Mrs. Merkel’s Triumph?

Three weeks ago, Stein Ringem, Professor of Sociology at Oxford University, wrote a rather smug op-ed piece in the Financial Times entitled “Time for economists to eat humble pie . . . again,” ridiculing all the economists who had been criticizing Mrs. Merkel for not being more forthcoming in negotiating debt relief for Greece and other over-indebted European countries, who had warned that the euro would collapse if Mrs. Merkel did not relent in her opposition to bailouts, proving her economist critics wrong.  Rejoicing in Mrs. Merkel’s vindication, Professor Ringen let loose on her critics.

Economists warned politicians not to dither. In the New York Times, Paul Krugman poured scorn over Europe’s politicians.

The implication of these calls for bold action was simple: Greece was in effect bankrupt; governments, notably Germany, would one way or another have to pay up if they wanted to save the euro. Ms Merkel’s line was different. Yes, Greece was bankrupt, but the solution was that Greece would carry as much as possible of its own debt, that private bondholders would be made to write down as much as possible, with speculators punished, and that other governments and the European Central Bank would contribute as little as possible.

Had the balance of opinion among economists prevailed, private bondholders, who had lent recklessly, would have been let off scot-free at European taxpayers’ expense. Why were so many commentators so careless? I have no problem with the “chief economists”, whose job is to protect the banking sector, but what about the independent academic economists?

There was never a sovereign debt crisis. There were two separate problems. The Greek government had more debt than it could manage and would somehow have to default. No other European government had an unmanageable debt level but some, such as Italy and Spain, did not have the trend under control and were at risk of moving to an unsustainable level. The solution to that problem was not bailouts, which would have been counterproductive and benefited lenders too much, but pressurize these governments to get their own affairs under control. That is being achieved in Italy.

Here is where Professor Ringem’s disdain for economics gets him into serious trouble. He is right that there was no debt crisis. Spain and Italy need to control and reform their finances, but that is not why interest rates on their 10-year notes have jumped more than 50 basis points in the three weeks since Ringem wrote his little paean to Mrs. Merkel. The real problem is that the European Central Bank, despite occasional signs of independence, remains firmly under Mrs. Merkel’s control, refusing to provide enough cash to the Eurozone economy to allow a real recovery to get started. As long as interest rates exceed the rate of growth of nominal GDP, the real debt burden in Europe will continue to increase, no matter how ruthlessly Mrs. Merkel inflicts austerity on the rest of Europe.

The need to predict, a psychological urge in the economic tribe, led to the wildest warnings. Ms. Merkel’s genius was to see that serious problems are solved by hard work and that what is at its core political cannot be solved by technocratic fiat. . . While experts panicked, politicians kept their cool.

No, serious problems are solved by clear thinking about their causes, and, once the causes are identified, taking the appropriate steps to counteract them. If the cause of an unmanageable debt burden is that nominal debt is growing faster than nominal income, the solution is to increase the rate of growth of nominal income until it is growing faster than nominal debt.

So what we have seen was not pretty. But it has been political craftsmanship of the highest order. Government borrowing has not been discredited but chronic borrowing to fund consumption is hopefully on its way to becoming history.

Nominal income fell in the Eurozone in the fourth quarter of 2011, the first time it fell since the second quarter of 2009, falling in Ireland, Italy, Malta, Netherlands, Portugal, and Spain. Some craftsmanship.

Europe’s leading politicians have performed admirably. They have done their job by staying level-headed and trusting themselves. One lesson is clear: beware the experts who come bearing advice and in particular economic experts.

No, the lesson that is clear is to beware of politicians and sociologists unable to grasp the laws of arithmetic and compound interest.

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12 Responses to “Mrs. Merkel’s Triumph?”


  1. 1 Marcus Nunes April 19, 2012 at 9:07 pm

    It will be shown to have been a Pyrrhic Victory. And I agree that the ECB is pro German:
    http://thefaintofheart.wordpress.com/2012/01/06/the-pro-german-ecb-is-not-a-myth/

  2. 2 Tas von Gleichen April 20, 2012 at 1:58 am

    Well no surprise the ECB is based in Frankfurt, Germany. The financial center of Europe soon replacing London. Anyway, I agree there is a huge political will to keep the Eurozone a live. The problem is whether Mrs. Merkel excepts the role of being the leader of the pack. Therefore, taking the responsibility of this crisis. I don’t know if Germany is ready to take that leadership rule. Also, I think that if we don’t have the Eurozone anymore emerging economies would beat as badly. To the point that we would wish to have the Eurozone again.

