An Impeccable Disaster
Paul Krugman NY Times Op-Ed: 9/12/2011
On Thursday Jean-Claude Trichet, the president of the
European Central Bank or E.C.B. -- Europe's equivalent
to Ben Bernanke -- lost his sang-froid. In response to a
question about whether the E.C.B. is becoming a "bad
bank" thanks to its purchases of troubled nations'
debt, Mr. Trichet, his voice rising, insisted that his
institution has performed "impeccably, impeccably!" as
a guardian of price stability.
Indeed it has. And that's why the euro is now at risk
Financial turmoil in Europe is no longer a problem of
small, peripheral economies like Greece. What's under
way right now is a full-scale market run on the much
larger economies of Spain and Italy. At this point
countries in crisis account for about a third of the
euro area's G.D.P., so the common European currency
itself is under existential threat.
And all indications are that European leaders are
unwilling even to acknowledge the nature of that
threat, let alone deal with it effectively.
I've complained a lot about the "fiscalization" of
economic discourse here in America, the way in which a
premature focus on budget deficits turned Washington's
attention away from the ongoing jobs disaster. But
we're not unique in that respect, and in fact the
Europeans have been much, much worse.
Listen to many European leaders -- especially, but by no
means only, the Germans -- and you'd think that their
continent's troubles are a simple morality tale of debt
and punishment: Governments borrowed too much, now
they're paying the price, and fiscal austerity is the
Yet this story applies, if at all, to Greece and nobody
else. Spain in particular had a budget surplus and low
debt before the 2008 financial crisis; its fiscal
record, one might say, was impeccable. And while it was
hit hard by the collapse of its housing boom, it's
still a relatively low-debt country, and it's hard to
make the case that the underlying fiscal condition of
Spain's government is worse than that of, say,
So why is Spain -- along with Italy, which has higher
debt but smaller deficits -- in so much trouble? The
answer is that these countries are facing something
very much like a bank run, except that the run is on
their governments rather than, or more accurately as
well as, their financial institutions.
Here's how such a run works: Investors, for whatever
reason, fear that a country will default on its debt.
This makes them unwilling to buy the country's bonds,
or at least not unless offered a very high interest
rate. And the fact that the country must roll its debt
over at high interest rates worsens its fiscal
prospects, making default more likely, so that the
crisis of confidence becomes a self-fulfilling
prophecy. And as it does, it becomes a banking crisis
as well, since a country's banks are normally heavily
invested in government debt.
Now, a country with its own currency, like Britain, can
short-circuit this process: if necessary, the Bank of
England can step in to buy government debt with newly
created money. This might lead to inflation (although
even that is doubtful when the economy is depressed),
but inflation poses a much smaller threat to investors
than outright default. Spain and Italy, however, have
adopted the euro and no longer have their own
currencies. As a result, the threat of a
self-fulfilling crisis is very real -- and interest
rates on Spanish and Italian debt are more than twice
the rate on British debt.
Which brings us back to the impeccable E.C.B.
What Mr. Trichet and his colleagues should be doing
right now is buying up Spanish and Italian debt -- that
is, doing what these countries would be doing for
themselves if they still had their own currencies. In
fact, the E.C.B. started doing just that a few weeks
ago, and produced a temporary respite for those
nations. But the E.C.B. immediately found itself under
severe pressure from the moralizers, who hate the idea
of letting countries off the hook for their alleged
fiscal sins. And the perception that the moralizers
will block any further rescue actions has set off a
renewed market panic.
Adding to the problem is the E.C.B.'s obsession with
maintaining its "impeccable" record on price stability:
at a time when Europe desperately needs a strong
recovery, and modest inflation would actually be
helpful, the bank has instead been tightening money,
trying to head off inflation risks that exist only in
And now it's all coming to a head. We're not talking
about a crisis that will unfold over a year or two;
this thing could come apart in a matter of days. And if
it does, the whole world will suffer.
So will the E.C.B. do what needs to be done -- lend
freely and cut rates? Or will European leaders remain
too focused on punishing debtors to save themselves?
The whole world is watching.
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