Today the European Central Bank announced it would not cut interest rates further as many had hoped. Due to the ongoing Eurozone crisis, the ECB is projecting that growth will continue to slow throughout the year. As we discussed in class earlier today, a way to deal with this slowdown potentially could involve cutting interest rates down. This would spur further investment and consumption and would help dig the Eurozone countries out of a recession.
Struggling Eurozone countries seem to be hoping for a further decrease in the interest rate. Since cutting rates causes the euro to depreciate relative to other currencies, this could help spur exports and stimulate local economies further. In the past month's Italian elections, voters turned down austerity measures and budget cuts that were listed on the ballot. Greece has voted similarly in the past as well. Yet Mario Draghi, the ECB head, seems determined for these countries to put their fiscal houses in order in spite of voter sentiment before they receive any other help.
A second interesting article that is worth a read describes the potential benefit to struggling Eurozone countries of a large depreciation of the euro. For most of the Eurozone except Germany, countries are running a negative current accounts balance. A depreciation of the Euro would help these countries to reverse the trend and end current accounts deficits. Although the magnitude of depreciation in the article seems a little unrealistic, it is interesting to see that the ECB refuses to cut interest rates any lower given how much it could help out. Germany must be applying a lot of political pressure to keep them higher.
I don't think they should raise the interest rates higher anytime soon. Although Germany's economy is doing well, there are still too many countries struggling. Spain and Greece have unemployment rates of 25% and 27% respectively. As we discussed in class, Germany is against increased inflation and this NY Times article discusses how the richer countries, like Germany, Finland, and Austria, want out of the EU. The main reason is that they are tired of picking up the tab for the struggling countries (Spain, Greece, Italy) and that they would not have to keep being the competing view against the states that want to keep the interest rates and be able to do things their preferred way.
ReplyDeletehttp://www.nytimes.com/2012/10/07/sunday-review/a-european-union-of-more-nations.html?pagewanted=all&_r=0
One of the interesting points from the reading was the "Philips Curve" principle, that asserts a correlation between high inflation and higher employment, and low inflation with low employment. We know that Germany is rather fond of low inflation, which can be brought on by higher interest rates. It's entirely plausible that higher unemployment could result from higher ECB interest rates as a result.
ReplyDeleteIt's interesting to think about how today's economic climate will affect European presidential elections in the years to come. For example, Mr. Hollande was elected on the promise to revive France's economy and end unemployment, yet that promise has yet to materialize. Part of it is due to France's unfavorable business climate (rigid labor and product market regulation, high taxes and the euro zone’s heaviest social charges on payrolls), yet it also lacks the monetary autonomy to do anything about their interest rates. Although voters may very well be aware of this predicament, general anger about austerity measures and unemployment could manifest itself as votes for the opposition.
ReplyDeleteSince decreasing the interest rate is not an option for the Euro Zone. The guardian article in this post concludes that the only way for these countries (Italy and Spain) to get out of their fiscal deficits is growth. Austerity measures have brought protest to the streets in Italy and Spain. Most of the political contenders running for office are running on the platform of no more austerity. The solution they propose is raising taxes on property owners to fund their budget deficits. The problem with this type of policy is that raising taxes to support current deficit spending and lack of demand in these countries does not encourage new businesses to open in these countries. Your post gives Germany the comparative advantage because of its high productivity relative to other Euro Zone countries, lower wages and ease of doing business. Until these countries work on dismantling policies that inhibit businesses growth the German Economy will continue to have an advantage over its periphery.
ReplyDeleteI agree-without these under-performing countries cutting out some of their (overly high) social services, they are unlikely to grow. And since the populations are obviously against these actions, its difficult for me to believe that will happen any time soon. If I were Germany or Finland, I would give these countries an ultimatum: make concessions or we will leave the Euro zone.
DeleteI think it will take a long time for the Euro zone to recover and get back on the growth path. A lower Euro should help. However, I think it is a mentality that got them where they are today and I do not see that mentality changing for a long time.
ReplyDeleteThe difference that I have noticed between this article and the "Brazil:Interest Rate to Remain All Time Low" is that in Europe, companies are already set up, and technically there is no need to create incentives to investors and entrepreneurs to built a new business, or borrow and risk as much as a developing country. Although with high interest rate Europe may take longer to recover from the Euro Zone Crisis, it seems to be a safer decision by the EU.
ReplyDeleteSome people contend that Austerity is the solution to the debt problems and I would agree that it does cut deficit. The only thing is there is no evidence of any nation instituting Austerity, resulting in growth.So Austerity may reduce debt but at a cost to economic/employment growth. Its here that Keynes would say that the government should spend more and get in more debt to ultimately dig itself out of the hole.
ReplyDeleteGermany is the driving force of the EU and it seems plausible that Germany and the ECB wants to see the struggling Eurozone countries get their fiscal houses in order with austerity measures. Cutting interest rates wouldn't seem to be in the best interest of Germany and the ECB but I would contend that in the long run it is. Cutting interest rates would depreciate the currency further and hurt savings which would seem undesirable to those who are at least decently well off in countries like Germany. But the problem is that the ECB refuses to cut interest rates any lower and the struggling countries can't borrow enough money to generate investment and growth. The Germans and the ECB need to be willing to cut interest rates and have their currency depreciate to try and generate economic growth in the EU. Getting Germany and the ECB to accept this is the difficult challenge.
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