Monday, June 13, 2011

Options for the Eurozone

Nouriel Roubini has written a number of good pieces on the Eurozone crisis.  His latest one in the Financial Times is no different.  It provides a summary of how the Eurozone got to this point and the options left for it going foward.  Here are the options according to Roubini:
(1) The euro could fall sharply in value towards – say – parity with the US dollar, to restore competitiveness to the periphery; but a sharp fall of the euro is unlikely given the trade strength of Germany and the hawkish policies of the European Central Bank.
(2) The German route — reforms to increase productivity growth and keep a lid on wage growth — will not work either. In the short run such reforms actually tend to reduce growth and it took more than a decade for Germany to restore its competitiveness, a horizon that is way too long for periphery economies that need growth soon.
(3) Deflation is a third option, but this is also associated with persistent recession. Argentina tried this route, but after three years of an ever deepening slump it gave up, and decided to default and exit its currency board peg. Even if deflation was achieved, the balance sheet effect would  increase the real burden of private and public debts. All the talk by the ECB and the European Union of an internal depreciation is thus faulty, while the necessary fiscal austerity still has – in the short run – a negative effect on growth.
(4) So given these three options are unlikely, there is really only one other way to restore competitiveness and growth on the periphery: leave the euro, go back to national currencies and achieve a massive nominal and real depreciation. 
A key point here is that ultimately a real depreciation is needed for the troubled Eurozone countries.  How it gets done is the burning question.   


  1. Excellent blogging, this latest one and many preceding.

  2. Roubini's enumeration of the possible outcomes is interesting. But I continue to be preplexed as to why German productivity growth has been stagnant for the last three years. Kurzabeit is at an end I believe. If Germany had experience productivity growth their economy would not be overheating right now.

    And I'm beginning to believe in the possibility of a major default in the eurozone which in turn could lead to another surge in demand for dollars. Will the Fed do something this time or stand pat as usual.

    P.S. Next month the ECB will probably raise its policy rate.

  3. This is incredibly frustrating. There are other clear options:

    5) Significant default, but remain within the Euro.

    6) Point 3) is silly. Instead, go for inflationary deflation: Deflate relative to Germany.

    Some combination of 2), 5) and 6) would solve the problem nicely (although it would obviously require recapitalising the banks)

  4. Anonymous:

    I agree with your point that all is needed is for Germany to have higher inflation than the periphery. See my previous post titled "Fiddling While the Eurozone Burns."

  5. Mark:

    Yes, I am concerned that we me soon have another Lehman type shock in Europe that will cause a spike in the demand for safe dollar assets. I also worry about a financial panic arising from a congressional impasse on the debt ceiling.