Lessons from the Eurozone

See:
http://www.economist.com/node/21536871?fsrc=scn%2Ffb%2Fwl%2Far%2Fveryshorthistoryofthecrisis

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Debt in these countries has become a burden not because of government profligacy but because each enjoyed a decade of low interest rates and was then hit by the financial crisis. Easy credit fuelled debt in households and the financial sector. The European Central Bank oversaw a binge of cross-border lending. In the crisis unemployment and hardship have deepened, increasing the bill for welfare. Some countries, such as Ireland and Spain, have needed to find money to prop up their banks. These new expenses fell on the state just when tax receipts collapsed—catastrophically in countries that had seen a property boom.

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Even where troubled euro-zone countries had not been profligate, they have been running unsustainable current-account deficits. Low interest rates fuelled domestic spending and spurred inflation in wages and goods, which in turn made their exports more expensive and left imports relatively cheaper. But it was also because Germany was recycling the surpluses produced by its export machine, financing their consumption.

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And even when the crisis has abated, restoring Europe to health will take many years. That is because the troubled countries need to control their government deficits and to re-establish sound current accounts by improving their competitiveness. Germans feel that the responsibility for this lengthy adjustment lies exclusively with borrowers, which must urgently restore budget discipline. Significantly, the German word for debt,Schulden, is the plural of Schuld, meaning guilt or fault.

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However, this strategy risks being self-defeating. By pushing for immediate austerity the euro zone is deepening recession in the troubled economies, which will only make their debt harder to service. Germany’s approach suffers from a fallacy of composition. It is not possible for everyone to save their way to prosperity. As Keynes argued after the Depression, someone, somewhere must be consuming. In Europe that should be countries such as Germany and the Netherlands that were running vast current-account surpluses during the boom. But the creditors are loth to accept that they are part of the problem.

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