Goolsbee gets it right

These days, everyone’s got a theory as to why the euro zone will or won’t break up. Most have to do with the reluctance of the Germans to abandon their fiscal ideology and bail out their no-good southern neighbors; or the lack of a lender of last resort; or the fundamental unsustainability of a currency union without a fiscal union. But in an interview with Ezra Klein, Austan Goolsbee brings up the key overlooked issue in the whole debate: growth.

EK: Are you of the camp that thinks the European Central Bank could end this if it wanted to?

AG: No, I’m not. Europe has two-and-a-half crises it’s facing. The first is an immediate banking crisis very much like our crisis in 2008. A large number of their financial institutions are viewed as being insolvent. That run has already begun. It’s slow, but it’s there. In my opinion, they will have to recapitalize their banks, one way or the other. Second crisis, which is related but distinct, is the fiscal crisis. There’s sort of a run on the public issuance of new debt.

So one is a toxic, existing asset problem, The banks hold all this sovereign debt, and as the value of all that existing stuff goes down, that’s almost exactly parallel to mortgage-backed assets going down in 2008. But then the governments of Southern Europe have to fund themselves, but they’re having a hard time doing that. And in there is the Northern European viewpoint that this is just a spending problem. And that leads to the half crisis, which is that they’re not growing. The normal thing you would do, which is devalue and have an export-led growth strategy, is impossible, and therefore someone has to have an explanation for how these countries will grow. Otherwise, we’ll just repeat this again and again.

The first two problems, in other words, are probably solvable with a massive ECB intervention. But that third (or two-and-a-halfth) one is the sticking point. The economies of southern Europe are contracting under the strain of the crisis, thereby decreasing their tax revenue and increasing their debt. Germany’s demands for austerity are only exacerbating the problem in the short term, which in turn makes it a longer-term problem, and one that’s very hard to escape.

I’m not quite as pessimistic as Goolsbee about the future of the euro, but I do agree that the current formula — essentially requiring continued economic contraction in the countries that can least afford it — isn’t going to make the euro zone any more sustainable.

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