Monday, January 16, 2012

Zombie Talking Point #17: We're Becoming Greece!

Or Italy, or Ireland, or Portugal or now even France.  No... We're not like them at all.  Anyone who tells you that we are is either lying to you or is too stupid to understand why the United States (like the UK) is in a much different circumstance.  We are not like the Eurozone.

Greece, Italy, Ireland, Portugal, France, Germany and all the other Eurozone countries share more than just a common currency.  They share a common monetary policy.  This means that they rise and fall as a group.  The problem is, they don't share a common fiscal policy.  The United States does not suffer from this untenable policy divorce.  Why is this important? Because.  It severely limits the response these nations have to economic turbulence.

Consider how France, for example, would have responded in the 1990’s to a substantial decline in demand for its exports. If there had been no government response, production and employment would have fallen. To prevent this, the Banque de France would have lowered interest rates. In addition, the fall in incomes would have automatically reduced tax revenue and increased various transfer payments. The government might have supplemented these “automatic stabilizers” with new spending or by lowering tax rates, further increasing the fiscal deficit.

In addition, the fall in export demand would have automatically caused the franc’s value to decline relative to other currencies, with lower interest rates producing a further decline. This combination of monetary, fiscal, and exchange-rate changes would have stimulated production and employment, preventing a significant rise in unemployment.

But when France adopted the euro, two of these channels of response were closed off. The franc could no longer decline relative to other eurozone currencies. The interest rate in France – and in all other eurozone countries – is now determined by the European Central Bank, based on demand conditions within the monetary union as a whole. So the only countercyclical policy available to France is fiscal: lower tax revenue and higher spending.

While that response implies a higher budget deficit, automatic fiscal stabilizers are particularly important now that the eurozone countries cannot use monetary policy to stabilize demand. Their lack of monetary tools, together with the absence of exchange-rate adjustment, might also justify some discretionary cyclical tax cuts and spending increases.

The Eurozone countries are, in effect, completely restrained by the policies of an un-elected ECB.  But these nations are also attempting to rein in spending at the same time that monetary policy is contracting.  This is a recipe for depression.  Their deficits are not structural, they're cyclical. Yet the governments of the Eurozone are behaving as if they face structural deficits.  They're using austerity measures to cut government spending when that is the worst thing you could do.  It's pouring gasoline on a raging brush fire.  It's obvious that none of these countries posses sufficient economic velocity to escape the gravity well of the depression that it pulling them down.

The problem for the US?  If Europe really does slip into depression, this will have a significant impact on US exports.  That will drive the US economy closer to recession at a time when a fragile recovery is underway.  That, my friends, would be very, very bad.

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