The same sorry tale has now been repeated for the third time: put on a brave face, say you are different, that you have a plan and don’t need help, watch as every passing rumour and data blip sends the cost of your debt spiralling, and then, finally, go cap in hand for a bail-out.
First Greece. Then Ireland. Now Portugal. Europe is engaged in a sort of ‘musical chairs’ game in which in every round the weakest country (more precisely: the one perceived as weakest by the collective ‘wisdom’ of the financial markets) finds itself with no place to sit and has to fall back on the harsh charity of an EU/IMF bailout. The charity is grudgingly provided so as to prevent the loser, in falling, from upsetting all the other chairs on which those still in the game increasingly anxiously sit.
What Europe still has not managed is to change the rules of the game so that either the music does not stop, or there are enough chairs to go around.
Worse, the likelihood that the music will soon stop for a fourth player has just increased substantially: the ECB has today made good on its promise at last month’s rate-setting meeting to begin raising interest rates. It is central bank independence (a sensible basic principle in many ways) gone mad to have the powerful lever of monetary policy thrust in the opposite direction to that required by the most pressing issue of economic policy making in Europe: the need to arrest the sovereign debt crisis. Nor is it justified by inflationary fears. Even if the 25 bp increase is of course small, it sends a strong signal that simply pushes all the key variables in the wrong direction: the exchange rate up, output and inflation (and thus nominal growth) down, unemployment and fiscal deficits up.
Fiscal consolidation measures are necessary (in some countries more than others), but it is sheer masochism or if you prefer: sadism) not to make sure that the framework conditions, and specifically the monetary conditions, are as favourable as possible.
The need for monetary accommodation to underpin fiscal consolidation is a central policy message from the first joint IMK, WIFO, OFCE European economic forecast, also published today (auf deutsch). Amongst many other things the institutes forecast that growth in Germany, while strong in the current year, will weaken markedly to 1.7% in 2012. The economic momentum in Germany has to be set against ongoing contraction in the three countries undergoing bail-outs plus likely stagnation in Spain, leading to a euro area average of 1.5% in both this and the coming year. As previous blog posts have emphasised, this is too little to meaningfully reduce unemployment: the institutes forecast a fall of just 0.3 p.p. to 9.5% in 2012.
I allow myself just one (conditional) forecast: I do not wish it, but if either Spain or Italy (the third and fourth biggest euro area economies) need a bail-out, the music will stop for good and the rules of the game will finally have to be changed.