks, which could ultimately be ring-fenced.
All that is required is the same resources that the European Central Bank is squandering today on at-par debt purchases from distressed peripheral sovereigns – an effort that does not seem to be impressing the markets. In fact, spreads on Spanish and Italian bonds are higher today than before the ECB’s program was put in place.
Finally, European governments seem to be competing to carry out the most drastic fiscal adjustment. This is a self-defeating solution that can appeal only to the most myopic market analysts – and, curiously enough, to a bipolar International Monetary Fund that, less than a year ago, correctly advocated synchronized fiscal stimuli precisely for the same reasons that synchronized fiscal restraint is bad policy for Europe today.
In this context, Germany’s new austerity package is the latest and most striking element in a sequence of ill-advised responses.
Fiscal austerity in Germany can only reduce demand for eurozone products, and result in lower German inflation. And lower inflation in Germany means that, to close the inflation differential, peripheral countries will need a bout of outright deflation.
In other words, fiscal cuts in Germany mean deeper fiscal cuts in Greece and Spain. This is a baffling policy choice at a time when Germany should be using its room for fiscal maneuver and its economic clout to create and enhance the demand that peripheral Europe needs in order to grow out of its misery.
Such a policy would also generate some welcome inflation to facilitate the relative price adjustment within Europe.
Last year, the London G-20 summit recognized that the global crisis required coordinated spending to pull economies back from the brink.
Fifteen months later, Europe and the IMF, by endorsing unqualified fiscal restraint, fail to recognize that the European crisis calls for differentiated policies to achieve multiple and different objectives.
Implementing today’s conventional un-wisdom promises only a deeper recession and the postponement of the inevitable day of reckoning.
Mario I. Blejer was Governor of the Central Bank of Argentina. Eduardo Levy Yeyati is a visiting professor at the Barcelona Graduate School of Economics.