"Europe Defends Its Course By Carter Dougherty
Editor’s note: Carter Dougherty, European economic correspondent for The International Herald Tribune and The New York Times, writes with the view from Europe on whether European policy makers have done enough to address the global economic crisis.
Suggesting that the United States has been more active in fighting the financial-turned-economic crisis gets under the skin of European officials. Which is where Paul Krugman finds himself these days.
More stimulus. More central banking. More anything! That seems to be the Krugman message, and it is not hard to understand why, given the gravity of the crisis in the United States.
Things are generally less acute in continental Europe, where the financial system is limping, not sprawled out on the floor as it is in the United States. Combined with generous welfare states to cushion the blow of a downturn, many Europeans have a hard time understanding what the fuss is about.
But Mr. Krugman implied something deeper was at work: that Europe does not have the institutional capacity to make policy in a crisis. Not at the 27-nation European Union. Not at the European Central Bank, which makes monetary policy for 16 of those countries.
In the response below, first published in Italian in the newspaper La Repubblica, Lorenzo Bini Smaghi, a member of the European bank’s executive board, takes aim at this very American view. In his analysis, the Europeans are acting at least as decisively as their American counterparts.
And, he has one other message, repeated sotto voce all over Europe since Sept. 15: We’re not the geniuses who let Lehman Brothers go to the wall.
To the Editor.
In a recent article in The International Herald Tribune, Professor Paul Krugman states that Europe may have made a mistake in adopting the euro 10 years ago. His point, he claims, is corroborated by the euro area’s apparent institutional inability to react to the severe crisis we are facing at present, an inability which, he claims, may have disastrous results.
The claims made in the article are in no way supported by empirical evidence. I don’t want to bother the readers with too many figures and statistics, but we should also avoid gross inaccuracies.
Let’s get the facts straight, starting with the question of fiscal policy, an area in which — according to Krugman — Europe has failed, more so than the United States, to enact an effective recovery policy. This conflicts with recent I.M.F. calculations, which show that the fiscal stimulus in European countries is wholly comparable to that seen in the United States, particularly when taking into account measures to cushion the effect of automatic stabilizers, which, by contrast with the United States, are a major factor in Europe. For instance, for the period 2009-10, discretionary measures adopted in Germany total 3.5 percent of G.D.P., compared with 3.8 percent in the United States. In some European countries, such as Italy, the size of such stimulus measures is relatively limited owing to the high levels of debt, but in other countries the total fiscal stimulus is larger than in the United States.
The perception that more has been done in the United States probably stems from the extensive financial measures adopted in support of the U.S. banking system. It should be pointed out, however, that the U.S. banking system was in greater need of such measures than the European banking system. When overall stimulus measures are considered in relation to the situation, the differences are indeed fairly limited.
As regards monetary policy, the degree of stimulus can be better measured by comparing market interest rates, rather than official interest rates. Such a comparison shows that European rates are more or less in line with those observed in the United States, and are even lower in some cases. For example, 6- and 12-month interbank interest rates in Europe are slightly lower than their U.S. equivalents. Furthermore, real interest rates — i.e. net of inflation — are markedly lower in Europe than in the United States, and retail interest rates on mortgage lending and lending to non-financial corporations are of a comparable magnitude, if not somewhat lower in Europe.
As regards action taken by the central bank, following the initial liquidity injection of in excess of €90 billion in August 2007, the E.C.B.’s balance sheet has steadily grown, increasing by approximately €600 billion to reach a level of 16 percent of G.D.P. (compared with 13 percent of G.D.P. for the U.S. Federal Reserve). There is a major difference, however: the E.C.B. lends to the banking system against collateral, thereby reducing the risks for European taxpayers.
According to Krugman, the fact that the E.C.B. does not have a government behind it which can cover any losses accounts for its being overly cautious. However, this assumption implies that the taxpayer should bear the burden — through inflation — of the difficulties experienced by the banking system. I’m not so sure that this is what U.S. citizens want, and it is certainly not what people in Europe want.
To sum up, Krugman’s argument is that it is better to have only one decision-maker in a crisis, rather than 16 governments which need to coordinate their actions, as is the case in the euro area. In theory, this seems reasonable. But it doesn’t explain how the most fateful decision of all — the decision to allow a systemically important bank to fail in the midst of a financial crisis — was taken by a single decision-maker, while the 16 euro-area governments have managed to avoid making such a large mistake. Neither does it explain how euro area governments have managed to agree on measures aimed at bank recapitalization, at guarantees to bank liabilities and on principles for removing toxic assets from banks’ balance sheets, decisions which have become a point of reference for all the countries of the G20.
