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Germany must choose its poison
Event
Market disruption in the Euro Area has become a threat to the sustainability of
the European Union.
Impact
The failure of Plan A, inflicting austerity programs on the debtor economies of
Europe without offsetting stimulus in the surplus economies, has failed.
So now it is time for Plan B. While liquidity support will be a necessary
condition to stabilise European markets, it is unlikely to be sufficient. Germany
is also going to have to make some painful decisions over the coming months.
Probably the easiest path is to acknowledge that Germany’s real interest rates
will have to remain negative for years. This could mean an inflation rate that is
higher than desirable. But it would be a small price to pay compared to the
alternatives.
Analysis
In some respects the European single currency has all the downsides of the
Gold Standard and none of the upsides.
The rules of the Gold Standard forced surplus countries to reflate when deficit
countries deflated. There was a vaguely similar rule in the Bretton Woods
regime. In practice, however, the system was never so smooth since the
surplus countries sometimes cheated and refused to reflate their economies.
In the end it meant a collapse of fixed exchange rates.
For the Euro Area there is no rule that forces surplus countries to reflate when
other countries are deflating. Which means that this monetary regime has the
downside of the Gold Standard (no currency depreciation by a struggling
economy) and lacks the upside (reflation in the stronger economy).
Germany was able to capitalise on this flaw during the boom times. The
restoration of German competitiveness after the Euro was introduced in 1999
was a long, grinding process that lowered German unit labour costs. It
required Germany to accept very sluggish consumption and investment
growth for a considerable period of time.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Germany must choose its poison
Event
Market disruption in the Euro Area has become a threat to the sustainability of
the European Union.
Impact
The failure of Plan A, inflicting austerity programs on the debtor economies of
Europe without offsetting stimulus in the surplus economies, has failed.
So now it is time for Plan B. While liquidity support will be a necessary
condition to stabilise European markets, it is unlikely to be sufficient. Germany
is also going to have to make some painful decisions over the coming months.
Probably the easiest path is to acknowledge that Germany’s real interest rates
will have to remain negative for years. This could mean an inflation rate that is
higher than desirable. But it would be a small price to pay compared to the
alternatives.
Analysis
In some respects the European single currency has all the downsides of the
Gold Standard and none of the upsides.
The rules of the Gold Standard forced surplus countries to reflate when deficit
countries deflated. There was a vaguely similar rule in the Bretton Woods
regime. In practice, however, the system was never so smooth since the
surplus countries sometimes cheated and refused to reflate their economies.
In the end it meant a collapse of fixed exchange rates.
For the Euro Area there is no rule that forces surplus countries to reflate when
other countries are deflating. Which means that this monetary regime has the
downside of the Gold Standard (no currency depreciation by a struggling
economy) and lacks the upside (reflation in the stronger economy).
Germany was able to capitalise on this flaw during the boom times. The
restoration of German competitiveness after the Euro was introduced in 1999
was a long, grinding process that lowered German unit labour costs. It
required Germany to accept very sluggish consumption and investment
growth for a considerable period of time.
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