Wednesday, November 30, 2011

Its Time For Ruthless Truth Telling In Eurozone

This Financial Times article argues that it is time for the IMF to make governments in Europe, particularly Germany face the truth. The truth is that the crisis in the eurozone is not the result of fiscal irresponsibility. Therefore, the fiscal integration proposed by Germany is not the solution. It would only create fiscal rules that can be enforced to prevent fiscal irresponsibility in the future. Politically, it is difficult for the German government to propose anything else because much of its public believes that the problem is due to irresponsible southern european governments.

Prior to the crisis the excess savings of households were absorbed by business and by government. They ran deficits that maintained aggregate demand at full employment levels. After the crisis, business spending fell and the business sector is running surpluses instead of deficits. This placed he burden on government to run deficits to absorb the excess savings of households. The problem in the eurozone is a lack of aggregate demand that can no longer be created by governments in Southern Europe Business and household spending must increase in order for aggregate demand to reach the levels required for full employment. That will have to come from countries that are in better fiscal condition. Austerity in the core countries spells disaster for the eurozone.

The IMF does not have the resources to fix the problems in the eurozone. It can deliver the needed message, however, to the leaders responsible for managing the crisis. The question is whether the leaders continue to defer effective actions because they will be politically unpopular. The consequence of refusing to make the hard decisions will be catastrophic.

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