THE EURO DEBT CRISIS AND GERMANYS EURO TRILEMMA

THE EURO DEBT CRISIS AND GERMANY’S EURO TRILEMMA by Jörg Bibow Levy Economics Institute of Bard College May 2012 The Euro Debt Crisis and Germany’s Euro Trilemma by Jörg Bibow Levy Economics Institute of Bard College May 2012

Aim & message AIM: Investigate the causes behind the euro debt crisis, particularly Germany’s role in it MESSAGE: Not primarily a “sovereign debt crisis”, but rather a (twin) banking and balance of payments crisis Germany is facing a trilemma, led by it’s decisions regarding: Breaking the golden rule of a monetary union: commitment to a common inflation rate Misdiagnosis and the wrongly prescribed medication of austerity The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 2

Structure of talk 1. 2. 3. 4. 5. 6. 7. Euroland in global perspective A look inside Euroland Divergencies and intra-area imbalances Miraculous healing of the “sick man of the Euro” Germany’s “Euro trilemma” Unconditional austerity and it’s implications Concluding remarks The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 3

1. Euroland in global perspective The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 4

1. Euroland in global perspective The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 5

1. Euroland in global perspective The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 6

1. Euroland in global perspective Denial of the authorities made things worse: • False belief that Euroland was a victim of an external crisis • October 2008: Half-hearted participation in globally coordinated stimulus • Fresh illusion: Euroland has fallen victim to a “sovereign debt crisis” The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 7

2. A look inside Euroland ECB’s stability-oriented monetary policy: 1) Inflation below but close to 2 percent 2) Budget deficits below 3 percent A look at budget balances made it obvious that it was the economic union part of the “EMU” that had failed The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 8

2. A look inside Euroland The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 9

2. A look inside Euroland The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 10

2. A look inside Euroland The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 11

3. Divergencies and intra-area imbalances Current account imbalances in the Euroland, due to: Competitiveness positions running out of kilter Divergent domestic demand growth rates Evolution of competitiveness at the national level shaped by: The rate of increase in wages, relative to the rate of productivity growth (unit labor cost) The exchange rate (not an option in a currency union) Coordination needed to prevent national wage trends from becoming the source of assymetric shocks The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 12

3. Divergencies and intra-area imbalances The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 13

3. Divergencies and intra-area imbalances The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 14

4. Miraculous healing of the “sick man of the Euro” 1998: Germany barely met the 3 -percent (critical in getting the euro off) deficit hurdle Pillars of German policymaking: § Unconditional fiscal consolidation – austerity measures § Wage restraint Ø Result: Germany among the first countries to breech the SGP’s magic number of 3 -percent deficit hurdle in the early 2000 s (“the sick man of the euro”) The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 15

4. Miraculous healing of the “sick man of the Euro” The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 16

4. Miraculous healing of the “sick man of the Euro” The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 17

4. Miraculous healing of the “sick man of the Euro” The crisis is benefiting Germany in two ways: § By depressing the euro and hence stimulating non-euro net exports § By depressing German interest rates, owing to the market convention of Germany as a safe haven The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 18

5. Germany’s “Euro trilemma” European Commision report (2012): Intra-area rebalancing will have to involve both surplus and deficit countries alike Germany: runs persistent current account surpluses – is thereby improving its net international investment position either by paying off foreign debts or acquiring foreign assets IMF study (2010): Germany’s global financial intergration is especially concentrated within Euroland The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 19

5. Germany’s “Euro trilemma” TARGET 2: Automated transfer system of Bundesbank, linking wholesale payment systems and money markets across Euroland It is essential to the implementation of area-wide monetary policy and interbank refinancing activities. It’s balance arises endogenously when EMU members’ balance of payments are not otherwise balanced over a certain period TARGET 2 balances could not arise without Eurosystem lending The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 20

5. Germany’s “Euro trilemma” Germany’s euro trilemma: Germany cannot have all three: perpetual export surpluses, a no transfer/no bailout monetary union, and a “clean” independent central bank. Therefore, its perpetual export surpluses can only be sustained if offset by fiscal transfers Germany designed the Maastricht regime, so as to exclude both transfers and bailouts of partners, but ignored that running perpetual trade surpluses would bankrupt its trade partners and make application of the forbidden medicine inevitable. Simple choice: Bail out its bankrupt EMU partners or its own banks (hit by EMU partners’ defaulting on their debts) The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 21

6. Unconditional austerity and it’s implications Typical German position: Deficit countries must adjust and address their structural problems. They must reduce domestic demand, become more competitive and increase their exports 2 percent inflation growth target: It’s not on the table, cause the adjustment path will make Germany less competitive Germany intends to stay the course and force everyone else to converge to its new zero percent stability norm instead The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 22

6. Unconditional austerity and it’s implications The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 23

7. Concluding remarks Causes behind the euro debt crisis: § Critical flaws in the design of the Maastricht regime § Regime-antagonistic policies pursued by the monetary union’s largest member, Germany Ø Possible solutions: § Bank recapitalization and symmetric internal rebalancing § Reforming EMU in the direction of a full-blown fiscal union The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 24