May 09, 2003

Be Careful: If You Look Into the Abyss

Morgan Stanley's Stephen Roach looks into the abyss that is the western European business cycle conjuncture, and emerges even more frightened and desperate than usual...

Morgan Stanley: ...Therein lies the potential for a serious growth shock to Europe. Lacking in support from domestic demand, a sharply appreciating currency will likely deflate Euroland?s external growth cushion, unmasking the full extent of the weakness that has emerged on the domestic demand front. In that context, and with layoffs and unemployment back on the rise, it is all the more critical for policy makers to apply counter-cyclical stimulus in order to jump-start anemic growth in domestic demand. Unfortunately, those options have all but been closed off by the institutional constraints of the European Monetary Union -- the Growth and Stability Pact, which effectively rules out fiscal expansion, and the backward-looking inflation-targeting mandate of the ECB, which inhibits aggressive monetary ease....

And dramatic change is exactly what?s now in the air. The Federal Reserve said it all with its extraordinary policy statement of May 6: After nearly 18 months of steadfast denial, America?s central bank has finally conceded that the risks are now skewed toward deflation. With most of Asia in deflation and US monetary authorities now sounding the alert, it?s hard to fathom the possibility that a structurally impaired Europe might be spared from this increasingly global phenomenon. If anything, the sharp appreciation of the euro makes the case for Euroland deflation all the more compelling. Yet the ECB's stunning intransigence at its May 8 policy meeting takes the concept of denial to an entirely different level. I believe European policy makers are taking unnecessary risk when they can least afford to do so -- precisely the opposite of what is required to fight deflation. The strictures of EMU are being placed ahead of increasingly worrisome economic perils. Something has to give -- either the economy or an increasingly antiquated policy framework. I vote for the latter. Rules-based policy constraints don't fly in an increasingly deflationary world -- especially if those rules are set with an eye toward fighting the old battle of inflation.

There?s an added twist to this unfortunate state of affairs -- the special problems of Germany. For years, the Europhiles have been telling us to ignore country-specific issues in the new "United States of Europe." Just as Americans don't worry about California, went the logic, Europeans shouldn?t worry about Germany. Never mind that Germany accounted for one-third of Euroland activity -- three times California?s share in the US economy. The model of EMU was built on the pan-regional policy design of "one size fits all." The German experience draws that theoretical presumption into serious question. With Germany's core inflation rate down to 0.8% in March 2003 -- essentially half the Euroland average -- deflationary perils in Europe?s largest economy are considerably greater than is the case elsewhere in the region.

Obviously, it wouldn't take much to push Germany through the deflationary threshold. That push may now be at hand. With the German economy probably contracting in the current quarter and the unemployment rate extraordinarily high (10.7%) and rising, there is every reason to expect further disinflation in this extremely low-inflation economy in the months ahead. A whiff of German deflation could be complicated all the more by the nation's increasingly fragile financial system -- banks and insurance companies, alike. The Japan comparison is no longer a stretch for Germany. And if that's the case, you have to wonder if the rest of Euroland has the capacity to avoid a similar outcome. As I see it, the German experience has revealed a critical and potentially fatal flaw of EMU: Without true economic convergence, it may well be that the big economies in this heterogeneous union have to be treated as special risks. If and when they are judged to be in a state of acute distress, pan-regional policies may need to be tailor-made for the weak link in the chain. The mounting perils of Germany are now screaming out for just such a remedy. Euroland's once proud growth engine has been transformed into the deadweight of an anchor.

Posted by DeLong at May 9, 2003 01:58 PM | TrackBack


This is completely off-topic, but I just noticed that you've been quoted in this week's Economist survey:

"Brad DeLong, an economics professor at the University of California at Berkeley, puts it somewhat more succinctly: I am optimistic about technology, but not about profits."

Too modest to mention it yourself, I presume, as you've almost certainly read the article in question by now.

Posted by: Abiola Lapite on May 9, 2003 04:02 PM

The Economy of God


Deflationary position means you have underutilized resources. Especially pay attention to the males in the 18-30 age group. This is also true of Japan, which will be needed in helping to deal with N. Korea, since China will be very busy in near future balancing its overinvestment in Manuf with Health Services needed to rebuild stable economy. This means you should probably start rebuilding up your armed forces to help in rebuilding effort. AIDS, Africa, SARS, there is much work to be done. Greater investment in UN will be needed from Europe because US is stretched thin.

How's your R+D doing? You may need to put some more in that, to maintain your leadership position in quality manufacturing.

Posted by: nkirsch on May 9, 2003 04:38 PM

The Economy of God

These are problems that can not be solved with consumption of material goods. You have oversupplied the world with things, and not about love and caring for each other.

This is a very dangerous time, and all males in the 18-30 age group SHOULD BE DIRECTED TO A USEFUL PURPOSE, OR THERE COULD BE A DISASTER.

Remember what Roosevelt did: He saved us from Communism by taking young males out of the city to the country to work on bridges, parks, they are beautiful. Unemployed Italian stonemasons helped them build some beautiful bridges here. These men, in their obituaries, recall their service during the Depression, and how much it meant to them.

Posted by: nkirsch on May 9, 2003 05:00 PM

Economy of God

Balance Sheet for the World

Material Goods PPE

Service + R&D/reserved resources(protection of group from disaster)

Accounts must balance. Advance in computer technology/productivity means that less and less of our humanity is a part of each product. When the expansion line suddenly leaps forward, the world must pause and address its problems, and make up for the decreased humanity on the debit side with something on the credit side. The expansion of the debit side, means there must be a deficit on the credit side, with our health problems I guess we have one helluva problem. So everything waits, the stock market- it goes up it goes down, waiting to see what you will do.

Posted by: nkirsch on May 9, 2003 05:34 PM

France Seeks Pension Reform, Confronting Unions

France's social safety net is less safe than ever these days.

By far the most explosive domestic issue in the country is reform of the expensive and generous pension system, a "pay-as-you-go" setup in which today's workers pay for the retirement of the previous generation.

But confronted with the demographic reality of retirees who are living longer and the prospect of waves of baby-boom retirees, the center-right government has decided to confront the unions and try to push through painful reforms in the public sector by the summer....

Posted by: bill on May 10, 2003 02:42 PM


I really can not understand what you are writing. Try simply making points rather than just preaching.

Posted by: dahl on May 10, 2003 02:45 PM

Henny Penny journalism, to quote that nasty man.

Posted by: John Isbell on May 10, 2003 05:06 PM
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