There’s No Euro Crisis; It’s an ECB crisis

Pascal Salin is a distinguished French economist.  I met him many years ago at a conference and subsequently corresponded with him.  He was also a contributor to  Business Cycles and Depressions:  An Encyclopedia which I edited.  His op-ed in Thursday’s Wall Street Journal is a cut above the usual fare in the Journal‘s opinion section.

Salin correctly points out that there is no reason why a default by one government should have an adverse effect on another government just because the two governments are using the same currency.  And certainly Professor Salin is also right in observing that joint European responsibility for the debts incurred by individual European governments is not logically entailed by the existence of a common currency. And I think he is very much on target when he makes the further point that the crisis is being used by those with a political agenda of creating a more centralized European super-state despite the apparent opposition to such a state by most Europeans.

The “euro crisis” is a pure political construction. It is a splendid opportunity for many politicians to impose some of their longstanding goals on everyone else. For instance, before the introduction of the euro, many politicians who called themselves Europeans considered monetary union a stepping stone to political union. I was opposed to the euro before its creation, precisely because I feared that the currency’s stewards would take this arbitrary link between the monetary system and national policies as a pretense to further centralize political decisions.

Politicians now argue that “saving the euro” will require not only propping up Europe’s irresponsible governments, but also centralizing decision-making. This is now the dominant opinion of politicians in Europe, France in particular.

But despite those valid points, I am afraid that Salin misses the key point, simply ignoring the indefensible role that the European Central Bank has played in this awful mess. Salin argues as if the difficulties of European governments in repaying their debts were entirely the result of their own profligacy and bad management, though I would not suggest that the governments in question are entirely blameless. But he says not a word about stagnation in European nominal GDP growth, as if nominal GDP were determined independently of monetary policy.  In fact, since the bottom of the downturn in the second quarter of 2009, nominal GDP in the Eurozone has grown at an annual rate of 2.3%, slowing to a rate of 0.84% from Q2 2011 to Q1 2012.   Cyprus, Italy, Netherlands, Portugal, and Spain have all experienced contractions in NGDP in the last three quarters.  That is an unconscionable performance.

The New York Times reported on Wednesday that the IMF is now warning of a sizable deflation risk in the Eurozone. Guess what?  The deflation has already started. If it’s not showing up in the official price indices, that’s probably because of improperly constructed prices indices (perversely counting increases in VAT as price increases). The problem is not that some European countries won’t pay their debts; the problem is that a deflationary ECB monetary policy is preventing them from earning the income with which to pay their debts. Talk about blaming the victim.

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9 Responses to “There’s No Euro Crisis; It’s an ECB crisis”


  1. 1 Marcus Nunes July 18, 2012 at 7:36 pm

    David, “But despite those valid points, I am afraid that Salin misses the key point, simply ignoring the indefensible role that the European Central Bank has played in this awful mess”
    That´s interesting because if I remember correctly PS was square in the monetary approach to the balance of payments camp in the 70s!.

  2. 2 Benjamin Cole July 18, 2012 at 10:50 pm

    I still contend there are certain powers that a sovereign must retain: Military, police powers, administration of justice, and printing of currency, protection of public health and a few more.

    Yes, all of these powers have, regrettably, been terribly abused. The constant charge on citizens in democracies to to try to prevent abuse of these powers, while granting them to the state.

    But without a currency printing press, a sovereign cannot guarantee it will meet its debts, even in deflated currency. Moreover, there are exigencies, such as war or huge calamities, that require printing up lots of money.

    Greece should be printing drachmas to the moon, and David Glasner should be readings ads in the paper (okay, on the blogs) and saying, “Wow, I can cruise in Greece for two weeks for $700, including meals!”

    Greece doesn’t export much, buy whatever its does should be dirt cheap.

  3. 3 dajeeps July 19, 2012 at 6:16 am

    In the NYT article it says:

    “Richard Barwell, an economist at the Royal Bank of Scotland, doubted that the central bank would follow the monetary fund’s advice without evidence of deflation throughout the euro zone. “I think they would view it as being counterproductive,” he said. “It would be alleviating all pressure on policy makers to solve the underlying cause of the problem.”

    “But fund officials framed their call for big bond purchases as a way for the central bank to maintain its control over interest rates and contain borrowing costs for troubled countries.

    “It is an essential part of the E.C.B. fulfilling its mandate,” Helge Berger, an adviser in the fund’s European department, said during a conference call Wednesday with reporters.”

