Summers avoids difficult question of imbalances

Sir, Lawrence Summers is certainly correct in asserting that the right focus of the European countries must be on restoring economic growth if they are to restore fiscal sustainability (“Growth not austerity is the best remedy for Europe”, April 30). However, he is mistaken in thinking that all that is required to restore European economic growth is a lesser emphasis on fiscal austerity in the periphery and expansionary fiscal policies in Germany.

Prof Summers bases his recommendations on the over-simplistic assessment that Europe’s problem countries are in trouble because the financial crisis under way since 2008 has damaged their financial systems and led to a collapse in economic growth. In so doing, he totally overlooks the mother of all housing bubbles in Ireland and Spain between 2000 and 2009, whose bursting has both given rise to large public finance imbalances and constituted a significant headwind to economic growth in those countries. He also totally overlooks the cumulative loss in international price and wage competitiveness of between 15 and 20 percentage points in Greece, Portugal, and Spain, which gave rise to serious external imbalances in those countries.

Against the backdrop of still very high budget deficits and rapidly growing public debt levels in Greece, Ireland, Portugal, and Spain, it is heroic for Prof Summers to presume that markets would be forgiving of countries that backed off on efforts at budget consolidation. It would seem very much more likely that any backing off on fiscal consolidation would only validate the market’s fears that the European periphery was engaged in a Ponzi scheme with its public finances that justified even higher interest rates for those countries’ sovereigns.

In recent statements, Mario Monti, the Italian prime minister, has reminded us that, while salutary for longer-term growth performance, most structural reform policies have a short-term negative impact on aggregate demand. This has to raise the uncomfortable question Prof Summers chooses not to address as to whether reducing the large public sector imbalances in the European periphery is compatible with their remaining within the euro straitjacket that precludes them from resorting to devaluation as a means to stimulate export growth.

Desmond Lachman is a Resident Fellow at AEI.

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