Matt Yglesias

Europe’s China Problem

Paul Krugman has a wise column about the havoc being wreaked by China’s refusal to let its currency get more expensive relative to the dollar. Krugman thinks we should be trying to do something about this. But as Dan Drezner observes, though China’s dollar-linkage policy is a problem for us, it’s a much bigger problem for Europe and other developing countries:

As a matter of direct economic interest, however, why haven’t the Europeans and East Asians been screaming bloody murder about this? China’s policies are forcing them to take actions they don’t want to take — so why aren’t they complaining more loudly about this?

Why?

Optimistically, it’s been my experience that members of other countries tend to have a better appreciation than America does that making loud public demands is often a counterproductive diplomatic approach. But one has to fear that the real culprit here may be the European Central Bank’s weird deflationary bias.

What is the European Central Bank Thinking?

Willem Buiter has an excellent post up at the FT asking, basically, why on earth the European Central Bank is sitting on its hands while the Euro area undergoes inflation. He points out that its attitude toward deflation is both dumb and in violation of its legal mandate under the treaty establishing it:

The asymmetry in the response of the ECB to inflation rates above the level deemed consistent with price stability in the medium term, as opposed to inflation rates below that level is staggering and poses a material risk to the independence of the institution. [...] The ECB is violating its price stability mandate by tolerating, aiding and abetting deflation in the Euro Area.

Buiter observes that recent changes in the relative position of the “core” vs “headline” inflation rate give us a case study in this asymmetry:

When the headline rate was high but the core rate was below the ECB’s long-term 2 percent target, the ECB emphasized the headline rate and tightened monetary policy. But now that the headline rate is negative, the ECB chooses to emphasize the core rate and decline to ease further. I would note, in addition, that even the core rate is substantially below the ECB’s self-proclaimed target.

When I was in Germany, my group had the opportunity to speak with Bundesbank President Alex Weber. Unfortunately, the discussion was off the record. But suffice it to say that in keeping with stereotype, rather than in keeping with the actual legal mandate of the ECB, Weber’s point of view is very much that this kind of asymmetry is appropriate and he was very committed to the idea that the purpose of central bank independence is to allow one to be indifferent to the human consequences of this kind of commitment to low inflation at all costs. That really doesn’t seem correct to me. Among other things, as Buiter says it seems to me that this behavior is actually threatening the ECB’s independence. It’s one thing to go against a plain reading of your legal mandate. And it’s one thing to allow employment and production to become depressed. But to do the two simultaneously is willfully playing with fire.

The rubber hasn’t really hit the road on this issue yet since the recession’s not that bad in France and Germans are maniacal about inflation. But things are really falling apart in Spain and Ireland and the Germans are probably looking at a big run-up in unemployment soon, too.

Deflation in the Eurozone

Ruining everything

A shocking number of American commentators and an even larger number of European policymakers continue to be worried about the specter of possible future inflation even as the opposite is happening right before our eyes:

The eurozone’s annual rate of inflation turned negative in June for the first time since the single currency was introduced in 1999. Prices in the 16-nation zone fell 0.1% in the past year, Eurostat said. The inflation rate had been 0% in May. Inflation in the eurozone has been dragged down by lower energy and food prices, and by falling demand for goods from companies and households.

This is, simply put, a disaster. In particular, the devastated economies of Spain and Ireland are never going to recover with this sort of thing going on. And that, in turn, is only going to make things worse for Germany and the rest of them. From the get-go the European response to the recession has been very misguided. And to a striking extent, the American debate continues not to recognize that the European Union has surpassed the United States of America in terms of the scale of its economy. Jean-Claude Trichet is the most important central banker in the world, and it’s extremely difficult for anything Barack Obama and Ben Bernanke try to do to work if the Europeans make poor choices.

Additional Easing in Europe

The European Central Bank continues to seem pretty behind the curve in terms of recession-fighting tactics, but with today’s announced steps they’re at least moving in the right direction. Given that the EU’s balance of payments situation is much more reasonable than ours in the USA, it’s arguably more important to stimulate consumer demand over there than it is over here.

Jean-Claude TrichFAIL

The conventions of central bank independence dictate that the bizarre behavior of the European Central Bank not be discussed at the G-20 meeting, but with the ECB cutting rates by less-than-expect, bank chief Jean-Claude Trichet seems to be continuing his campaign to drag the world into years of depression.

This whole issue continues to be generally under-discussed. It’s widely understood in the United States context that Ben Bernanke is one of the very most important economic policymakers in the country. He’s probably the number two guy after Barack Obama. But the Eurozone’s economic output is about the same as that of the United States—it varies according to the exchange rate of the day. This means that Trichet is about as important as Bernanke, and probably more important than any of Europe’s elected officials. He’s a top-five guy in terms of determining the economic fate of the globe. And he’s a rare dissenter from the general view that the current downturn is a true crisis that requires emergency measures. This is a big deal and, if he’s wrong, a very big problem.

Lack of Eurostimulus: Political or Structural?

It’s hard to visit Spain and not become alarmed about the economic situation in Europe. Certainly I became alarmed when I visited, and now Paul Krugman’s alarmed too. Of course what’s scary is all right out there in facts and figures, but walking around the streets and seeing massive discounts in every single store window as the country faces “a grinding process of wage cuts” that “will be almost inconceivably painful if, as seems all too likely, the European economy as a whole is depressed and tending toward deflation for years to come.” It’s doubly alarming because whatever you think of the Obama administration’s response to the situation, they certainly seem alarmed by it. The key European leaders, by contrast, are much more focused on the medium-term issue of regulatory reform than on short-term rescue measures.

