EU Economics

Eurozone economy dead in the water, with crisis expected to carry on ‘a long time’

Photo: AP

 It’s taken a long time, but the International Monetary Fund finally seems to be talking some sense about the beleaguered deficit economies of the eurozone. In a new analysis of continuing imbalances within the single currency area, it pretty much concludes that the situation is hopeless without the sort of eurozone-wide macro economic policies – monetary as well as fiscal – which are specifically rejected by the high command in Berlin. OK, so it doesn’t quite say that, but even so, this will make deeply depressing reading for the struggling economies of Greece, Ireland, Italy, Portugal and Spain.

Many additional adjustments are needed to achieve the dual objectives of restoring external balance––that is, a net financial liabilities (NFL) position that is deemed sustainable by market participants––and internal balance, namely sufficiently high and sustainable growth to reduce unemployment to acceptable levels. Given the absence of nominal exchange rates, relative price adjustment needs to come via relative changes in prices and costs: internal devaluations. To the extent that these devaluations are achieved mainly by falling prices in deficit rather than rising prices in surplus economies, they can reduce domestic demand and exacerbate debt overhang problems.

In any case, “under current projections, it will take a long time” for imbalances to correct and these economies to get onto a sustainable footing, a conclusion which gives the lie to repeated claims among some eurozone policymakers that the crisis is now largely over.

The reality is that relative price adjustments have been proceeding at glacial speed, and to the extent that there has been real exchange rate adjustment via reduced unit labour costs, it has tended to through reduced employment rather than wages per se. The same goes for the once burgeoning current account deficits of these countries, which have largely closed but only via the mechanism of a collapse in internal demand.

While exports have typically rebounded, slumping internal demand (and imports) account for much of the reduction in current account deficits. This trend has not been matched by stronger demand and narrower current account surpluses elsewhere in the euro area. Thus the current account balance of the euro area as a whole has shifted from deficit into surplus, and internal rebalancing has come with subdued activity, notably very high unemployment in the deficit economies, contributing to more painful adjustment.

So what’s the solution? Fairly obvious, really. “Macroeconomic policies are needed to support demand and bring inflation in line with the “below but close to 2 percent” medium-term price stability objective, as well as further bank balance sheet repair to improve prospects for credit and investment. Structural reforms in labor and product markets are critical to improve productivity and support the reallocation of resources to tradable sectors in the medium run, thereby helping deficit countries to grow within a tighter external budget constraint”.

Simples. In truth it requires a whole lot more than this, but it is unrealistic to expect the IMF to attack some of its largest funders and advocate a breakup of the eurozone, which as far as I can see is the only way of forcing the big surplus economies to to play their part in the necessary rebalancing. The alternative of some form of debt mutualisation is a non starter for the foreseeable future. As I say, depressing reading.

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