The euro crisis: The non-puzzle of peripheral pain | The Economist - 0 views
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Mystery mostly solved, then; the rich periphery's riches relative to Germany were largely a short-run phenomenon driven by a dramatic short-run divergence in house price trends.
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Investors who bet that productivity growth would be much faster in the south were wrong.* All the prices and wages set on the basis of the expectation of faster productivity growth were correspondingly wrong and needed to adjust. Real effective exchange rates were badly out of alignment.
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Two things began happening in the euro zone in 2007. Growth in the number of euros spent every year began slowing, and the distribution of euro spending within the euro area began shifting back northward.
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The picture is one in which there are many fewer euros floating around the euro area than markets expected a half decade ago, and the distribution of those euros is moving northward.
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It seems reasonable to argue that the distributional shift needed to occur, given the actual productivity performance. The overall slowdown in euro spending growth, however, looks like an unnecessary and painful complication to adjustment.
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This has all been the result of the commitment to keep just one euro. But that commitment is painful, and the alternative—more than one euro—is looking more attractive.
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Where prices were rigid, as in goods and labour markets, fewer euros meant slow disinflation but rapid contraction in output and a big rise in unemployment.
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If there had been no single currency, the northward capital flight would have depreciated peripheral currencies. Had the periphery borrowed in its own currency, that would have imposed losses on its foreign creditors while also boosting its export industry. Had peripheral economies instead borrowed in dollars or deutschmarks their debt burdens would have ballooned with depreciation, potentially pushing banks and sovereigns into default—but the depreciation boost to competitiveness would have remained. Either way, the depreciation of the currency would effectively shrink the value of wealth in the periphery.
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Where prices were more flexible, as in asset markets, price adjustment was quick. Over the past two years, Spanish equities have fallen 24%, while German equities are up 8%.
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The northward euro shift had two nasty effects, then: it shrank asset values while also (via wage rigidity) creating substantial unemployment.
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as markets observed the periphery's reduced ability to pay off its debts, they moved their euros northward even faster
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For the periphery to raise its external surplus (necessary in order to service its large and growing debts) it must rely much more on import compression than on export growth.