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Monday, November 14, 2011

All Quiet on the German Front

The interview with Bundesbank President Jens Weidmann in today's Financial Times shows that the walls of German policy blindness are not going to come tumbling down like Jericho's anytime soon. Weidmann is still wedded to the received wisdom:
  1. The Euro crisis is primarily due to the fiscal policies of the member states, not a crisis of relative competitiveness, balance of payments, and lack of aggregate demand.
  2. A return to the meaningless Maastricht criteria and greater fiscal policy integration would solve the underlying problem.
  3. Eurozone countries have to follow Germany's lead in reforming their labor markets. That is, they have to make sure that nominal wages rise significantly slower than productivity in a race to the macroeconomic bottom that is rewarded by export-led growth.
  4. German fiscal stimulus would be ineffective. 
  5. The ECB acting as lender of last resort is ruled out by the Maastricht Treaty, would reward wayward governments like Italy's by monetarizing their deficits, and would represent a politically unacceptable transfer of resources between Northern and Southern Eurozone countries.
What the received wisdom overlooks is that a firm commitment to act as lender of last resort, when effective, would not need to mobilize resources because it would be a credible deterrent. This is something even a leveraged EFSF can never be, quite aside from the hypocrisy and financial contortions going through the detour of the EFSF represents to implement the same backstops that would be a fall from grace for the ECB to provide. The lesson of this fiasco is that you cannot have a common currency without a lender of last resort, and that implies a certain solidarity and coordination of the member states like in the US.

What it also overlooks is that Germany's labor market reforms are precisely the factor that led to the fiscal crisis of the periphery. They are intimately related, not separate items on the menu. A race to the deflationary bottom in the periphery will only lead to a collapse of German exports to the rest of the Eurozone and a double-dip recession, something not in Germany's interests either. Having wages trail productivity everywhere as a macroeconomic policy principle is a recipe for an aggregate demand disaster in the Eurozone unless you really expect emerging  market export demand to make up the difference. If you don't, the only other possible source of aggregate demand is the German domestic economy.

What Europe needs is higher productivity growth and demand stimulus, not beggar-thy-neighbor wage dumping ("Lohndumping" in German, the root of the Eurozone problem) and fiscal austerity.

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