The Eurozone Crisis Is Not About Market Discipline

December 19, 2011

Dean Baker
Al Jazeera English, December 19, 2011

See article on original website

The people who gave us the eurozone crisis are working 24-7 to redefine it so they will be able to profit from it politically. They are running editorials as news stories in media outlets everywhere claiming that the euro crisis is a story of profligate governments being reined in by the bond market. This is what is known in economics as a “lie.”

The eurozone crisis is most definitely not a story of countries with out-of-control spending getting their comeuppance in the bond market. Prior to the economic collapse in 2008 the only country that had a serious deficit problem was Greece. In the other countries now having trouble financing their debt, the debt-to-GDP ratio was stable or falling prior. Spain and Ireland were actually running budget surpluses and had debt-to-GDP ratios that were among the lowest in the OECD.    

The crisis changed everything. It threw the whole continent into a severe recession. This had the effect of causing deficits to explode since tax revenues plummet when the economy contracts and payments for unemployment benefits and other transfer programs soar. Spain was especially hard hit by this contraction because it had a huge housing bubble. This bubble fueled an enormous construction boom that went bust after the crash.

Ireland saw its debt explode because it got stuck with a huge bill from bailing out its free-wheeling bankers. It is possible that its financial system could have been kept in tack at a lower cost to taxpayers by forcing creditors to take losses, but in any case this is not the classic story of profligate government spending. Other governments in the region have also incurred debts to bail out banks that got themselves in trouble with reckless lending.

The story here is of the incredible failure of the European Central Bank (ECB) to take any steps to rein in the housing bubbles across Europe before they grew so large that their inevitable collapse would lead to economic wreckage across the continent. This failure might make a good argument for punishing the ECB (maybe the pensions of their senior staff should be slashed), but this is absolutely not a story of government profligacy.

Even after the collapse, the ECB has exacerbated the debt problem with its wrongheaded policies. The ECB could end the debt crisis at any time by acting as a lender of last resort, as central banks are supposed to do in a crisis. This would mean making a commitment to guarantee the bonds of the heavily indebted countries. That would immediately end the runs that Spain and Italy and now other countries are seeing on their debt.

Expecting positive actions from the ECB to end the crisis might be asking too much from this institution, but at least it should not be taking measures that actively make the crisis worse. For example, in the spring, it raised its overnight lending rate from 1.0 percent to 1.5 percent, ostensibly to counter concerns about inflation.

While the Fed has kept the overnight lending rate at zero since the early days of the crisis, the ECB has never allowed the rate to go below 1.0 percent. To lower long-term interest rates, the Fed has bought up close to $3 trillion worth of government bonds. The ECB bond purchases have been an order of magnitude lower. The dampening impact of the ECB’s policies on growth worsens the debt situation of governments across Europe.

Furthermore the ECB’s commitment to capping eurozone inflation at 2.0 percent makes it almost impossible for the southern European countries to regain competitiveness. They would have to see years of deflation for their economies to again be able to compete with Germany and other northern European countries.

In short the crisis of the Italy, Spain and other heavily indebted countries is absolutely not a story of the market disciplining profligate countries. It is a story of countries who have been victimized by the mismanagement of the ECB.

To claim that is just a case of the bond market exerting its discipline would be like saying that a sailor who died of thirst and starvation after pirates tore up his sail, smashed his motor, and stole his lifeboat was just a victim of the sea. It is only because the ECB pirates have wrecked these nations’ economies that they are now so vulnerable to the vicissitudes of the bond market.

People should recognize this process for what it is: class war. The wealthy are using their control of the ECB to dismantle welfare state protections that enjoy enormous public support.

This applies not only to government programs like public pensions and health care, but also to labor market regulations that protect workers against dismissal without cause. And of course the longstanding foes of Social Security and Medicare in the United States are anxious to twist the facts to use the eurozone crisis to help their class war agenda here.

The claim that the countries in Europe are just coming to grips with the reality of modern financial markets is covering up for the class war being waged on workers across the globe. The assertion that this crisis is about market discipline should not appear in a serious newspaper, except on the right side of the opinion page.

Support Cepr


If you value CEPR's work, support us by making a financial contribution.

Si valora el trabajo de CEPR, apóyenos haciendo una contribución financiera.

Donate Apóyanos

Keep up with our latest news