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Will Europe save itself?

The concessions announced in the EU summit are insufficient to tackle the crisis.

india Updated: Jul 03, 2012 23:11 IST
Paul Krugman
Paul Krugman

Over the past few months I’ve read a number of optimistic assessments of the prospects for Europe. Oddly, however, none of these assessments argues that Europe’s German-dictated formula of redemption through suffering has any chance of working. Instead, the case for optimism is that failure — in particular, a breakup of the euro — would be a disaster for everyone, including the Germans, and that in the end this prospect will induce European leaders to do whatever it takes to save the situation.

I hope this argument is right. But it comes as something of a shock, even for those of us who have been following the story all along, to realise that more than two years have passed since European leaders committed themselves to their current economic strategy — a strategy based on the notion that fiscal austerity and ‘internal devaluation’ (basically, wage cuts) would solve the problems of debtor nations. In all that time the strategy has produced no success stories.

Meanwhile, the euro’s crisis has metastasised, spreading from Greece to the far larger economies of Spain and Italy, and Europe as a whole is sliding back into recession. Yet the policy prescriptions coming out of Berlin and Frankfurt have hardly changed at all.

But wait, you say — didn’t last week’s summit meeting produce some movement? Yes, it did. Germany gave a little ground, agreeing both to easier lending conditions for Italy and Spain and to a rescue plan for private banks that might make some sense. But these concessions remain tiny compared with the scale of the problems. What would it really take to save Europe’s single currency? The answer, almost surely, would have to involve both large purchases of government bonds by the central bank, and a declared willingness by that central bank to accept a somewhat higher rate of inflation. Even with these policies, much of Europe would face the prospect of years of high unemployment. But at least there would be a visible route to recovery.

Yet it’s really hard to see how such a policy shift could come about.

Part of the problem is the fact that German politicians have spent the past two years telling voters something that isn’t true — namely, that the crisis is all the fault of irresponsible governments in Southern Europe. Here in Spain, now the epicentre of the crisis, the government actually had low debt and budget surpluses on the eve of crisis; if the country is now in crisis, that’s the result of a vast housing bubble that banks all across Europe, very much including the Germans, helped to inflate. But now the false narrative stands in the way of any workable solution.

Yet, misinformed voters aren’t the only problem; even elite European opinion has yet to face up to reality. To read the latest reports from European-based ‘expert’ institutions, like the one released recently by the Bank for International Settlements, is to feel that you’ve entered an alternative universe, one in which neither the lessons of history nor the laws of arithmetic apply — a universe in which austerity would still work if only everyone had faith, and in which everyone can cut spending at the same time without producing a depression.

So will Europe save itself? The stakes are very high, and Europe’s leaders are, by and large, neither evil nor stupid. But the same could be said, believe it or not, about Europe’s leaders in 1914. We can only hope that this time is different.

New York Times

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