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.

by Jörg Bibow Levy by Jörg Bibow Levy Economics Institute of Economics Institute of

Bard College May 2012 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: 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 The Euro Debt Crisis and Germany’s Euro Trilemma, by Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 Jörg Bibow Levy, May 2012

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1. Euroland in global perspective2. A look inside Euroland3. Divergencies and intra-area imbalances4. Miraculous healing of the “sick man of the Euro”5. Germany’s “Euro trilemma”6. Unconditional austerity and it’s implications7. Concluding remarks

The Euro Debt Crisis and The Euro Debt Crisis and Germany’s Euro Trilemma, by Germany’s Euro Trilemma, by Jörg Bibow Levy, May 2012 Jörg Bibow Levy, May 2012

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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”

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

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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

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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

Result: Germany among the first countries to breech the SGP’s magic number of 3-percent deficit hurdle in the early 2000s (“the sick man of the euro”)

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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

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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

TARGET2: 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

TARGET2 balances could not arise without Eurosystem lending

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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)

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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

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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

Possible solutions: Bank recapitalization and symmetric internal rebalancing Reforming EMU in the direction of a full-blown fiscal

union

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