by Jörg Bibow Levy Economics Institute of Bard College May 2012 The Euro Debt Crisis and Germany’s Euro Trilemma by Jörg Bibow Levy Economics Institute of Bard College May 2012

 AIM: Investigate the causes behind the euro debt crisis, particularly Germany’s role in it  MESSAGE: Not primarily a “sovereign debt crisis”, but rather a (twin) banking and balance of payments crisis  Germany is facing a trilemma, led by it’s decisions regarding:  Breaking the golden rule of a monetary union: commitment to a common inflation rate  Misdiagnosis and the wrongly prescribed medication of austerity The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

1. Euroland in global perspective 2. A look inside Euroland 3. Divergencies and intra-area imbalances 4. Miraculous healing of the “sick man of the Euro” 5. Germany’s “Euro trilemma” 6. Unconditional austerity and it’s implications 7. Concluding remarks The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

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7  Denial of the authorities made things worse: False belief that Euroland was a victim of an external crisis October 2008: Half-hearted participation in globally coordinated stimulus Fresh illusion: Euroland has fallen victim to a “sovereign debt crisis”

ECB’s stability-oriented monetary policy: 1) Inflation below but close to 2 percent 2) Budget deficits below 3 percent A look at budget balances made it obvious that it was the economic union part of the “EMU” that had failed The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

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The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

 Current account imbalances in the Euroland, due to:  Competitiveness positions running out of kilter  Divergent domestic demand growth rates  Evolution of competitiveness at the national level shaped by:  The rate of increase in wages, relative to the rate of productivity growth (unit labor cost)  The exchange rate (not an option in a currency union)  Coordination needed to prevent national wage trends from becoming the source of assymetric shocks The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

 1998: Germany barely met the 3-percent (critical in getting the euro off) deficit hurdle  Pillars of German policymaking:  Unconditional fiscal consolidation – austerity measures  Wage restraint  Result: Germany among the first countries to breech the SGP’s magic number of 3-percent deficit hurdle in the early 2000s (“the sick man of the euro”) The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

The crisis is benefiting Germany in two ways:  By depressing the euro and hence stimulating non-euro net exports  By depressing German interest rates, owing to the market convention of Germany as a safe haven The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May  European Commision report (2012): Intra-area rebalancing will have to involve both surplus and deficit countries alike  Germany: runs persistent current account surpluses – is thereby improving its net international investment position either by paying off foreign debts or acquiring foreign assets  IMF study (2010): Germany’s global financial intergration is especially concentrated within Euroland

TARGET2: Automated transfer system of Bundesbank, linking wholesale payment systems and money markets across Euroland It is essential to the implementation of area-wide monetary policy and interbank refinancing activities. It’s balance arises endogenously when EMU members’ balance of payments are not otherwise balanced over a certain period TARGET2 balances could not arise without Eurosystem lending The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

Germany’s euro trilemma: Germany cannot have all three: perpetual export surpluses, a no transfer/no bailout monetary union, and a “clean” independent central bank. Therefore, its perpetual export surpluses can only be sustained if offset by fiscal transfers Germany designed the Maastricht regime, so as to exclude both transfers and bailouts of partners, but ignored that running perpetual trade surpluses would bankrupt its trade partners and make application of the forbidden medicine inevitable. Simple choice: Bail out its bankrupt EMU partners or its own banks (hit by EMU partners’ defaulting on their debts) The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

Typical German position: Deficit countries must adjust and address their structural problems. They must reduce domestic demand, become more competitive and increase their exports 2 percent inflation growth target: It’s not on the table, cause the adjustment path will make Germany less competitive Germany intends to stay the course and force everyone else to converge to its new zero percent stability norm instead The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May

Causes behind the euro debt crisis:  Critical flaws in the design of the Maastricht regime  Regime-antagonistic policies pursued by the monetary union’s largest member, Germany  Possible solutions:  Bank recapitalization and symmetric internal rebalancing  Reforming EMU in the direction of a full-blown fiscal union The Euro Debt Crisis and Germany’s Euro Trilemma, by Jörg Bibow Levy, May