Eurozone crisis: It ain’t over yet

By Don Alexander, MBA
Associate, RSD Solutions Inc.
Mr. Alexander also lectures at NYU and SunySB

As the famous American philosopher Yogi Berra noted “It ain’t over till it’s over”.  All G7 economies are struggling in the post-crisis climate, but US GDP has recovered to pre-crisis levels, while the Eurozone lags.  Paolo Manasse in a VOXEU communique (Jan. 17^th) portrays the global crisis as a transitory shock for the US, but as a quasi-permanent shock for Europe.

The policies needed to get the Eurozone back on track are not politically feasible.  As tension rises with every quarter of stagnation, prospects for the survival of the euro are not improving, but getting worse.  Calmness settled when Mario Draghi pledged that the euro was an irreversible project.  Yet, the forces that could eventually break up the Eurozone are not only untamed but are growing due to serious policy mistakes.

A useful starting point is to compare how the US and Eurozone have been affected by, and have responded to the recent financial crisis.  These comparisons include: a comparison of permanent versus transitory consequences of shocks; active versus passive policy responses; and symmetric versus asymmetric shocks.

The financial crisis originated in the US and later spread to the Eurozone:  the fall in output is larger on impact in the Eurozone than the US; the US economy started recovering 2009 and continues, while in the Eurozone recovery has been short-lived, and stagnates.

The labor market comparison tells an interesting story.  First, note that the rise in unemployment in the US is an impact much larger than in the Eurozone.  Second, following the sharp rise in the unemployment rate, the US rate starts to decline.  Third, the European unemployment rate rises slowly, but shows no sign of reversal.  The evidence points to much more persistent contractionary effects in the Eurozone than in the US.  The global crisis seems to have been a quasi-permanent shock for the Eurozone but a transitory shock for the US.

A look at fiscal and monetary policies in the two reveals important differences.  The rise in deficit/GDP ratio in the US – is far more pronounced than in the Eurozone.  This occurs despite the fact that Europe experienced a deeper recession, which reduces GDP and raises the deficit due to automatic stabilizers.  The ‘expansionary’ stance in the Eurozone is short-lived, and reverts as soon as 2009 while the deficit/GDP ratio in the US improves only from 2010.  As a consequence, the debt/GDP ratios that was approximately at 70% in both the US and the Eurozone start diverging since 2007, with a much larger rise in the US.

In considering central bank policies, the size of the ECB interventions is about one fifth of that of the Fed, about 4% of GDP compared to over 20%.  The difference in fiscal stances between the US and the Eurozone goes a long way in accounting for the worse performance of the Eurozone compared to the US.  This suggests that Eurozone problems are largely homemade.  Other explanations include different labor markets, country specific shocks, different institutions and policy responses.

The Eurozone policy response to the crisis, fiscal tightening and reinforced constraints on Eurozone national borrowing to prevent moral hazard, is not only imparting a recessionary impact on the Eurozone, but it is also aggravating the ‘original sin’ of the euro: asymmetry.  Thus, in a context of scarce international labor mobility and lack of wage and price flexibility in some Eurozone countries, the lack of an operative ex-post transfer/insurance scheme becomes more serious.

The problem is a very difficult one.  A centralized ‘ex-post’ transfer scheme is necessary, but does not seem to be politically feasible.  The adopted Macroeconomic Imbalances procedure, a mere ‘ex-ante’ monitoring device – akin to a score board – for detecting ‘asymmetries’ is probably counter-productive.  Instead of transferring resources to countries suffering shocks, it punishes them.  The longer-term prospects for the survival of the euro not only are not improving, they are getting worse.

www.voxeu.org/article/eurozone-crisis-it-ain-t-over-yet