Thursday, December 8, 2011

What's The Short Term and Longer Term Outlook In Europe?

This is one of many analyses of the eurozone crisis and how it will turn out. It has the ring of truth to it. It starts with the premise that leaders now understand the implications of a disorderly collapse. It will result in depression and they will do what is needed to backstop the eurozone to prevent a collapse. This means doing what is needed to protect creditors from defaults that lead to a collapse of the banking system. The ECB will purchase Italian and Spanish bonds to keep interest rates from rising.

It is politically necessary for Germany and the Netherlands to impose fiscal austerity on the nations that require financial assistance. Some proposals are being made that promise a eurozone with more fiscal integration and discipline. This is ultimately unworkable. Raising taxes and reducing public spending in the periphery will increase debt to GDP ratios unless private spending increases to compensate for austerity measures. Moreover, it is unlikely that Germany will be able to enforce fiscal rules on the periphery countries when they get out of line. Essentially the system is unworkable in the long run because convergence will not happen. That is, the periphery will not become more competitive with the core countries by getting a greater return on capital investments than countries that are already capital intensive. The likely outcome is a modified eurozone in which processes are put in place for an orderly exit by countries on the periphery.

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