The Continuing Crisis: Brussels Means Nothing

Peter Dorman at Econospeak takes a political-economic look at the Brussels agreement:

First of all, it is important to bear in mind that this is an agreement of the European right.  The economic collapse of 2008 resulted in an electoral rout of social democrats throughout the continent (and in the UK).  That’s a story that needs more explanation, but for now the point is simply that conservative parties have absolute control over Europe, and the agreement just reached represents their priorities.  It is for hard money, austerity in the face of recession, full guarantees for creditors, and implicitly for reining in the costs of the welfare state, which must happen if the deficit targets are to be met under foreseeable conditions.  This is why politics matters, after all.

Not liking a political program is not the same as predicting its failure, however.  It could happen that the conservatives get their way and a socially regressive stability takes hold.  Under this scenario, the fiscal crisis recedes and Europe enters a long period of slow growth which is favorable for those who acquired wealth during the go-go years: the value of their assets is protected, and labor is mortally weakened.  For those who designed the Brussels agreement, and for those who bankrolled them, this would look like victory.

...

Absent a miracle, Europe is sliding into a recession.  This will affect Germany as much as the weaker countries, even more considering its dependence on Eurozone exports.  (Germany suffered an exceptionally sharp contraction post-Lehman too.)  The result will be a risk of debt deflation in all markets.  The sovereign debtors will again face default as public revenue dries up.  Speculative assets like real estate will resume their decline.  Overleveraged financial institutions—and Europe is the world leader in overleveraged finance—will need to be bailed out.  Of course, a rise in unemployment will trigger automatic stabilizers and increase the pressures for discretionary fiscal deficits as well.  It is likely that there will be a wave of elections in which center-left parties take revenge for their defeats of the past few years—Germany could lead the way, in fact.

And here's Krugman:

So last week European leaders announced a plan that, on the face of it, was pure nonsense. Faced with a crisis that is mainly about the balance of payments, with fiscal crisis as a secondary consequence, they supposedly committed everyone to severe fiscal austerity, which would guarantee a recession while leaving the real problem unaddressed.

But all this was supposed to work, according to many observers — and, briefly, the market — because the pain would provide the cover the ECB needed to step in and buy lots of Italian and Spanish bonds. In effect, the plan is supposed to rely on a Draghi ex machina, which turns contractionary policies expansionary.

It’s actually quite remarkable how many sensible people base their analyses on the presumption that the ECB will do what has to be done. Barry Eichengreen, who is a genuine expert on all things euro, starts his analysis of prospects for 2012 with the confident assertion that Draghi will ride to the rescue.

But as far as anyone can tell, the monetary cavalry aren’t coming. And the bond market has figured this out.

What Anglo-Saxon economists need to understand is that the Germans and the ECB really, really don’t share our worldview; they really do believe that austerity is all you need. And all indications are that they will cling to that belief, even as the euro falls apart — an event they will insist was caused by the fecklessness of the debtors. Given a choice between saving Europe and remaining righteous, they’ll choose the latter.

Barry Eichengreen, strikes a more positive note:

Many people think that 2012 will be the make-or-break year for Europe – either a quantum leap in European integration, with the creation of a fiscal union and the issuance of Eurobonds, or the eurozone’s disintegration, igniting the mother of all financial crises.

In fact, neither scenario is plausible. The collapse of the eurozone would, of course, be an economic and financial calamity. But that is precisely why the European Central Bank will overcome its reluctance and intervene in the Italian and Spanish bond markets, and why the Italian and Spanish governments will, in the end, use that breathing space to complete the reforms that the ECB requires as a quid pro quo.

Comments

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