Krugman concludes that countries such as Spain would have been better off without the euro. Again, in theory he has a point, since devaluing one’s currency might seem attractive in the current circumstances. In practice, however, when global trade grinds to a halt and the financial market is in distress, the depreciation of a currency can trigger a loss of market confidence in the country, which can further aggravate the economic and financial crisis. This is what happened in Italy in 1992-93, for example. Krugman should travel to those European countries which do not yet have the euro and would really like to introduce it as soon as possible; he would not fail to notice that the reality is very different from textbooks economic theory.
Nobody can claim that Europe is perfect; quite the opposite. We should continue to strengthen economic integration and the coordination of financial and economic policies. We just need to build on what we already have, in particular the euro.
Lorenzo Bini Smaghi
Member of the Executive Board of the European Central Bank"
“Krugman concludes that countries such as Spain would have been better off without the euro. Again, in theory he has a point, since devaluing one’s currency might seem attractive in the current circumstances.”
What he means is that Spain would do it if it could. Since Spain is spending a much larger amount on its stimulus, it will need to be subsidized. Or, as Euro Watch put it:
For example, ECB Executive Board member Lorenzo Bini Smaghi’s recent attempt to argue that Krugman has it wrong, and that (we can manage with what we have) fails stupendously to convince, in my opinion, and especially the extract I reproduce below (which exemplifies precisely the point those who want new achitecture are making).
” For instance, for the period 2009-10, discretionary measures adopted in Germany total 3.5% of GDP, compared with 3.8%in the United States. In some European countries, such as Italy, the size of such stimulus measures is relatively limited owing to the high levels of debt, but in other countries the total fiscal stimulus is larger than in the United States.
The whole issue is that we need a mechanism to average out the stimulus, is that so hard to understand? Is this obscurantism, or simply stupidity?”
“We’re not the geniuses who let Lehman Brothers go to the wall.”
As was pointed out by the Economics Of Contempt:
“Whoa, let’s remember what actually happened. The Fed and the Treasury successfully brokered a private-sector rescue for Lehman, in which Barclays would buy all of Lehman except for $40 billion of commercial real estate assets, which would be acquired by a consortium of major banks. Since Barclays is a British bank, the deal required approval from the UK’s Financial Services Authority (FSA). On Sunday morning, though, the FSA unexpectedly rejected the deal.”
And I added:
One of the attendees, Merrill CEO John A. Thain, 53, took stock of his own company’s best interests and initiated merger talks with Bank of America. Lewis had concluded on Friday that he couldn’t do a deal with Lehman without government backing, which he thought would be forthcoming. After Paulson made it clear to Lewis that a government role wasn’t in the cards, the Bank of America CEO pulled his team out of the Lehman talks.
That left only Barclays, since Nomura told Lehman it was unable to move fast enough. Fuld, who rarely left his office that weekend — working the phones, fielding calls from deputies, talking to Barclays executives — thought he had a deal Saturday night. Barclays was willing to buy Lehman for about $5 a share if it could leave behind the most troublesome assets, the ones Lehman had proposed spinning off into a separate company as well as some others Barclays didn’t want.
Sunday morning brought a false dawn. Geithner and Paulson had talked a syndicate of banks into backstopping the creation of a new entity that would take over $55 billion to $60 billion of Lehman’s problem assets, according to people with knowledge of the negotiations.
Everyone was basking in what seemed a done deal until word came at 11:30 a.m. in New York that the U.K.’s FSA, which regulates that country’s banks, refused to waive normal shareholder-approval requirements or to allow Barclays to guarantee Lehman’s debts until obtaining that approval. The reason, people familiar with the decision say, was that Barclays lacked sufficient capital to absorb Lehman.
“The only reason it didn’t happen,” Leigh Bruce, a Barclays spokesman said today, “is that there was no guarantee from the U.S. government, and a technical stock-exchange rule required prior shareholder approval for us to make a similar guarantee ourselves. We didn’t have that approval, so it wasn’t possible for us to do the deal. No U.K. bank could have done it. It was a technical rule that could not be overcome.”— Don the libertarian Democrat