Saturday, February 28, 2015

Jan Kregel — Europe At The Crossroads – Financial Fragility And The Survival Of The Single Currency

To outside observers, Germany's insistence that the new Greek government continue to impose austerity policies in the presence of rising unemployment and mounting debt levels appears to defy economic logic. However, an acquaintance with the historical evolution of the path to the creation of the common currency in the European Union (EU) sheds some light on the logic of the German government's strategy in dealing with the eurozone sovereign debt crisis and its negative response to Greece's request for an alternative economic policy.

Given the continuing divergence between progress in the monetary field and political integration in the euro area, the German interest in imposing austerity may be seen as representing an attempt to achieve, de facto, accelerated progress toward political union; progress that has long been regarded by Germany as a precondition for the success of monetary unification in the form of the common currency.
Yet no matter how necessary these austerity policies may appear in the context of the slow and incomplete political integration in Europe, these policies are ultimately unsustainable.

The survival and stability of the euro, in the absence of further progress in political unification, paradoxically require either sustained economic stagnation or the maintenance of what Hyman Minsky would have recognized as a Ponzi scheme. Neither of these alternatives is economically or politically sustainable.
Levy Economics Institute of Bard College
Europe At The Crossroads – Financial Fragility And The Survival Of The Single Currency
Jan Kregel | Senior Scholar

Note: Paragraphing changed for ease of reading online.


PeterP said...

Most of it makes sense to me but I think one sentence is complete nonsense:

"for a closed system to maintain output levels requires 0 =(S-I) + (T-G)"

But this is simply an accounting statement which is true whether output falls or not! It doesn't know nor care if output falls or rises, if the economy is in equilibrium etc.

peterc said...

I haven't read the paper yet, but the sentence you quote makes sense in terms of ex ante (planned) outcomes as opposed to ex post (actual) outcomes.

As you say, the relation is an identity ex post. But ex ante, it is true to say that if, for instance, the non-government intends to generate a surplus equal to 2% of the current level of GDP but the government attempts to balance its budget, income will fall.

Bill Mitchell often makes the same point Kregel appears to be making.

peterc said...

Actually, as stated my example above is not quite accurate. It is necessary to specify the starting position.

Suppose initially that the non-govt surplus and govt deficit are 2% of GDP. Suppose also that the non-govt is satisfied with this outcome but the govt isn't.

The govt decides to take steps to balance its budget while the non-govt's intentions remain unchanged (i.e. a surplus equal to 2% of GDP).

In that case, the growth rate of GDP will fall.

(The example in my previous comment was not quite right because it is possible, for instance, that the non-govt had previously been aiming at a higher surplus equal perhaps to 3% of GDP, rather than 2%, with the govt aiming to balance its budget or possibly even run a surplus. In that case, a change in plans such that the govt desired to balance its budget and the non-govt lowered its targeted surplus to 2% of GDP would have a positive impact on the growth rate of GDP.)

Restating the idea slightly differently, suppose in the current period that the actual non-govt surplus happens to equal the govt deficit at 2% of GDP. Then a balanced budget in the next period will impact negatively on GDP growth unless the non-government just so happens to alter its intentions and targets a surplus of zero.

The 'confidence fairy' defense of austerity essentially appealed to such a behavioral adjustment on the part of the private sector. It was claimed that tighter fiscal policy would boost confidence and result in higher private investment For a given propensity to save, this would amount to a reduction in the non-govt's planned surplus.