Lars Christensen on the Eurozone Crisis RIP

UPDATE:  In my enthusiasm and haste to plug Lars Chritensen’s post on the possible end of the Eurozone crisis, I got carried away and conflated two separate effects.  The dollar’s appreciation against from July to September was associated with a steep drop in inflation expectations, the TIPS spread fallling from about 2.4% in July to about 1.7% on 10-year Treasuries.  The dollar rose against the euro from July to September from the exchange rate moving from the $1.42 to $1.45 range in early July to the $1.35 to $1.38 range in September.  From September to December, inflation expectations rose modestly, the TIPS spread on 10-year Treasuries recovering to about 1.9%.  It has only been since December that the dollar has been appreciating against the euro even as inflation expectations have risen to over 2% as reflected by the TIPS spread on 10-year Treasuries.  The actual data are thus more consistent with Lars’s take on the Eurozone crisis than suggested by my original comment  .Sorry for that slip-up on my part.

Check out this fascinating post by Lars Christensen on how the Eurozone Crisis (not to be confused with the Greek Debt Crisis) came to an end last July.  The key to understanding what happened is that on July 1 the dollar/euro exchange rate was $1.4508/euro.  Yesterday it was about $1.32/euro.  The appreciation of the dollar would have been a disaster for the US and the rest of the world, except for the fact that inflation expectations in the US have increased, not decreased, since July (even as measured inflation — both headline and core — has fallen).  Ever since 2008, US inflation expectations and the dollar/euro exchange rate have been positively correlated (i.e., increased inflation expectations in the US have been associated with a falling value of the dollar relative to the euro).  Since July US inflation expectations have increased while the dollar has appreciated against the euro.

HT:  Lars Christensen and Marcus Nunes


11 Responses to “Lars Christensen on the Eurozone Crisis RIP”

  1. 1 Lars Christensen February 21, 2012 at 10:03 am

    David, thanks for commenting on this…I think policy makers should maybe have a good look at googlenomics in the future. At least it seems to say a lot more about the real world than outdated economic data.


  2. 2 Edwin A February 21, 2012 at 10:07 am

    What I’m confused about is that the Cleveland Fed seems to suggest inflation expectations are at an all time low, but the inflation expectations in the TIPS spread shows that it’s growing.


  3. 3 Luis H Arroyo February 21, 2012 at 10:14 am

    I’m sorry, Dave, but I cannot accept simply that euro crisis has been solved because the ECB has implemented the LTRO program. Too easy.
    the Euro Zone has been accumulating growing disequilibria in competitivity. There is not only a monetary problem, but also imbalanced exchange rates as Miton Friedman talk abouy in 1953 “the case for Free Exchange Rate”.
    Obviusly, exchange rates problems are monetry problems. But, as Roggoff explains (,1518,816071,00.html) the increase in the inflation in EZ is not sufficient to erase all the cumulative problems.
    To reduce all to an only a variable es not reasonable. I would say that the problem is not only depressed demand; it is its distribution.


  4. 4 David Pearson February 21, 2012 at 10:30 am

    Oil in Euro terms is back to the 2008 high (Brent Crude). I’m wondering what the effect will be on real growth in the periphery of further ECB easing. Seems to me the beneficiaries of 3%+ inflation are the Gulf States, Australia/Canada/Russia/Brazil, Chinese workers, and hedged high net worth individuals. Those that are hurt are highly indebted households employed in the service sector. Its not clear how it all nets out for Europe and the U.S.. Keep an eye on stocks v. oil (and gold): if they regain an inverse correlation, it will tell you something about the mix of real growth vs. inflation going forward…


  5. 5 David Pearson February 21, 2012 at 10:33 am

    Another thing to track: 5yr TIPS real rates vs. the inflation spread. The spread is back to 2011 highs (2.21%) despite the real rate being at near-record lows (-1.30%). Again, this indicates that, on the margin, markets are expecting more inflation than real growth ahead.


  6. 7 Lars Christensen February 21, 2012 at 12:44 pm

    Luis, obviously the euro zone have some serious structural problems which can not be solved by monetary easing, but the main course of the near-collapse of the euro clearly is the massive drop in euro zone NGDP and the expectation for a further drop in NGDP. An increase in the expectations for a NGDP level in the euro zone reduces the expectation for European debt ratios (Debt/NGDP). This obviously eases the tensions in the euro zone dramatically. Fiscal tightening will most likely have very little impact on improving sentiment.

    But again, yes Europe needs serious structural reforms, but the euro nearly did not blow up because of these structural problems, but rather because of too tight monetary policy – and I am very certain Friedman would agree on that.


  7. 8 Luis H Arroyo February 21, 2012 at 2:09 pm

    Mmmmm, I don’t know exactly. what will be the result of an expansive MP witout readjustment in relative prices?
    on the other hand, I am serious doubts on the effectiveness of the LTRO from a monetarist point of view, more when the ECB has decide to stop its buying bonds program. I dont see how it can stabilise bond markets only with LTRO.
    But you are right that for the moment, break up of euro is not so imminent.


  8. 9 David Glasner February 21, 2012 at 6:36 pm

    Lars, You have certainly piqued my interest in googlenomics.

    Edwin, Good point. I have not been following the Cleveland Fed estimates of inflation expectations recently, which is an oversight on my part. Evidently the decline in real interest rates has been associated with increasing uncertainty about expected inflation. I will have to look at their data more closely.

    Luis, You may be right. However, it may be that the LTRO has eased the situation sufficiently to keep the crisis from getting out of hand, as it seemed on the verge of doing in December. Just because the patient is no longer in immediate danger does not mean that he does not require a lot of therapy. Thanks for the graph. As Lars’s comment below and your reply to him indicate, we are not that far apart in our assessments.

    David, I agree that another spike in oil prices will be tough to swallow. However, a spike in oil prices was not the only factor that was working against recovery last year, so history will not necessarily repeat itself. In my view, declining (and negative) real interest rates raise the optimal rate of expected inflation, so the case for monetary expansion is getting stronger.


  9. 10 Luis H Arroyo February 22, 2012 at 9:34 am

    Well, David, i’ m cosidering me Monetaris/Keynesian, wich is an unidentified anilmals, taking account I hate proactive fiscal policy. But sure I’m nor fare awyay of your position. BTW, I hate the euro because is the opposite the economy I’ve learned from american economist.
    I’ve never learned anything from European economists. Except Blanchard, perhaps.


  10. 11 David Glasner February 22, 2012 at 6:47 pm

    Luis, Friedman himself was a Keynesian of sorts, and not just in his youth.


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. 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.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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