richard koo

Great note from Nomura’s Richard Koo, looking at the so-called “competitiveness problem” of the Southern European nations. Rather than some inherent problem found there, Koo says that what happened is that after the 2000 tech bubble collapsed (a bubble which Germany shared heavily in) the ECB used exceptionally loose monetary policy to stimulate the economy, so that Germany wouldn’t have to revive its economy via fiscal policy.

This didn’t do much domestically in Germany (which was suffering from a balance sheet recession) but did really rev up the bubbles in the periphery, causing the boom in imports from Germany, thus putting the periphery in debt, and boosting Germany’s export sector, rescuing it from the post-tech-bubble funk.

Says Koo:

The countries of southern Europe, which had not participated in the IT bubble, enjoyed strong economies and robust private- sector demand for funds at the time. The ECB’s 2% policy rate therefore led to sharp growth in the money supply, which in turn fueled economic expansions and housing bubbles.

Wages and prices increased… leaving those countries less competitive relative to Germany.
In short, the ECB’s ultra-low policy rate had little impact in Germany, which was suffering from a balance sheet recession, but it was too low for other countries in the eurozone, resulting in widely divergent rates of inflation.

As Germany became increasingly competitive relative to the strong economies of southern Europe, exports grew sharply and  pulled the nation out of recession. Germany’s trade surplus quickly overtook those of Japan and China to become the world’s largest, with much of the growth fueled by exports to other European markets.

ECB, not southern Europe, responsible for competitiveness gap

In 2005, I told a senior ECB official that it was unfair to force other countries to rescue Germany by boosting their economies with loose monetary policy without requiring Germany to administer fiscal stimulus, when it was Germany that had become so deeply overextended in the bubble. The official responded that that is what a unified currency means: because Germany could not be granted an exception on fiscal stimulus, the only option was to lift the entire region with monetary policy.

In other words, there would have been no need for such dramatic easing by the ECB—and hence no reason for the competitiveness gap with the rest of the eurozone to widen to current levels—if Germany had used fiscal stimulus to address its balance sheet recession.

The creators of the Maastricht Treaty made no provision for balance sheet recessions when drawing up the document, and  today’s “competitiveness problem” is solely attributable to the Treaty’s 3% cap on fiscal deficits, which placed unreasonable demands on ECB monetary policy during this type of recessions. The countries of southern Europe are not to blame.

Nailed it.