It’s useful to look at three related but distinct perspectives on why peripheral Europe is in economic crisis. The three perspectives come from the three members of the Troika, so you’d think they’d capture a consensus about why the Troika has to do what it does. And yet.
Consider first the European Commission’s Spring Economic Forecast —
The first quarter of 2013 is likely to have marked the trough of a protracted balance-sheet recession that started at the end of 2011 and is linked to the financial crisis and unsustainable debt levels. The euro area entered its fifth quarter of contraction, while the downturn in the EU was only shortly interrupted in the third quarter of last year. Balance-sheet recessions tend to be characterised by deeper downturns as well as shallower recoveries and are often associated with substantial and permanent output losses.
These sentences refer to Richard Koo for the definitive account of balance sheet recessions. And note also for those of you used to thinking as the global economic crisis as an event unfolding since 2007, the Commission quite clearly dates the recent unpleasantness to 2011.
On now to Mario Draghi at a speech yesterday in Rome
In a second phase [of crisis] beginning in 2011, the lack of credit to the more vulnerable sovereign issuers became the centre point of the crisis.
Finally now to the IMF statement on Greece yesterday —
Looking over the period 2010–2012, the much deeper than expected recession was overwhelmingly due to a progressive loss of confidence, culminating in acute concerns about euro exit, as political uncertainty continued to grow, making it increasingly evident that there was no strong political resolve to stand up to vested interests fiercely opposed to reforms. This led to a dramatic contraction in investments not only through poor sentiment, but directly through deleveraging and an attendant sharp credit contraction.
It should of course be allowed that not all Eurozone crises are like Greece, although the jury is still out on whether Greece is just further along the continuum or contains some unique elements; nevertheless during 2010-11 it was clearly a source of contagion to other peripheral economies funding ability.
So what’s the issue? The European Commission sees a full-on balance sheet recession — public and private deleveraging in the face of debt overhangs. Mario Draghi sees a specific shut-down in credit to sovereigns. And for Greece, the IMF sees all of the above, but fundamentally driven by a paralyzed structural reform process.
Not surprisingly, different interpretations should come with different policies. In classic balance sheet recessions, expansionary fiscal policy is justified, as Richard Koo himself has emphasized. If it’s a dry-up of funding for sovereigns, then the ECB diagnosis and reaction is the most internally consistent: eliminate the extreme risk in sovereign bonds (OMT) and cajole official funders to the table.
But the IMF diagnosis is the most sweeping and potentially radical: the fundamental overhang is not economic or financial, but political. Strictly construed, it suggests that the focus on the pace of fiscal consolidation in program countries is somewhat misplaced. The focus should instead be on the pace of economic reforms, with the more front-loaded the better. Is the EU ready to pursue that logic in the case of the big Eurozone countries currently not in programs but showing similar signs of a stalled structural reform agenda?