The Euro’s Hard Rain Falls

SWEDEN – The blame game is in fashion as crisis and desperation spread across Europe. News reporting, as well as political and economic debate, now focuses on identifying the culprits, with bankers and politicians emerging as the prime suspects. Bankers are blamed because their irresponsible lending and speculation brought about the fall of economies like Ireland and Latvia, as well as deep trouble in countries like Spain and Portugal. Politicians are blamed because they did not tighten fiscal policies when needed in order to prevent property bubbles, rein in external deficits, and avert economic overheating. Now, after the bubbles have burst, and the property market’s inevitable collapse has been followed by that of banks, public finances, and labor markets, the villains must be punished. But this popular exercise is beside the point. It is obvious that politicians and bankers made grave errors that contributed to the current crisis. But, regardless of how bad Europe’s political and financial leaders may seem, a sudden rise in the number of incompetent or immoral individuals throughout the eurozone’s periphery is not a credible explanation of this crisis. The people running Ireland and Latvia were praised as role models just a short time before they became scapegoats. Instead, the blame should be shared by those who knew, or should have known, about the risks of giving up the ability to set interest rates in individual countries. We know that extremely low real interest rates produce massive expansion of credit. In countries with higher price growth than in Germany, but with the same borrowing costs, this cannot produce anything but overheating, higher inflation, and even lower real interest rates. To stem this flood of credit-induced demand with fiscal policy alone is impossible, and it is absurd to try. How do you tighten fiscal policy to make up for more than 100% of GDP in credit-induced spending power in only three years, as occurred in Ireland in 2004-2007 – and in a democracy sporting a fiscal surplus, as Ireland is? To ask politicians in a democracy with big surpluses to raise taxes or cut benefits or public investment by the enormous magnitude needed to stave of disaster strikes is to be out of touch with reality. Quite simply, the risks for small peripheral countries are inherent in the system created by the European Monetary Union. The main blame should therefore be put on the system’s founders, or those who saw the problems coming but chose not to raise a word of warning. The dream of European unity evidently induced some to remain silent in an effort to preserve the euro project’s visionary goodwill. Now we have awakened to an existential crisis for the common currency. Neglecting the risks and exaggerating the benefits of the euro in order to promote short-term support for it inevitably became self-destructive. Those who not only tolerated but actively encouraged the excesses of countries like Latvia – by making eventual euro adoption a precondition for European Union membership, and promising that it would produce only growth, prosperity, and discipline – are those who should be chased by the blame game. Every economy needs someone who can ensure that the proverbial punch bowl is taken away when the party gets out of hand. This is what independent central bankers are for, and that is why their independence from political interference has been enshrined in the European Treaty. But this insight is not reflected in monetary union’s design. Smaller members of the eurozone, particularly those on its periphery and with weaker economic links to the heartland of the EMU, become vulnerable to overheating and inflation when their ability to raise interest rates is abolished. No provisions in the Treaty address this fundamental problem. Many are now suffering as a result. Leif Pagrotsky, a member of the Swedish parliament, is Vice Chairman of the General Council of the Riksbank, and a former Swedish Minister of Industry and Trade. Ends