Readers question: What exactly are the solutions to the EU crisis?
It is a difficult question to answer. The dynamics of the single currency mean that many of the conventional solutions to economic problems cannot be used. The difficult task is to reduce levels of government borrowing whilst also managing to target economic recovery and lower unemployment.
Problems Facing EU
If you looked at an economy such as Ireland, Greece Portugal, or Spain. They face these problems
- High unemployment
- Stagnant economic growth, and the chance of prolonged recession.
- Very large current account deficit due to loss of competitiveness.
- High government borrowing. Higher interest rates on government bonds because of fears over default.
The obvious solution is to devalue the currency. This helps to regain competitiveness, reduce the budget deficit, reduce unemployment and help the economy recover. Economic recovery is an essential ingredient in reducing the budget deficit. Yet, devaluation is not an option. Countries could leave the Euro, but this would be very damaging and lead to capital flight (see: leaving the Euro). It is not like devaluing in a fixed exchange rate (ERM)
Therefore, countries like Ireland, Greece and Portugal are currently facing internal devaluation. They are trying to restore competitiveness by reducing wages, costs and inflation. But, this deflationary process (spending cuts, higher taxes) is causing lower growth and higher unemployment.
Solutions to EU Crisis
Problem of Government Debt
- Debt Consolidation. Greece is bankrupt. They will need a partial debt default. The EU shouldn’t try to prop up Greece when there is no chance of repayment. They should allow Greece to default, then they should concentrate on strengthening the position of countries like Italy which should be able to repay debt, but may face liquidity constraints (temporary shortage of money due to market fears)
- Growth. the EU and ECB have to see the importance of economic growth. At the moment, the only policy recommendations seem to be spending cuts and austerity, but this is pushing countries into a negative spiral of lower growth, higher unemployment and lower tax revenues.
- ECB should pursue monetary easing. Target a higher inflation rate, pursue quantitative easing. Give peripheral countries some monetary stimulus in face of all the deflationary pressures they face. The ECB have the wrong attitude to inflation. (pursing wrong objective) e.g. faced with the prospect of double-dip recession, they increased interest rates because inflation was temporarily above target.
- Supply-side policies to improve competitiveness and efficiency. Important for economies like Portugal and Greece
The Economist does a good job in offering solutions to crisis Europe’s Crisis
Mervyn King also talks about the need to rebalance the world economy – too much spending in West, too little in the East.