On Bernanke’s newest blog post, Greece and Europe: Is Europe holding up its end of the bargain?, he discusses whether the Eurozone has held up its end of the bargain. He starts out by examining the unemployment rates in the EZ compared to that of Germany. According to his figures, the rate for the EZ excluding Germany is just above 13% while Germany’s rate is a little less than 5%. Bernanke then continues:

Other economic data show similar discrepancies within the euro zone between the “north” (including Germany) and the “south.”

The promise of the euro was both to increase prosperity and to foster closer European integration. But current economic conditions are hardly building public confidence in European economic policymakers or providing an environment conducive to fiscal stabilization and economic reform; and European solidarity will not flower under a system which produces such disparate outcomes among countries.

So the EZ is doomed. And his reasons are (abridged by me):

  • Political resistance to appropriate monetary policy
  • Excessively tight fiscal policy
  • Delays in repairing and consolidating regulatory structures for the financial system

These are somewhat obvious points, but he goes on to point to some specific problems beyond these general observations which find fascinating:

What about the strength of the German economy (and a few others) relative to the rest of the euro zone, as illustrated by Figure 2? As I discussed in an earlier post, Germany has benefited from having a currency, the euro, with an international value that is significantly weaker than a hypothetical German-only currency would be. Germany’s membership in the euro area has thus proved a major boost to German exports, relative to what they would be with an independent currency.

I don’t really buy the currency argument as it is presented. But I had to sit and think about this because this paragraph comes out of left field.

Just suppose that Germany wasn’t a member of the EZ, and Germans had the same sort of monetary preferences they do now. Assuming that without Germany’s influence on the euro or against a backdrop of each member having their own currencies, the effect on German trade from tight money polices might be entirely different.*

*I had to put an asterisk there because the impact would be only in short run, and we are far from the 2008 short run.

Bernanke continues:

Nobody is suggesting that the well-known efficiency and quality of German production are anything other than good things, or that German firms should not strive to compete in export markets. What is a problem, however, is that Germany has effectively chosen to rely on foreign rather than domestic demand to ensure full employment at home, as shown in its extraordinarily large and persistent trade surplus, currently almost 7.5 percent of the country’s GDP. Within a fixed-exchange-rate system like the euro currency area, such persistent imbalances are unhealthy, reducing demand and growth in trading partners and generating potentially destabilizing financial flows. Importantly, Germany’s large trade surplus puts all the burden of adjustment on countries with trade deficits, who must undergo painful deflation of wages and other costs to become more competitive.

He could have left off “to become more competitive” and the last sentence would have been more accurate. But, what he is saying here seems to be that the structure of the German economy is such that it doesn’t have to rely heavily on domestic demand management, and by extension, gets to have its monetary cake and eat it too by advocating tighter monetary policy and exporting the resulting deflation to its euro partners.

Bernanke has a suggestion on how Germany can help:

Germany could help restore balance within the euro zone and raise the currency area’s overall pace of growth by increasing spending at home, through measures like increasing investment in infrastructure, pushing for wage increases for German workers (to raise domestic consumption), and engaging in structural reforms to encourage more domestic demand. Such measures would entail little or no short-run sacrifice for Germans, and they would serve the country’s longer-term interests by reducing the risks of eventual euro breakup.

I don’t agree with Bernanke’s recommendation because the problem isn’t competitiveness (entirely), and therefore if Germany became less efficient, it would solve the problem.

Rather, I could speculate that the problem lies in why Germany prefers tighter money. Many people think that it’s a bit of the zeitgeist, or maybe a collective anxiety about inflation like a nameless fear. But is it probably is based in some sort of reality. They’re not stupid, or shamanistic.

Supposing that everything is made in Germany and it is the recipient of large amounts of foreign demand, inflation is likely a valid concern. In reality then, the answer is probably more along the lines that Germany isn’t particularly efficient on the supply side, just more efficient than others; or there is some advantage beside price (crony capitalism at the EU level, maybe?). It can’t expand production fast enough to accommodate shifts in demand, or it can’t or is unwilling to import labor in addition to being unwilling to source more from abroad.

So, more likely, the better answer is not to make Germany less efficient, but to improve their flexibility and some other things related to regulation and immigration so that they can tolerate monetary policy that is more appropriate for the EZ as a whole.

But yes. I agree the entire euro project is currently a house of cards. Without reforms all around, it will come crashing to the ground. It isn’t matter of if, but when.

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