Home Europe COLUMN – Europe’s hair-trigger economy: Summers – Reuters

COLUMN – Europe’s hair-trigger economy: Summers – Reuters

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Mon Mar 18, 2013 8:58am EDT

By Lawrence Summers

March 18 (Reuters) – Europe’s economic situation is viewed
with far less concern than was the case six, 12 or 18 months
ago. Policymakers in Europe far prefer engaging the United
States on a possible trade and investment agreement to more
discussion on financial stability and growth. However, misplaced
confidence can be dangerous if it reduces pressure for necessary
policy adjustments.

There is a striking difference between financial crises in
memory and as they actually play out. In memory, they are a
concatenation of disasters. As they play out, the norm is
moments of panic separated by lengthy stretches of apparent
calm. It was eight months from the Korean crisis to the Russian
default in 1998; six months from Bear Stearns’s demise to Lehman
Brothers’ fall in 2008.

Is Europe out of the woods? Certainly a number of key credit
spreads, particularly in Spain and Italy, have narrowed
substantially. But the interpretation of improved market
conditions is far from clear. Restrictions limit pessimistic
investors’ ability to short European debt. Regulations enable
local banks to treat government debt as risk-free, and they can
fund it at the European Central Bank (ECB) on better-than-market
terms. The suspicion exists that, if necessary, the ECB would
come in strongly and bail out bondholders. Remissions sometimes
are followed by cures and sometimes by relapses.

A worrisome recent indicator in much of Europe is the
substantial tendency of stock and bond prices to move together.
When sentiment improves in healthy countries, stock prices rise
and bond prices fall as risk premiums decline and interest rates
rise. In unhealthy economies, however, as in much of Europe
today, bonds are seen as risk assets, so they are moving, like
stocks, in response to changes in sentiment.

Perhaps it should not be surprising that Europe still looks
to be in serious trouble. Growth has been dismal; the euro-zone
gross domestic product has been below its 2007 level for six
years, and little growth is forecast this year. For every
Ireland, where there is a sense that a corner is being turned,
there is a France, where questions increasingly arise about the
political and economic sustainability of policy.

The controversy surrounding the decision by the European
authorities to bail out Cypriot bank depositors suggests the
degree of fragility in Europe. The idea that converting a small
portion of deposits into equity claims in an economy with a
population of barely more than 1 million could be a source of
systemic risk suggests the hair-trigger character of the current
situation.

Everything is compounded by political uncertainty. Italy’s
last election was inconclusive even by Italian standards.
Scandals and staggeringly high unemployment are taking their
toll in Spain. France is much calmer about its situation than
are many outside observers. And Germany’s primary concern is
avoiding turmoil ahead of its fall elections. Given a choice,
all would almost certainly prefer some kind of macroeconomic
unorthodoxy to the breakdown of their monetary union. But there
is a serious risk that as nations pursue their parochial
concerns, the political and economic situation will deteriorate
beyond repair.

Continued structural reform in the most troubled economies
is essential, and the work of building a more satisfactory
institutional foundation for the euro must go on. Critical to
success will be (the belated) recognition of the paradox that in
economic policy, as in so much of life, what is good for one is
not good for all.

German policymakers constantly note that fiscal
consolidation and structural reform were key to Germany’s rise
from “sick man of Europe” to today’s position of strength. But
Germany’s export growth and huge trade surplus were enabled by
borrowing on the European periphery. If Europe’s debtor
countries are to follow Germany’s historic adjustment path
without economic implosion, there must be a strategy that
assures increased external demand for what they produce. Simply
put, there cannot be exports without imports. This could come
from a German economy prepared to reduce its formidable trade
surplus, from easier European monetary policies that spur growth
and competitiveness, or from increased deployment of central
funds such as those of the European Investment Bank or perhaps
other sources. The crucial point is that no strategy for debt
repayment can succeed without providing for an increase in the
demand for the exports of debtor countries.

Invocation of necessity is not a strategy. As any student of
Germany’s experience of the 1920s knows, it is far from a viable
strategy to require a nation to service large debts by being
austere when there is no growth in demand for its exports.

European policymakers, the International Monetary Fund and
others with a stake in Europe’s outcome need to recognize that
the history of financial crisis is a history of windows of
opportunity missed. New business is always more exciting than
unfinished business. And where matters are controversial, forced
moves are easier for policymakers because they can be portrayed
as moves of necessity rather than choice. So outsiders avoid
confrontation and insiders embrace drift. The consequences could
be grave.

COLUMN – Europe’s hair-trigger economy: Summers – Reuters

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