At first glance, I agreed with Krugman that the problem here was fundamentally structural and institutional in nature. The EU has created a very integrated economic unit whose political institutions are far too puny to respond rapidly and effectively in a crisis. It’s as if we were running the modern-day United States under the Articles of Confederation. As Rick Hertzberg says, it’s conservative precepts of “states’ rights” and “small government” run amok.

More recently, I’ve started to have some doubts that this is the whole story. Krugman says that “to hear anything in America comparable to the know-nothing diatribes of Germany’s finance minister you have to listen to, well, Republicans.” Precisely because of that factor, and because Chancellor Angela Merkel is from Germany’s conservative party, I’ve heard several people mistakenly say that he’s a rightwing politician. In fact, he’s a Social Democrat—part of the national unity government in Germany is that the two most important ministries are in SPD hands, even as Merkel runs the show. The fact that Steinbruck has opinions on fiscal stimulus that would count as far right in the United States even though German political culture is generally less market-oriented than American points to a substantial difference of opinion on the merits about this sort of thing. And, indeed, though Steinbruck’s remarks about “vulgar Keynesianism” are well-known, it’s worth observing that Germany has hardly been the most stingy country on the continent in terms of fiscal stimulus. The French, who don’t shy away from state intervention in the economy, prefer to put their faith in more targeted ventures than in broad fiscal stimulus.

Meanwhile, the small European economies appear to me to be less interested in participating in a German-led coordinated stimulus than the Germans are in leading such a stimulus. Long story short, though it’s true that European institutions would make it challenging to put a Krugman-sized stimulus together, I’m not at all sure that this is the actual reason it’s not happening. In the United States, I think it’s pretty clear that were the institutional hurdles to stimulus smaller (i.e., majority rule in the Senate) the administration would have preferred somewhat more stimulus. In Europe, I think national government leaders are, except for Gordon Brown, more-or-less getting what they want.

I don’t have any real knowledge of the deep roots of this difference in political culture except to offer the customary tip ‘o the cap in the direction of German fear of hyperinflation. I would say, though, that Europe’s stronger welfare states mean that people don’t necessarily have the terror of economic downturn that exists in the United States. Recessionary conditions tend, in the U.S., to reduce inequality (the rich, having more money, stand to lose more) but cause the most intense suffering at the bottom because people slip through the cracks of our tattered safety net. In Europe, perhaps the downside risk to the working class is much less, reducing the pressure for stimulus, especially if the European business class shares the American business class’ evident (see, again, the Republican Party’s) distaste for Keynesian measures.

That said, Americans stopped paying attention to European politics on September 12, 2001 and are now waking up to find that we live in a world in which Jean-Claude Trichet rather than Ben Bernanke is arguably the world’s most important central banker. It’s also a world in which a revival in global demand probably needs to come from China rather than from a cuddly democratic ally.

ECB Starting to Get Serious

Ezra Klein observes that the European Central Bank is buckling in the face of overwhelming pressure from American bloggers and loosening monetary policy.

The Need for Eurostimulus

Lest you think my concerns about Jean Claude Tricet’s too-tight monetary policy are just more left-wing lack of thrift, check out Megan McArdle agreeing with me. Meanwhile, as Felix Salmon observes the Europeans aren’t just being laggard on the monetary policy front. Laggards on monetary policy are naturally going to be laggards on fiscal policy, too. The issue, as best one can tell, is primarily Germany where they’re paranoid about inflation. German sluggishness about this is triply damaging. First, Germany is one of the world’s largest economies. Second, Germany has a huge current account surplus, so they’re much better-positioned to do stimulus than is (say) the United States. And third, Germany’s central position in Europe makes it difficult for Europe’s small countries (who collectively add up to a pretty major economy) to engage in any meaningful stimulus absent Germany leadership.

Kevin Drum remarks:

I don’t have any brilliant suggestions for getting Europe to become a little more proactive on the let’s-avoid-another-great-depression front. Just one more job for the Obama economic team to work on, I suppose. Maybe someday Treasury will actually hire someone besides Tim Geithner and we can start pushing on this a little harder than we are now.

I think it’s important to move beyond dry wit and really ring the alarm bells on this. The economy is very global, and it’s extremely difficult to see it pulling short of a depression if the European Union and Japan are twiddling their thumbs. Beyond that, if there isn’t meaningful global coordination of stimulus efforts then protectionist pressures are going to become harder-and-harder to resist in China and the United States to prevent free riding. That, in turn, would buy some short-term assistance at the cost of really hobbling the prospects for recovery down the road. Under the circumstances, it really would be nice if we had an Undersecretary of Treasury for International Affairs. In the past, the job has been held by such figures as Lawrence Summers and Timothy Geithner, so they must know some people who work in this field. And it would also be nice to see the President and the White House team more focused on this. They seem primarily interested in doing domestic political battle with the GOP over their budget proposal, which is understandable but they need to recognize that their political prospects are closely tied to the fate of the global economy and for better or for worse Trichet, Angela Merkel, Taro Aso, Nicholas Sarkozy, and Hu Jintao are more relevant to this than is Rush Limbaugh.

On a related note, a hobbyhorse of mine over the past couple of years has been the relative neglect of Europe in foreign policy conversations. There’s not that much thrilling bloodshed in Europe, but the immense wealth and productive capacity of the E.U. nations means that, in practice, the everyday lives of Americans are more impacted by political events in Europe than by events in Baghdad or Teheran.