It’s Déjà vu All Over Again

On Thursday, it was Pascal Salin in the Wall Street Journal; now on Friday, as if not to be outdone, comes Nobel laureate Edmund Phelps in the Financial Times. Salin told us on Thursday that the cause of the eurocrisis is not the euro, but the profligacy of and bad management by the various governments now on the brink of insolvency; Phelps tells on Friday that the cause of the crisis is not Chancellor Merkel’s insistence on austerity measures and labor-market reforms, but the failure of the governments on the verge of insolvency to emulate the German model.

Chancellor Angela Merkel and Wolfgang Schäuble, her finance minister, are right to oppose fiscal and bank unions without political union. Without any teeth in such agreements, the nations now besotted with wealth, private and social, could use the loans and grants for financing more deficits and more entitlements – another round of corporatist excess – rather than for smoothing the way to fiscal responsibility.

It is entirely possible, even likely, that wage reductions and labor-market liberalization would be beneficial for all European countries. But that is not the issue. France and Italy and other European countries can choose their own budgetary and labor-market policies. Those choices imply costs and consequences. High taxes and unproductive government expenditures will tend to depress growth rates. If France and Italy choose to grow at a slower rate than Germany, they have the right, as sovereign countries, to do so. The choice of a reduced rate of growth need not entail insolvency, and it is not Germany’s job to impose a higher rate of growth on France and Italy than they want. Except for Greece, which is a special case, the potentially insolvent countries in Europe are facing insolvency not because of their budgetary and labor-market policies, but because of a sharp slowdown since 2008 in rate of growth in nominal GDP in the Eurozone as a whole (averaging just 0.6% a year since the third quarter of 2008). Why has nominal GDP not increased as rapidly since 2008 as it did before 2008? Some of us think that that it has something to do with policies followed by the European Central Bank, policies that by and large are determined by the country in which the ECB is domiciled. (Can you guess which country that is?)

But for some reason – I can’t imagine what it would be — in the 670 words in his piece in the Financial Times, Professor Phelps, in discussing the causes of the Eurozone crisis and in defending Chancellor Merkel’s role in the crisis, didn’t mention the European Central Bank even once. Go figure.

12 Responses to “It’s Déjà vu All Over Again”

  1. 1 Martin July 19, 2012 at 11:03 pm


    As much as I agree with you that the ECB failed to keep NGDP stable, I do think Salin & Phelps made good points: I don’t think a drop in NGDP could have ’caused’ nearly as much trouble as it did if the European economies were not so terribly fragile.

    If the European economies wouldn’t be as fragile as described by the authors, don’t you think that a drop in NGDP would have caused much less human suffering?

  2. 2 Lorenzo from Oz July 20, 2012 at 12:50 am

    Martin: central banks should manage monetary policy for economies as they are, not as they ought to be.

  3. 3 Olivier Braun July 20, 2012 at 1:35 am

    Dr Glasner,

    Thank you, I would have missed E. Phelps op-ed and I’m looking forward to read it. I agree with you, every country shall be free to choose it’s budgetary policy and labor policy and it is not Germany’s rôle to dictate that. But, as you wrote, “Those choices imply costs and consequences” and countries have to face them without “forcing” the German taxpayer to finence their choices, via taxes or via inflation. That is why the Maastricht treaty in the first place, considerind the political pressures (à la Meltzer shall I say 😉 deficits would cause on the ECB and other members, explicitely forbade “excess deficits”, direct monetazing of public debt and bailouts.
    As I mentioned in a comment under your post about Salin’s piece, Thomas Sargent had something of interest to say about that.
    I mean, if the Germans have to bailout the deficit-prone countries (I don’t think they should), it is understable that they ask foe austerity.
    Phelps is supposed to be a keynesian, isn’t he ? All the more strange that he favors austerity and doesn’t mention, as you said, the ECB. His economic principles textbook was the first economic textbook I read, in the ancient days when I was a law student. Frankly, I prefer to read Phelps than Krugman, the former desn’t seem to ave an axe to grind.

  4. 4 Martin July 20, 2012 at 3:58 am


    “Martin: central banks should manage monetary policy for economies as they are, not as they ought to be.”

    That seems rather beside the point to me?

