Bernanke's fierce attack on Eurozone economic and fiscal policy

Just a day after Donald Tusk gave his FT interview telling the world, it’s “an economic and ideological illusion that we have a chance to build some alternative to [the] traditional European economic system” (in fact, Tusk thinks the debate is “very similar to 1968”!) – along comes Ben Bernanke, to argue the precise opposite.  In a scathing article for Brookings, “Greece and Europe: Is Europe holding up its end of the bargain?” he concludes, in effect, that it is not.

The ex-chairman of the US Federal Reserve asked:

specifically, is the euro zone's leadership delivering the broad-based economic recovery that is needed to give stressed countries like Greece a reasonable chance to meet their growth, employment, and fiscal objectives? 

and explained that

Over the longer term, these questions are evidently of far greater consequence for Europe, and for the world, than are questions about whether tiny Greece can meet its fiscal obligations.

In answering his own question, he pulled no punches:

Unfortunately, the answers to these questions are also obvious. Since the global financial crisis, economic outcomes in the euro zone have been deeply disappointing. The failure of European economic policy has two, closely related, aspects: (1) the weak performance of the euro zone as a whole; and (2) the highly asymmetric outcomes among countries within the euro zone.

He rightly puts the focus immediately on the unemployment record of the Eurozone, comparing it in a chart with the US rate.  Both reached over 10% in 2009 to 2011, but thereafter, the US rate has declined while the Eurozone rate soared to 12%, and is still over 11%.

In fact, this higher Eurozone rate of unemployment is if anything better illustrated by comparing the Eurozone rate with the whole-EU rate (the now wide gap would be far larger if you compare only the non-Euro countries with the Eurozone members):

unemp EU ez.PNG


The divergence between the Eurozone as a whole and Germany in particular is clearly shown in the next unemployment chart – showing German unemployment at aroiund 5%, while the “rest of Eurozone” figure is an appalling 13% that ought to shame (but seemingly does not do so) the European institutions and IMF:

Bernanke argues (like us) that the Euro in practice is having the opposite effect than that supposedly intended by its creators:

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.

The risks for the European project posed by these economic developments are real, no matter what the reasons for them may be. In fact, the reasons are not so difficult to identify. 

He then sets out three main reasons why “recovery” has been so elusive, in sweeping criticisms that combine fiscal decisions by national governments (especially Germany) and – bolder still - the sustained monetary policy pursued by the European Central Bank

The slow recovery from the crisis of the euro zone as a whole is the result, among other factors, of (1) political resistance that delayed by many years the implementation of sufficiently aggressive monetary policies by the European Central Bank; (2) excessively tight fiscal policies, especially in countries like Germany that have some amount of "fiscal space" and thus no immediate need to tighten their belts; and (3) delays in taking the necessary steps, analogous to the banking "stress tests" in the United States in the spring of 2009, to restore confidence in the banking system. 

I would not, by the way, put "structural rigidities" very high on this list. Structural reforms are important for long-run growth, but cost-saving measures are less relevant when many workers are already idle; moreover, structural problems have existed in Europe for a long time and so can't explain recent declines in performance.

The last point is very important to note as it contradicts (again, in my view correctly) the core of Eurozone and Troika policy, which places enormous stress on dealing with “structural rigidities” as a front-line set of priorities that are considered to be “growth-friendly” in the short term.   It is good to see such a senior figure make this case.

Bernanke then moved on to assess the impact of the euro on Germany, and of Germany’s impact on other member states; and again, he is very clear and very critical (implicitly of both government and Bundesbank ):

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.

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% 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. 

(Readers may recall that Bundesbank President Jens Weidmann strongly defends the fact that the entire burden is on trade deficit countries).  

Back to Bernanke:

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.

Finally, some reflections on and beyond the present Greek debt crisis:

I'll end with two concrete proposals. First, negotiations over Greece's evidently unsustainable debt burden should be based on explicit assumptions about European growth. If European growth turns out to be weaker than projected, which in turn would make it tougher for Greece to grow, then Greece should be allowed greater leeway after the fact in meeting its fiscal targets.

Second, it's time for the leaders of the euro zone to address the problem of large and sustained trade imbalances (either surpluses or deficits), which, in a fixed-exchange-rate system like the euro zone, impose significant costs and risks. For example, the Stability and Growth Pact, which imposes rules and penalties with the goal of limiting fiscal deficits, could be extended to reference trade imbalances as well. Simply recognizing officially that creditor as well as debtor countries have an obligation to adjust over time (through fiscal and structural measures, for example) would be an important step in the right direction.

In sum, Mr Bernanke has written an important, straight article – one that needs to be printed in every EU language and distributed widely, to counter the ideology and propaganda of those like Mr Tusk who tell us, falsely, “there is no alternative” to the flawed Eurozone policies that are creating dangerous divergences across the continent.