The recent financial and economic crisis has generated a profound divide in the euro area, between debtors and creditors, between those who dictate what others should do and those who should obey the command, creating first and second category countries. To some extent the division is similar to the situation in 1997, when the debate was about which countries already qualified to enter the euro and which countries had to meet certain requirements to become a member of the club. The difference is that now all countries are inside the euro and, therefore, it is equivalent to being in a system of fixed exchange rates but without most of the benefits of belonging to a monetary union.
An effective monetary union requires an insurance mechanism to manage the impact of asymmetric shocks, but German opposition to more monetary stimulus is fierce. The German attitude to minimize the potential cost of monetary union is similar to the current debate about inequality—the obsession with fiscal austerity and inflation risks is explained by the focus of the better off to protect their interests as savers and investors, even if that leads to an increase in the gap between the rich and the poor.
The North-South divide is seen in three key areas. First, the lack of attention to demand policies. Second, the asymmetry in the design and implementation of the rules. And, third, on the insistence on crisis narratives that do not reflect reality.
The lack of attention to demand policies is manifested clearly in excessively high real interest rates (in the euro area as a whole, not in Germany), higher than the United States or the United Kingdom, despite having a much more precarious outlook for growth, unemployment, and inflation. Structural reforms will not work without growth. And it's time to admit, as the European Central Bank (ECB) seems to be finally recognizing, that weak growth dents potential growth, particularly because of persistent long-term unemployment. Not only does supply not create its own demand, but lack of demand generates lack of supply.
The asymmetry in the application of the rules is observed in several respects. On the one hand, the asymmetry in the euro area regulation of excessive imbalances: Current account deficits of more than 3 percent of GDP are penalized, but penalties apply only to current account surpluses of more than 6 percent of GDP. Why? Because, when the rule was created, Germany already had a surplus of more than 3 percent. It is true that an excessive deficit can create more problems than an excessive surplus. But it is also true that the German surplus, now well above 6 percent of GDP, is a reflection of its lack of commitment to the euro.
Despite all the talk about reforms, Germany is one of the euro area countries that has undertaken the fewest structural reforms in recent years, and it refuses to reorient its economy towards stimulating domestic demand and contributing to euro area growth—for example, by liberalizing the service sector and reforming its antiquated banking system to better manage the country's excessive level of savings. On the other hand, the asymmetry in the application of the rules of fiscal and monetary policy is palpable.
There is a constant insistence that all countries must meet the multiple rules that dictate fiscal adjustment, but the ECB is allowed to adopt a monetary policy that violates its mandate to generate stable inflation of close to, but below, 2 percent, making the fiscal adjustment more costly. Why? Because one of the consequences of the ECB aggressively trying to bring euro area inflation back towards 2 percent will be, most likely, that inflation in Germany will have to reach at least 3 percent (as inflation in the countries of the periphery is likely to stagnate at low levels), which will be politically difficult for Germany to accept.
The narratives that are generated after a crisis are critical because they determine the policies adopted to resolve the crisis. Consequently the impact of the crisis persists. The currently accepted narrative is this: The crisis resulted from the lack of competitiveness of the European periphery, and thus the solution is to regain that competitiveness. The example to follow for these countries is Germany, which undertook labor reforms and wage moderation during the decade before the crisis, and as a result now enjoys the best performing economy of the euro area, with low unemployment, a balanced fiscal position, and a large external surplus.
When read like this, the narrative makes sense. The problem is that is not true. Yes, Germany undertook reforms and regained competitiveness through wage moderation. But the key to its external success was not its cost competitiveness, but its success in producing a portfolio of products (mainly capital goods) whose global demand increased exponentially because of the rapid development of the Chinese economy and the rapidly increasing wealth of oil-producing countries (heavy consumers of capital goods).
The key to export success is always demand—unless you really want to compete on price, something impossible for developed countries given the wage levels in China and other emerging markets. Likewise, the key to Germany's economic recovery from the crisis is not its precrisis reforms. Yes, Germany increased the flexibility of its labor market with the reforms introduced by the government of former Chancellor Gerhard Schroeder.
But the key to the rapid German economic recovery has been the great monetary stimulus that it has enjoyed. Real interest rates in Germany have fallen during the crisis as much as in the United States—for all practical purposes, Germany has benefited from quantitative easing. Added to that, the German fiscal adjustment has been less stringent than in periphery countries—especially because falling interest rates have reduced the cost of public debt, thus requiring fewer spending cuts to generate the same fiscal adjustment.
The conclusion is clear: The German economy owes its recent boom mainly to cyclical factors. The boom also results from the fact that Germany has not suffered a housing crisis (but that is a historical accident, as Germany had its housing bust two decades ago). Wage moderation, by itself, does not generate growth. Demand stimulus is critical.
This North-South divide is not sustainable politically. Unfortunately, there are no signs of improvement. The center-right European People's Party (PPE) candidate for president of the European Commission, Jean Claude Juncker, began his campaign in Germany announcing that, if elected, there would be no eurobonds. The mandate of the president of the Commission is to maximize the welfare of the euro area as a whole, not just that of Germany, and it is in the interest of the euro area to create eurobonds, as the Commission has strongly argued. Who will be the leader that will aim to close the North-South divide and move towards a more prosperous euro area?