The elections in France and Greece tell us that austerity fatigue has set in. This is not surprising. For many countries no plausible exit exists from depression, deflation and despair. If the currency union were a normal fixed exchange rate arrangement, it would collapse, as did the gold standard in the 1930s and the Bretton Woods system in the 1970s. The question is whether the fact that it is a monetary union will do more than delay that outcome. The last chance of bringing needed change rests on the shoulders of François Hollande, the newly elected president of France. Mr Hollande says his mission is to give Europe "a dimension of growth and prosperity". So can he achieve this laudable aim?
Fiscal tightening does not improve outcomes in shrinking economies. Thus, austerity is merely begetting more austerity. According to the International Monetary Fund, the ratio of gross public debt to gross domestic product will rise, not fall, in every year from 2008 to 2013 in Ireland, Italy, Spain and Portugal. It will briefly fall in Greece, but only because of its debt restructuring.
The most frightening data are for unemployment (see chart). The proportion of young people between the ages of 15 and 25 who are now without a job is 51 per cent in Greece and Spain, 36 per cent in Portugal and Italy and 30 per cent in Ireland. France is in better shape, but even there the picture is dire, with one in five young people out of work. Is it plausible that people will put up with this indefinitely? No. Far more likely is a repetition of the protest votes we have seen in these elections. Nicolas Sarkozy was the eighth leader of a eurozone member country to have been swept from office in little over a year.
Economic prospects are poor. The IMF forecasts that the economy will shrink this year, in real terms, in Greece, Italy, Portugal and Spain and grow by just 0.5 per cent in Ireland. Growth is forecast, optimistically, at close to zero in the first four countries in 2013. This is politically perilous. The emergence of still more extremist parties and a rising sense of betrayal seems inevitable. It is also economically dangerous: how many of the brightest young people are now seeking to emigrate?
Something must change. Yet all routes seem blocked. Jens Weidmann, Bundesbank president, has argued in the Financial Times that monetary policy has reached, if not exceeded, its limits. The fiscal compact is designed to preclude discretionary fiscal policy. Anyway, in the absence of fiscal solidarity, member countries that face unsustainably high interest rates have no room for manoeuvre, while the currency union lacks a federal fiscal actor. This leaves "structural policies", which is what eurozone leaders mean by a growth policy. But the view that such reforms offer a swift return to growth is nonsense. In the medium run, they will raise unemployment, accelerate deflation and increase the real burden of debt. Even in the more favourable environment of the 1980s, it took more than a decade for much benefit to be derived from Margaret Thatcher's reforms in the UK.
Perhaps the most important sentence in Mr Weidmann's article was the following: "Monetary policy in the eurozone is geared towards monetary union as a whole; a very expansionary stance for Germany therefore has to be dealt with by other, national instruments." In brief: if you dream that Germany will allow a credit-fuelled boom to raise domestic inflation, stop. This is consistent with the IMF's forecasts. Up to the crash, inflation was consistently higher in the eurozone as a whole than in Germany, largely because of relatively high inflation in Spain and Italy. Logically, this must now be reversed. But that is far from what the IMF forecasts (see chart). According to the IMF, the European Central Bank will even fail to hit its inflation target of close to 2 per cent.
As Paul de Grauwe, now at the London School of Economics, stresses in a recent note, the current adjustment process is asymmetric: countries in difficulties disinflate; but countries in a good position do not inflate. This is not a monetary union. It is far more like an empire.
What, then, might Mr Hollande do? First, he is going to have to forget almost all of his domestic promises, not only because they are not going to help France, but also because German leaders will not take him seriously otherwise.
Then the new president must embark on a serious discussion with the latter on how they expect the eurozone to end its crisis. He should give enthusiastic support to the wise recent remarks by Wolfgang Schäuble calling for higher German wages. He should then point out that there seem to be only five ways this can end. The first and best would be symmetrical adjustment of the imbalances that built up before the crisis, along with reform in weaker countries. The second would be a permanent transfer of resources from surplus countries to deficit ones. The third would be a painful shift of the eurozone into external surplus – a Germany writ large, so to speak. The fourth would be semi-permanent depressions in weak countries. The last would be partial or total break-up of the eurozone.
The only sensible choice is the first. But that is not the path the eurozone is now on. Austerity has to be matched to the realistic pace of adjustment and structural reform.
The chances that Mr Hollande can deliver such a changed perspective are small. But the currency union was a French plan. It was François Mitterrand, his Socialist predecessor, who signed the Maastricht treaty. His task and his goal must be to turn hostility into hope. He may fail. But he alone of European leaders has the desire and the ability to try.
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