How to Solve the Euro Crisis? One Professor’s Ideas
On January 11th and 12th, Dr. Michele Fratianni spoke on the European Debt Crisis in Indianapolis and Bloomington. Dr. Fratianni is Professor Emeritus at the Indiana University Kelley School of Business, as well as a Professor of Economics at the Università Politecnica delle Marche in Italy. His talks focused on the current situation of government finances in the European Union, which was directly related to the major news in Europe that France, Italy, Span, the European Financial Stability Facility (EFSF), and six other countries all saw their credit ratings downgraded over the weekend.
Dr. Fratianni’s first point was that when you examine government debt since the creation of the euro in 2000, Japan, the US, and the UK have all seen their government debt rise much faster than the major countries of the Eurozone. In fact, Italy for instance has actually worked to reduce its government debt by consistently running a primary surplus (i.e. is government spends less than it earns in revenue, excluding debt interest payments). Yet, the Eurozone governments are those which have been attacked the hardest by the markets. Dr. Fratianni’s conclusion is that this is in part due to the fact that the euro is not a “one size fits all” currency, especially without a fiscal system that ties the 17 members together.
The talks then moved on to the high interest rates that the markets are forcing the governments to pay in order to sell their bonds and the current drive towards austerity. Dr. Fratianni’s calculations showed that Italy, Spain, and Ireland would all have to run primary surpluses of around 4% of GDP just to maintain the status quo (it is closer to 14% for Portugal!). This means that these three governments would have collect the equivalent of about four percent of the entire annual economic output of their country and instead of spending it on government services, use it to finance their pre-existing debt burdens. This situation could change if economies started to grow again, but right now that does not seem very likely. (The BBC had a story with a similar conclusion today.)
Clearly, European citizens will not tolerate their governments continually taxing them just to pay off previous debts, so what is to be done? Dr. Fratianni offered many scenarios ranging from bad to worse, but the options that he prefers have to do with freeing the European Central Bank (ECB) to inject money into the market. The ECB is the only European institution with the firepower to get European economies running again, and he believes that a little inflation will help the system. Currently, inflation in the Eurozone is around 2% which is historically very low, but a higher inflation rate would ease the pressure on governments to pay their debts. The logic is very simple—inflation helps debtors as they now have more euros (in absolute terms), while it hurts lenders since they have already loaned a fix amount of euros. Thus, governments would have more euros to pay back a debt that has stayed the same size.
Of course, there are hurdles that would need to be overcome. For instance, the ECB’s mission is to fight inflation and not cause inflation (their movie on the “inflation monster” makes this painfully obvious). In addition, Germany is very opposed to inflation due to their experience with hyperinflation in the 1920s. However, Dr. Fratianni believes that we are reaching the point where the side effects of some inflation are less bad for the Eurozone than the current prescription of austerity.