    That said, the statement itself is questionable. The central bank and the government are independent in name only; they’re linked together in the pre-constitutional stage. From that perspective the above statement makes no sense to me whatsoever. The economies “are” what we decide them to be.

    In the case of the ECB the economies of the Eurozone have chosen for the ECB to deliver price-stability. Now you can disagree with the goal, but the goal implies that the economies have made the political choice to adjust to shocks that are both real and nominal. Those are the rules of the game and that is how the Eurozone economies “are”.

    The problem is with the rules of the game not that the ECB is not managing monetary policy for economies as they “are”. You want the ECB to manage monetary policy for the economies as they “ought” to be, because you disagree with the rules.

  5. 5 Luis July 20, 2012 at 5:05 am

    The Phelps’ article is very surprising for me. Perhaps he is right. It seems to me that he is. But, Nom de Dieu, why not live without te Euro?
    I agree totally with tenis paragraph

    The difficulties of many European countries derive from their corporatism: state projects serving cronies and vast social protection programmes, both run by elites. These surged in the 1970s and 1980s. The prospect of a lifetime of such benefits – sweet contracts, soft loans, early pensions and the rest – created something new: social wealth.

    Yes, it is true. Spain os corporatist. It is a national evil, not easy to cure with euro. Spain and countries like ir need the exchange rate flexibility combines with “bonds vigilantes”. Both markets combine to Risk premia that are moré efficient in stoping excess of inflows and outflows in excess.

  6. 6 David Glasner July 20, 2012 at 9:45 am

    Martin, I agree that Salin and Phelps make good points. My problem is not with what they say, but with what they don’t say. They miss the big picture. I agree that the European economies are fragile and that the fragility is partly the result of bad policy choices made in the past. That does not excuse the ECB pushing those economies to the breaking point.

    Lorenzo, Just so.

    Olivier, For the past 60 years, Germany has prospered and grown beyond anyone’s expectations at the outset of the German wirtschaftswunder, and inflation in that entire 60 year period has never been as low as it has been for the last four years. So your attempt to make me sympathize with the potential suffering inflicted on Germans from moderately higher inflation is doomed to fail. The Maastricht treaty, if it prevents the ECB from acting to increase nominal GDP to a tolerable level, is a suicide pact and should be scrapped forthwith. Phelps may have started off as a Keynesian, but it has been a long time, a very long time, since he has been identified in that way, ever since he co-developed (with Milton Friedman) the natural-rate hypothesis.

    Martin, The rules cannot be interpreted in a way that causes self-destruction. If Maastricht is a suicide pact, it is null and void.

    Luis, First things, first. Before structural reform, the ECB policy of self-strangulation must be terminated. Only then will reform be possible.

  7. 7 teageegeepea July 20, 2012 at 3:54 pm

    John Cochrane had praised Salin’s op-ed and found it implausible that anyone could describe ECB policy as “tight” while interest rates are low and they appear to be monetizing debts. But he found your critique “interesting” and acknowledged that interest rates aren’t a good indicator, noting that he’ll have to return to the topic of NGDP.

  8. 8 David Pearson July 21, 2012 at 1:23 pm

    On the subject of ECB policy, the central bank recently cut its deposit (equivalent to IOR) rate cut to zero from 25bps. Draghi and other ECB officials have even said a negative rate is on the menu, while not yet under discussion. Further, Denmark has recently cut its IOR to -.20%, and there is talk the Swiss will soon follow. In your view, will the elimination of the IOR across Europe — and the signaling that a negative IOR is possible — have any impact on velocity?

  9. 9 Tas von Gleichen July 28, 2012 at 2:43 am

    Exactly not mentioning anything about the ECB’s Policy is just in there interest.

  10. 10 David Glasner July 29, 2012 at 7:30 pm

    teageegeepea, I saw Cochrane’s post, and your comment. Thanks.

    David, I think that eliminating interest on reserves is a necessary but not sufficient condition for an expansionary monetary policy.

    Tas, I see why some people would not want to mention ECB, but I don’t see why Phelps wouldn’t.

  1. 1 Glasner on Phelps | The Penn Ave Post Trackback on July 20, 2012 at 7:31 am
  2. 2 Glasner on Phelps | FavStocks Trackback on July 21, 2012 at 12:27 am

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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.

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