22 May 2012

Martin Wolf: A fragile Europe must change fast

If dismantling the euro is out of the question, true federal finance is unavailable and mutual solidarity will remain limited, what is left, asks Wolf in his FT column. The answer, he says, is faster adjustment to bring economies back to health.

So how is faster adjustment to be achieved? The answer is through a buoyant eurozone economy and higher wage growth and inflation in core economies than in the enfeebled periphery. Moreover, the required growth strategy is definitely not just a matter of policies for supply. According to forecasts from the International Monetary Fund, eurozone nominal gross domestic product will rise by a mere 20 per cent between 2008 and 2017. In the latter year, it will be 16 per cent lower than if it had continued to grow at the rate of 4 per cent achieved between 1999 and 2008 (consistent with 2 per cent real growth and 2 per cent inflation). For the economies under stress, such feeble growth in the eurozone is a disaster: it means that the eurozone as a whole tends to reinforce, rather than offset, their credit contractions and fiscal stringency. They can blame the universal adoption of fiscal stringency and the policies of the European Central Bank, which let the money supply stagnate.

What has this to do with the risk of a Greek exit and the need to manage the fallout, should this occur? Nothing and everything. Nothing, because it will still be necessary to manage panics, almost certainly by unlimited ECB support... Everything, because with large divergences in competitiveness, weak fiscal solidarity and fragile banks, a plausible prospect of adjustment into growth is vital. If countries face year after weary year of debt deflation and depression, the euro risks becoming a detested symbol of impoverishment. As a strong federal union, the US will bear the strain of such sustained disappointment. The far more fragile eurozone will not.

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