  3. 3 Ron Ronson April 20, 2012 at 8:41 am

    While accepting that the cause of the current recession is montetary – mis-management by central banks allowed NGDP to fall below trend with inevitable consequences – I am not convinced that bailing out governments who have over-borrowed or lenders who have lent unwisely should be part of the solution.

    The global money supply should have increased in 2009 to meet the increased demand. This could have been acheived by well-understood processes that do not involve bail-outs of failing governments or businesses. Perhaps if this had happened then some of the PIIGS could have escaped the consequnces of their recklessness and been able to continue to live beyond their means. However (with ot without correct monetary policy) it is a fact that any default that did occur would certainly have worsened the recession.

    The monetary aspects of this deepening could be mitigated by correct stabalizing monetary policy. Any default would also have caused a structural supply-side effect that would likely lead to lower RGDP. To me this would still not justify any bail-out – on moral hazard grounds.

    Market Monetarism is about free market solutions to problems caused by central banking – not interervening to save insitritutions that have acted stupidly.

  4. 4 Benjamin Cole April 21, 2012 at 11:10 am

    Greece needs the powers of a sovereign—its own currency and printing press.

    They cannot reflate; and with sagging economy, they will have trouble balancing budgets.

    They are in economic purgatory, designed by the Eurozone and ECB.

    Why one currency for Europe? Then, why not one currency for the world?

    Answer: Not every economy needs the same monetary policy. Duh.

  5. 5 Will April 21, 2012 at 4:39 pm

    Benjamin, I seldom find anything to disagree with in what you say. Here, though, your remedy will not work, because the patient refuses to take it. The Europeans, in an act that Veblen might describe as “naive shamanism”, impart to their euros the magical power of giving them political unity (and strength vis-a-vis those bossy Americans). Even my European friends who usually agree with me will not give ground when I suggest they should abandon the experiment. The solution will have to take a different form.

  6. 6 David C April 22, 2012 at 8:58 am

    Before the financial crisis, Spain had lower debt levels and lower deficits than Germany. Italy had a primary surplus, which means it took in in taxes more than it spent on government activities — and its debt to GDP ratio was declining steadily.

    The housing bubble in Spain was financed by easy credit from German banks. When it burst, revenue collapsed and thus the current fiscal problems. Italy saw significant wage inflation, financed by cheap money from the north.

    The German’s are hypocrites — they caused this depression, but will take no responsibility for ending it.

  7. 7 Julian Janssen April 23, 2012 at 3:37 pm

    Here’s my new post on Expectations and the Lesser Depression:

    http://socialmacro.blogspot.com/2012/04/expectations-and-lesser-depression.html

    I welcome any criticism anyone has to offer.

  8. 8 mgale April 23, 2012 at 7:29 pm

    We have found a pope for the Church of Angela Merkel, and his passion for the job is noted. Now all we need is a gospel that offers something besides the dogma of austerity.

  9. 9 David Glasner April 26, 2012 at 6:53 pm

    Marcus, Yes, indeed, another victory like this and we are undone.

    Tas, Yes, the Germans are in charge, and it is not even a century since World War I. I actually think that in many ways Mrs. Merkel is a very admirable individual, so I do not have any personal animosity towards her, and I think that the Germans have done a respectable job of making amends for their horrific past, but it is a tragedy that they have adopted anti-inflationism as a sort of national political religion.

    Ron, I am not in favor of bailouts to governments. I am in favor of a monetary policy that will eliminate the need for bailouts. Once we have the correct monetary policy in place, it will be up to the governments concerned to take whatever steps are necessary to manage their own finances. The Greek, Irish and Portuguese situations could have been dealt with. None of the other European countries would have been implicated if monetary policy had allowed a recovery.

    Ben and Will, The simple solution is to raise the inflation target of the ECB or to switch to a suitable NGDP target.

    David, I don’t know if the Germans caused the depression, but the lending practices of their banks were obviously irresponsible and their hands are not at all clean, so they certainly have no business claiming the moral high ground.

    mgale, I don’t think the church will attract many converts outside Germany.


  1. 1 Links for 2012-04-20 | FavStocks Trackback on April 20, 2012 at 12:39 am
  2. 2 Mrs. Merkel’s Triumph? | poleconomix.gr Trackback on April 21, 2012 at 1:20 am
  3. 3 Stein Ringens forunderlige verden « Tankeløse Plukk Trackback on June 7, 2012 at 3:29 pm

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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