    Later, it quotes Drahgi talking about concerns over credit seniority and political divisions within the euro zone as reasons to not buy sovereign bonds.

    If I’m not mistaken, allowing monetary deflation isn’t price stability and I have serious doubts that, even with the flaws in the treaty, the ECB lacks the capability to meet its obligations in that regard. There is simply no excuse for the foot-dragging. On the part of the governments in the south of Europe, it is worth questioning the legality of non-action and making an issue of it in the loudest possible way because it is beyond imagination that the price stability mandate means that deflation has to hit Germany before anything should be done about it.

  4. 4 Luis H Arroyo July 19, 2012 at 10:52 am

    Yes, you are right, but in any case te euro iis not an optimum currency area. So, as Krugman says, there are two problems. The NGDP and the lack of exchange rate adjustment.

  5. 5 David Glasner July 19, 2012 at 2:13 pm

    Marcus, That sounds right, but I don’t remember any particular contributions of his in that area. My interactions with him were related to our mutual interest in free banking.

    Benjamin, Greece seems to be a special case. There would be no danger that other eurozone countries would default if the ECB were acting responsibly.

    dajeeps, Thanks for providing that quote, that truly appalling quote, from Richard Barwell. The ECB is the underlying cause of the problem, and this just confirms that the ECB is engaged in an intolerable attempt to impose its own agenda on the European countries foolish enough to have adopted the euro as their own currency. You are absolutely right that the ECB has no basis for imposing deflation on the rest of Europe just to ensure that prices don’t rise in Germany. The ECB could ease its monetary policy without buying sovereign debt, and it is a red herring to frame the issue in those terms.

    Luis, I agree that the Eurozone is not an optimum currency area, but even if it is not ECB has the capacity to avoid disaster by increasing NGDP even without an exchange rate mechanism.

  6. 6 Olivier Braun July 20, 2012 at 1:08 am

    Dear Dr. Glasner,

    Though it is no surprise that you think the ECB is to blame for her tight monetary policy (I am not questionning that point), I am particularly happy that you wrote your agreement with Pascal Salin (I am a Salin fan, but why, I am French) about the possibility of a default while remaining in the eurozone. It is a dogma in Europe to insist that a default means an exit from the euro, for unstated reasons. And that kind of talk can only dramatize the situation, scare the investors and the businesses (will they be paid in euro or drachmas with no value ?) and encourage hording and bank runs. But it helps obtaining taxpayers funds to bail out some countries.
    Of course, I understand the political appeal of an exit to be able to inflate and escape the ECB’s policy (which by the way violated the treaties).
    A read two days ago an interview of Prof. Sargent in the Minneapolis Fed journal. Here it is :

    http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=4526

    The last part is about the eurozone trouble, the fiscal rules and the common currency. The idea is similar to Pascal Salin’s point.
    Your posts are always fresh and honests.
    Best regards.

  7. 7 Luis July 20, 2012 at 1:13 am

    Yes, of course. But it Will be always a suboptimAl solution, I think.

  8. 8 David Glasner July 20, 2012 at 9:14 am

    Olivier, I agree that there is no logical necessity for a default to require that the defaulting country stop using its currency. But if a country defaults on its debts, it cannot borrow and if it cannot borrow it must either raise enough revenue in taxes to cover its expenses, or it must print the money required to cover the shortfall of tax revenue relative to its expenditures. But that is only possible if the country controls its own currency. I agree with what Sargent says, but his discussion simply leaves out the effects of central bank policy on nominal GDP, which directly affects the fiscal constraint under which the government is operating. Hawtrey recognized this point very well 80 years ago, when he counseled against monetary tightening to save the gold standard in the Great Depression. Monetary tightening will only cause further economic contraction and will therefore increase pressure on the currency, not relieve it. The only way to save the currency is to use your reserves until they run out. If that doesn’t save the day, nothing will. I will try to find the exact quote over the weekend and post it.

    Luis, Whether it Is suboptimal or not depends on how the model is
    specified. But I don’t disagree that in a plausibly specified and empirically relevant model, a flexible exchange rate is likely to be optimal. But I think that the result is sensitive to the nature of the underlying assumptions.

  9. 9 Tas von Gleichen July 22, 2012 at 6:38 am

    The problem is that this countries have been living above there means. Spending more than what they earn. Any normal business would have gone out of business. I guess because we are talking countries here it is simply OK to behave irresponsibly. We can always use the taxpayers money to rescue us.


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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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