Krugman Rejects both PIIGS Deficit Story and "Unstable Welfare State" Story
This week, NY Times Economics Writer Paul Krugman rejected the prevailing myths about the Eurozone crisis brewing on both sides of the Atlantic.
The Republican Story
The idea that Europe is in trouble because of it welfare state is in fact in vogue among the American right, as well as in many economic faculties across the US. For some time now, European welfare policies have been seen as a disaster waiting to happen by both the American right and the American center. Preposterous as it may sound, the idea is that by helping the poor, we are all made worse off.
Unfortunately, this story has never been quite true, either in the European or in the global contexts. For starters, the welfare states in Scandinavia are still in one piece. Furthermore, the countries now in trouble spent less of the GDP on their social systems than their northern -and more economically secure- neighbors.
The German Story
The German story is one of how years of fiscal irresponsibility lead to the crisis that we are in now. While it might be true for Greece, it doesn't say much about the rest of southern Europe. Tellingly, this story does not hold true for Spain, Portugal or Ireland. Accordingly, the term "PIIGS" has been replaced in both European and American media by a more specific focus on Greece.
"What does ail Europe? The truth is that the story is mostly monetary"
According to Krugman, the root of Europe's economic troubles lies in the construction of a common currency without getting the underlying economic institutions right. Add to the that the steadfast insistence on austerity, despite both theory and practice being very clear about it being a failed policy for debtor nations (those who have doubts, google the words "IMF" and "austerity"). On top of that, the German refusal to change course on the ECB's monetary policy essentially means that viable monetary policy responses to Europe economic troubles. Of course none of this looks good to any traders or banks holding European assets, who at this point would rather just press the sell button on their screens and move on to greener pastures.
What do we Need?
The response is plain and simple. We either need a more serious and responsible monetary policy for Europe immediately, or else we are in a lot of trouble (IMF style austerity, followed by rioting, followed by 10 years of lost growth.)
At this point, "a more serious and responsible monetary policy" would involve both credit policy and a larger money supply. As annoying as it sounds that we will have a bit of inflation and that the ECB will help pick the winners for a time, it is better than half of Europe burning, which is what might just end up happening.