Friday, January 7, 2011

Eastern Europe is Now a Better Bet than Western Europe

From the Financial Times:
Another sign of the dwindling fortunes of the eurozone emerged this week. The economies of western Europe overtook their neighbours in central and eastern Europe as greater default risks....An index that measures the risk of default of 15 western European economies, including Germany, France and the peripheral eurozone countries, has surged higher than a comparable one comprised of countries such as Hungary and Ukraine. These indices, which measure the cost to insure the two geographical groups against default, suggest any hopes that the festive lull could give the eurozone a breathing space appear to be fading, only one week into the new year.
The article explains the key reason for the change is both the ongoing deterioration of the Eurozone periphery  and the improving lot of Eastern European countries like Hungary, Ukraine, and Poland.  The Euro itself  has been a big contributor to this mess.  Its existence meant applying a one-size-fits-all monetary policy to vastly different economies.  Because the largest two economies in the Eurozone, Germany and France, made up about half of the overall the Eurozone economy, it is not surprising that developments in these countries largely shaped the evolution of the one-size-fits-all approach to monetary policy.  Thus, in the early 2000s monetary policy in the Eurozone was appropriate for the core countries but too loose for the periphery.  Lately, Eurozone monetary policy has been too tight for the periphery while about right for the core. 

It is still possible for the ECB to save the Eurozone in its current form through monetary policy.  However, this outcome seems increasingly unlikely.  Charle Calomiris provides some advice for European leaders should there occur a break up of the Eurozone.  

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