Forum Post: weisbrot on euro economics

the new left review: The IMF has recently called for governments to slow the pace of their budget cuts - why do you think that states such as the UK and Germany are pursuing austerity measures with such little regard to the broader impact on their economies?

weisbrot: Well it is always difficult and rather speculative to explain the motivations of political actors, especially when they do things that are not obviously in their own political interest. I mean, the economic crisis in Europe has already toppled the governments of the UK, Ireland, Greece, Spain, Portugal, and Italy. So, one would think that governments in power now would want to be re-elected, and that the best way to get re-elected would be to bring about an improvement in the economy. Yet they are mostly pursuing policies that can be expected to make their economies worse, and even risking a more serious crisis. How can this be explained?

I think it is different in each country, but it is generally some combination of ideology, politics, incompetence, and of course powerful interests who want certain things. In Germany, things are not so bad. Unemployment is at 5.5 percent, lower than it was before the world recession. The standard analysis in the financial press is that the Germans haven’t recovered from the hyper-inflation of 85 years ago, and they are therefore more afraid of inflation than they are of having a second European recession in less than three years. And of course there is all the usual stuff about how Germans and other northern Europeans don’t want to “bail out” other countries, especially southern Europeans who they see as not sharing their work ethic, fiscal prudence, etc.

Personally, I think these views are highly exaggerated. For one thing, whatever the prejudices of any people – and I think there is also a lot of sentiment against bailing out the banks that goes unnoticed – it is not the people that are making these decisions. Policy for the eurozone is currently being made by the so-called Troika, which includes the European Central Bank, the European Commission, and the IMF – in that order of importance. The ECB is really the main player here, because they hold the key to resolving the crisis. In fact, they could resolve it quite quickly if they wanted to, simply by announcing that they would set a target interest rate for Italian and Spanish bonds, and pledge to buy those bonds as necessary to keep their interest rates below, say 3 percent. Why don’t they do this? The answer to this question was made clear in December of last year, when Mario Draghi, newly appointed head of the ECB, indicated that he might take steps in this direction, “if political leaders took more radical steps to enforce spending discipline among members.” (NYT) But within a day or so he walked back from his remarks.

So by then the ECB’s strategy was clear: they weren’t going to end the crisis because if they did, they wouldn’t have the leverage to force Italy, Spain, and other countries to adopt “reforms” – like raising the retirement age, shrinking the size of government, privatizations and other unpleasant things that people would never vote for.The Eurozone has been significantly more averse to stimulus measures than the United States - what do you attribute that to?

The main difference here is between the ECB and the U.S. Federal Reserve. The Fed has been willing to use quantitative easing and push down long-term interest rates. It should also be noted that when the Fed creates money and uses it to buy U.S. Treasury bonds, the resulting debt has no interest burden, because it is owned by the Fed and the interest is refunded back to the Treasury. In other words, it is net debt creation that matters, not gross debt. This is of course what the ECB needs to do, but it has refused to do it. Even the bond purchases it has made have been “sterilized,” that is, the ECB sells other assets so as to avoid increasing the money supply. How to account for this difference, which makes the Republican Fed Chairman Ben Bernanke look like a socialist in comparison with the ECB? It is partly a difference in the people in charge – Bernanke has studied the Great Depression and learned some lessons from it. But it is also a difference in the institutions – the ECB and the monetary union that created the euro was set up under a neoliberal, right-wing objective – its job was seen as to control inflation and there was not much of a mandate to promote full employment. And it wasn’t really created as a lender of last resort to the sovereign governments. Of course, that is no excuse – the rules are loose enough so that the ECB could do whatever is necessary – and Mario Draghi pretty much said that in December when he said that the ECB’s mandate to insure “price stability” also applied to avoiding deflation. In other words, they could do what the Fed has done in order to avoid a recession. And of course there are German politicians who push the ECB not to do what other central banks would do in this situation.

With regard to fiscal stimulus, it should be kept in mind that U.S. fiscal stimulus has been just a fraction of what was needed, about one-eighth the size (taking into account the fiscal tightening of the state and local governments) of the loss of demand from the bursting of the housing bubble. Of course, Europe has been even worse, but that is mostly because of the ECB and its allies, and the pressure that they have exerted on governments to engage in pro-cyclical fiscal tightening.