Interview: Paul Krugman: “The euro is a shaky construction”

The American economist at Princeton in 2008.
The American economist at Princeton in 2008.
6 September 2012 – L'Express (Paris)

To save the single currency beset by difficulties that stem from its initial design, Economics Nobel Prize laureate Paul Krugman argues that Europe should set its sights on low inflation but forget about implementing uniform austerity measures.

Your book End This Depression Now! appeals for an end to austerity and the dogmatic insistence on cutting public spending deficits. Do you think that Europe is fighting the wrong battle?

In the beginning it was just Greece. No one can deny that Athens had a problem with budgetary discipline and was responsible for many of the difficulties it faced. However, in what amounted to a moment of panic, the situation of Greece became the default explanation of the European crisis. It was perfectly in tune with central banks’ reflex for belt-tightening and the conviction that a lax attitude to social and budgetary targets was mainly responsible for the problems of the Eurozone. It also reflected the dogmatism of the Germans, who are always quick to highlight the faults of less virtuous countries. It was an explanation that overlooked the extent to which Greece was a unique and isolated case. But it nonetheless served to justify a general dogma of austerity and the belief in its universal application. And all other points of view were rapidly excluded from the ensuing debate which proved to be highly conformist.

So you believe the Germans were at fault?

Historically, their attitude is justified by a phobia of inflation, which they see as a major cause of past tragedies. But at the same time, they appear to have lost any collective memory of all the suffering caused by the terrible deflationist policies of the 1930s. Their influence at the ECB is, of course, a reflection of Germany’s dominant status in Europe but also of the long-standing aspiration for an institution that would act as an effective safeguard against a lack of budgetary discipline and inflation. […] As it stands, Germany is the creditor of a Europe which has lived through a period of extravagance. However, I would be curious to see what remedies would have been proposed, if, for example, capital had flowed from Spain into the German property market, rather than the reverse.

Have you been a eurosceptic from the beginning?

Yes, I think that the euro was a romantic idea, and a fine symbol of political unity. But when you give up your national currency, you lose a lot of flexibility, and it is not easy to compensate for the loss of room for manoeuvre. In the event of a localised crisis you have to rely on the mobility of labour to circumvent the decline in the jobs market, and more importantly, on fiscal integration to smooth over changes in tax revenue. In this regard, Europe is a much less suitable environment for a single currency than the United States. If we compare Florida and Spain: in both cases there was property bubble and then there was a crash. However, in the United States, people have the option of moving to another less affected state to find work. And benefits, health insurance, federal spending and banking guarantees for the entirety of the United States are all managed by Washington. This type of centralisation does not exist in Europe.

What do you think of the European response to the crisis?

My argument against austerity policies is addressed to countries that still have the choice. Spain and Greece had no option but to comply with Germany’s demands or run the risk of running out of funds. But to my mind, the budgetary situation in France is not quite so critical, and there is not the same need for austerity.

However, market confidence will continue to be vitally important … How can it be sustained?

The answer is an appropriate monetary response from the European Central Bank. On the one hand, I think there should be massive purchases of Italian and Spanish debt to prevent an excessive rise in interest rates. On the other, we need to see signs of a more flexible ECB policy: a pledge not to raise rates at the slightest sign of inflation, and realistic medium targets for 2% to 3% inflation instead of 0% to 1% which is what we have today.

What about Greece?

I cannot see how this country can remain in the euro. It is practically impossible. However, if it leaves there will be a massive withdrawal of deposits from Spanish and Italian banks, and the ECB will most definitely have to respond by providing unlimited liquidity. If it does not, within two weeks, the Bundesbank will throw in the towel, and that will be end of the euro.

What would be the consequences of the disappearance of the single currency?

Imagine all of those debts drawn up in a currency that no longer exists... I think the Eurozone would be plunged into a severe recession for a year while individual states find a means to continue trading, and countries like Spain and Italy recover some of their competitiveness. From a political point of view, it would be very serious: the failure of the biggest project in history would completely undermine the credibility of all of the leaders involved in the old regime and pave the way for populist and nationalist revolt.

What solution do you recommend for the Southern countries?

The classic solution would be internal devaluation: the principle being that a reduction in wage costs enables countries to become more competitive. But no country, not even Ireland or Latvia, has succeeded in engineering a real reduction in private sector wages. At the same time, the resulting deflation would increase the burden of private debt in euros. When you factor in the risk of capital flight and the instability of governments obliged to implement such measures, it is clear that this solution is a dead end. As it stands, Spanish wages are overvalued by 30%, when compared with wages in Germany. Instead of trying to force wages down, which is politically impossible, why don’t we allow German wages to rise so as to boost Spanish competitiveness? Of course, this would imply a less stringent monetary policy, and an inevitable increase in inflation in Germany.

So what future do you see for the Eurozone?

If the ECB implements the right measures, things could start to improve three to five years down the line. But Europe will still be fragile. Its currency is built on shaky foundations, and that will continue to be the case until a common European bank guarantee scheme is established. In the meantime, the system can quite comfortably survive if it is treated to a sufficiently strong dose of inflation. Let’s not forget: Europe’s problem is not one of fundamental decline. It continues to be a productive and innovative continent. The difficulties that it faces have been prompted by inadequate governance and a failure on the part of the institutions that are supposed to exercise economic control.

All of this can be repaired.

Translated from the French by Mark McGovern

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