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In Europe, a Repudiation of Austerity Policies

Paul Krugman: The European Central Bank’s interest rate cut is a repudiation of the nascent triumphalism of Europe’s austerians.

(Image: HAGEN; Norway / CartoonArts International / The New York Times Syndicate)

The European Central Bank’s rate cut has led to huge tensions, with the executive board split and many German economists protesting. As usual, a lot of the argument is about the perception that those lazy Southern Europeans are getting a free ride.

According to an article published recently in the Financial Times: “A commentary by the chief economist of the financial weekly WirtschaftsWoche called the decision a ‘diktat from a new Banca d’Italia, based in Frankfurt.'” Why can’t those Italians, etc., pull up their socks the way the Germans did?

What Germans — economists as well as the general public — still don’t seem to get is how much Germany’s success at emerging from its late-1990s doldrums depended on a somewhat inflationary boom in southern Europe. And they therefore also don’t realize how much damage Germany is causing by refusing to allow higher inflation in the euro zone.

After the euro’s creation, Germany was able to achieve large gains in competitiveness without deflation because Spain and others were willing to accept inflation that was well above 2 percent. But now the euro zone has an overall core inflation rate below 1 percent, which means that Spain can only achieve internal devaluation through crippling deflation. The Germans, in other words, aren’t asking the Southern Europeans to emulate them. They’re demanding that they accomplish a feat Germany never had to manage, and which hardly anyone has ever managed.

Mario and the Austerians

Just an obvious point that I’m not sure enough people have been making: E.C.B. President Mario Draghi’s surprise interest rate cut is, in effect, a repudiation of the nascent triumphalism of Europe’s austerians. Those who follow these things probably noticed that just a few weeks ago the austerians — European Commissioner Olli Rehn in particular, but many others too — were hailing signs of a bit of economic growth this quarter as vindication of their policies of the past four years.

Yes, it was silly — I mean, I could repeatedly hit myself in the head, then slow the pace of the punishment, and I would start to feel better. Does this mean that hitting myself in the head was good for me? Still, there it was. But then the E.C.B. took a look at more relevant indicators: unemployment that was still rising and core inflation that was dropping below 1 percent (Japan, here we come). And bank officials seem to have gotten very worried. Put it this way: The E.C.B. wouldn’t be slashing rates if it thought Europe had turned the corner.

Weaponized Keynesianism, Historical Edition

I recently wrote about how Europe is doing worse at this point — at least as measured by industrial production, and probably in terms of overall output — than it was during the Great Depression. The response I got from a lot of people was that things were different then, because Europe was rearming.

Um, and your point is? There’s nothing special that makes military spending a better stimulus than other kinds of spending — actually the reverse, because spending on useful stuff can enhance the economy’s long-term potential as well as giving it a short-term boost. So when you attribute European recovery in the 1930s to military spending, you’re saying that what the economy needed back then was expansionary fiscal policy — and it needed it so badly that even destructive spending had a positive effect.

This time around, the good news is that we have peace. The bad news is that Europe’s leaders, lacking the incentive to build up their armies, have listened to prophets of austerity and cut spending when it should have been going up. And the result is a depression that is well on track to growing worse than it was in the 1930s.