The Eurozone, Back in Crisis

Anyone who works in international monetary economics is familiar with Dornbusch’s Law: “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought,” the late economist Rudi Dornbusch said in an interview in 1997.

And so it is with the latest euro crisis. Not that long ago, the austerians who dictated macroeconomic policy in the eurozone were strutting around and proclaiming victory on the basis of a modest uptick in growth. Then inflation plunged and the eurozone economy began to sputter – and, perhaps more important, everyone looked at the fundamentals again and realized that the situation remained extremely dire.

Things looked very dire in the summer of 2012, too, and Mario Draghi, the president of the European Central Bank, pulled Europe back from the brink. And maybe, just maybe, he can do it again. But the task looks much harder now.

In 2012, the problem was very high borrowing costs in the eurozone’s periphery, which we now know were driven more by liquidity issues than solvency concerns. That is, the markets basically feared that Spain or Italy might default in the near term because they would literally run out of money – and these fears threatened to turn this scenario into a self-fulfilling prophecy. But all it took to defuse the crisis was three words: “Whatever it takes.” Once the prospect of a cash shortage was taken off the table, the panic quickly subsided. At this point both Spain and Italy have historically low borrowing costs.

What’s happening now, however, is very different. It’s a slower-motion crisis, involving the euro area as a whole, which is sliding into a deflationary trap. Mr. Draghi can try to get traction through quantitative easing, but it’s by no means clear that this would do the trick, even under the best of circumstances. And in reality, he faces severe political constraints on what he can do.

What strikes me, also, is the amount of intellectual confusion that remains. Germany still seems determined to regard the entire crisis as the wages of fiscal irresponsibility, which not only rules out effective fiscal stimulus but hobbles Q.E., since it’s anathema for Germany to consider buying government debt.

And it’s remarkable, too, how the logic of the liquidity trap remains elusive even after six years – six years! – with interest rates at the zero lower bound. Not the worst example, but I read a recent Financial Times column from Reza Moghadam, a vice chairman at Morgan Stanley, who wrote that, “wages and other labor costs are simply too high, even by the standards of rich countries, let alone emerging markets competitors.”

Augh! If it’s external competitiveness you’re worried about, you should depreciate the euro, not cut wages. And cutting wages in a liquidity-trap economy almost surely deepens the slump. How can this not be part of what everyone understands by now?

Europe has surprised many people, myself included, with its resilience. And I do think the Draghi-era E.C.B. has become a major source of strength. But I (and others I talk to) are having an ever-harder time seeing how this ends – or rather, how it ends noncatastrophically.

You may find a story in which Marine Le Pen takes France out of both the euro and the European Union implausible, but what’s your scenario?