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The IMF notes [in its World Economic Outlook] that eurozone internal adjustment requires two types of price change in crisis countries. First, the prices of non-tradeable goods – a haircut in Madrid – will have to fall relative to those of tradeable goods such as a Seat car. Second, the prices of Spanish tradeable goods would have to fall against those of non-Spanish tradeable goods elsewhere in the eurozone.
Different countries had different adjustment paths and most managed a relative improvement in their competitiveness. But the IMF asks whether this will continue. Probably not. Adjustment was driven by the end of capital inflows. When cyclical conditions improve, which they will, current account deficits will return.
Not only that. The IMF reckons that reducing net external liabilities to levels that would be considered healthy elsewhere would need “much larger relative price adjustments than implied by the need to reverse past unit labour cost appreciation or to achieve current account surpluses”. Put bluntly: the scale of necessary adjustment is absolutely enormous. The IMF does not believe that this is going to happen. Its baseline 2018 forecast for Greece, Ireland, Portugal and Spain has the net foreign asset position – the gap between the assets they own abroad, and the assets foreigners own in their country – at less than minus 80 per cent of GDP. This is a level generally not considered sustainable.
Adjustment remains possible in theory, but a scenario in which the eurozone adjusts is inconsistent with stated policy. Germany’s new grand coalition will be fiscally less austere, but I see no see no scenario under which Berlin reduces its current account surpluses over the next four years. Reform fatigue has befallen the crisis states. Adjustment on the scale the IMF is talking about is just not going to happen, not even with stronger than expected growth.
In a monetary union, adjustment is hard without any transfers and without a fiscal union. I know of no plausible plan how the eurozone can manage the dual feat of economic adjustment and debt sustainability within the straitjacket of official policy. And as long as such a plan does not exist, the crisis is not over.
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