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Welcome to the 1930s

15 Haziran 2012 Cuma

Martin Wolf is shrill (and rightly so). "Before now, I had never really understood how the 1930s could happen," the Financial Times columnist wrote in an op-ed published on June 5.

"Now I do. All one needs are fragile economies, a rigid monetary regime, intense debate over what must be done, widespread belief that suffering is good, myopic politicians, an inability to co-operate and failure to stay ahead of events."

Right on cue, the European Central Bank declined to cut interest rates, or announce any other policies that might help. Because what possible reason might there be to take action?

Survey data suggest that the euro area economy is really plunging now, plus Spain is on the brink. What about inflation? It's falling fast -- which is a bad thing under the circumstances.

I don't think there's any conceivable economic logic for the E.C.B.'s decision. It can only, I think, be understood as some kind of refusal to admit, even implicitly, that past decisions were wrong.

Like Mr. Wolf, I'm starting to see how the 1930s happened.

The Urge to Punish

I've been hearing various attempts to explain the E.C.B.'s utterly bizarre refusal to cut interest rates despite soaring unemployment, sliding inflation, and on top of all that the special problems of a monetary union that probably can't survive unless overall demand is strong.

The most popular story seems to be that the E.C.B. wants to "hold politicians' feet to the fire," letting them know that they won't get relief unless they do what's necessary (whatever that is).

This really doesn't make any sense. If we're talking about enforcing austerity and wage cuts in the periphery, how much more incentive do these economies need?

If we're talking about a broader fiscal union or something, what is it about the imminent collapse of the whole system that the Germans supposedly don't understand?

Is there any conceivable way that cutting the repo rate by 50 basis points will somehow undermine actions that would otherwise happen?

What does make sense, maybe, is a two-part explanation.

First, the E.C.B. is unwilling to admit that its past policy, especially its past rate hikes, were a mistake.

Second -- and this goes deeper -- I suspect that we're seeing the old Joseph Schumpeter "work of depressions" mentality: the notion that all the suffering going on somehow serves a necessary purpose and that it would be wrong to mitigate that suffering even slightly.

This doctrine has an undeniable emotional appeal for people who are themselves comfortable.

It's also completely crazy given everything we've learned about economics these past 80 years.

But these are times of madness, dressed in good suits.



Officials from the European Central Bank announced on June 6 that the bank's benchmark interest rate would remain at 1 percent, despite calls in Europe for more economic stimulus measures to help nations struggling with the sovereign debt crisis.


However, Mario Draghi, the bank's president, assured the public that policy tools are available if Europe's economic situation continues to deteriorate. "We monitor all developments closely and we stand ready to act," he said at a press conference in Frankfurt. But Mr. Draghi also stressed that the E.C.B. could not substitute for European governments that have failed to provide a sufficient policy response. "There is no horse trading here," he said.


As the euro zone's debt crisis threatens to destabilize Spain's economy (which is seeing its borrowing costs rise) and push Greece out of the monetary union, some economists believe that the E.C.B. may soon have little choice but to cut interest rates -- which are already at historic lows -- to make it easier for banks to borrow. Another way the E.C.B. can provide a monetary boost for European economies is by cutting the deposit rate, sometimes called the "repo rate," which acts as a floor for lending rates between banks. The deposit rate is currently at 0.25 percent.


Earlier this year, the E.C.B. launched three-year "long-term refinancing operations" programs that pumped about 1 trillion euros into Europe's banking system. However, according to an analysis published June 6 by Sakari Suoninen, a reporter at Reuters, the benefits have faded as borrowing costs for troubled nations have increased. "The bank's dilemma is that if it does too much, pressure for government action falls," Mr. Suoninen wrote. "Yet if it does nothing, troubled sovereign debtors could find it harder and harder to finance themselves or maintain confidence in the banks that have bought much of their debt."

Estonia's Not-So-Successful Success Story


Since Estonia has suddenly become the poster child for austerity defenders -- they're on the euro and they're booming! -- I thought it might be useful to have a picture of what we're talking about. Below is a chart showing the real gross domestic product, from Eurostat.


So, a terrible -- Depression-level -- slump, followed by a significant but still incomplete recovery.


Better than no recovery at all, obviously -- but this is what passes for economic triumph?


Why the Baltics Matter


Some readers have urged me not to spend time on Latvia, Estonia, etc., on the grounds that they are too small to matter. Sorry, but that's not true. For one thing, every economy -- even a small one -- is potentially a "natural experiment" that teaches us more about how economies in general work. Beyond that, the Baltics now loom large in the imagination of austerity's defenders, particularly since Ireland keeps refusing to play along and become a success story.


Jörg Asmussen is Germany's man at the European Central Bank, which means that what he says matters. Read his speech in Riga, Latvia, from earlier this month (available at ecb.int), asserting that the Baltic experience shows that austerity and internal devaluation actually do work. Notice that his evidence comes entirely from one year of fairly fast growth after an incredible decline. So it's important to say that this proves very little.


Troubling Business Cycles


My mild observations that a partial bounce back from a severe slump are not exactly an economic triumph are apparently already eliciting rage in Estonia. The Oxford economist Simon Wren-Lewis, writing about Latvia in his blog, is more caustic: "An extraordinary success story: after an 18 percent decline in G.D.P. in 2009, and flat G.D.P. in 2010, we now have 5.5 percent growth in 2011," Mr. Wren-Lewis wrote on June 7. "Isn't the 5.5 percent growth last year just the beginning, with the economy achieving a new dynamism? Mr. Asmussen does not provide any additional evidence on this. Perhaps wisely, as the I.M.F. are predicting 2 percent growth this year, and 2.5 percent next year. So the 5.5 percent growth last year is all we have."


He continued: "Earlier this year I wrote that when growth returned, some would say this proved those pessimistic Keynesians had been all wrong. I must admit the 'some' I had in mind were politicians and journalists, not senior central bankers. By this logic, an even better strategy is to close the whole economy down for a year. The following year we could get fantastic growth as the economy starts up again."


While I'm at it, let me address another issue. Quite a few people say that it's wrong -- or, as some say, "dishonest" -- to look only at the decline since the peak. After all, didn't the Baltics have very good growth in the years preceding the peak?


Yes, they did.


So did the United States before the Great Depression. Long-run growth and business cycles are different things: long-run growth represents rising economic potential, slumps reflect a shortfall of output below that potential.


Since the austerity/stimulus debate is about slumps, not long-run growth, talking about growth before the crisis is just irrelevant.


Anyway, I'm for the Wren-Lewis proposal: let's collapse the economy for a year, so we can have great growth the year following.

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