Column: The money trap

Written by New York Times | Updated: Nov 16 2013, 10:35am hrs
When Greece hit the skids almost four years ago, some analysts (myself included) thought that we might be seeing the beginning of the end for the euro, Europes common currency. Others were more optimistic, believing that tough lovetemporary aid tied to reformwould soon produce recovery. Both camps were wrong. What we actually got was a rolling crisis that never seems to reach any kind of resolution. Every time Europe seems ready to go over the edge, policy makers find a way to avoid complete disaster. But every time there are hints of true recovery, something else goes wrong.

And here we go again. Not long ago, European officials were declaring that the Continent had turned the corner, that market confidence was returning and growth was resuming. But now theres a new source of concern, as the spectre of deflation looms over much of Europe. And the debate over how to respond is turning seriously ugly.

Some background: The European Central Bank or ECB, Europes equivalent of the Federal Reserve, is supposed to keep inflation close to 2%. Why not zero Several reasons, but the most important point right now is that an overall European inflation rate too close to zero would translate into actual deflation in the troubled economies of southern Europe. And deflation has nasty economic side effects, especially in countries already burdened by high debt.

So its a source of great concern that European inflation has started dropping far below target; over the past year, consumer prices rose only 0.7%, while core prices that exclude volatile food and energy costs rose only 0.8%.

Something had to be done, and last week the ECB cut interest rates. As policy decisions go, this had the distinction of being both obviously appropriate and obviously inadequate: Europes economy clearly needs a boost, but the ECBs action will surely make, at best, a marginal difference. Still, it was a move in the right direction.

Yet the move was hugely controversial, both inside and outside the ECB. And the controversy took an ominous form, at least for anyone who remembers Europes terrible history. For arguments over European monetary policy arent just a battle of ideas; increasingly, they sound like a battle of nations, too.

For example, who voted against the rate cut Both German members of the ECB board, joined by the leaders of the Dutch and Austrian central banks. Who, outside the ECB, was harshest in criticising the action German economists, who made a point not just of attacking the substance of the banks action but of emphasising the nationality of Mario Draghi, the banks president, who is Italian. The influential German economist Hans-Werner Sinn declared that Draghi was just trying to give Italy access to low-interest loans. The chief economist of the newsweekly WirtschaftsWoche called the rate cut a diktat from a new Banca dItalia, based in Frankfurt.

Such insinuations are grossly unfair to Draghi, whose efforts to contain the euro crisis have been little short of heroic. Id go so far as to say that the euro probably would have collapsed in 2011 or 2012 without his leadership. But never mind the personalities. Whats scary here is the way this is turning into the Teutons versus the Latins, with the eurowhich was supposed to bring Europe togetherpulling it apart instead.

Whats going on Some of it is national stereotyping: the German public is eternally vigilant against the prospect that those lazy southern Europeans are going to make off with its hard-earned money. But theres also a real issue here. Germans just hate inflation, but if the ECB succeeds in getting average European inflation back up to around 2%, it will push inflation in Germanywhich is booming even as other European nations suffer Depression-like levels of unemploymentsubstantially higher than that, maybe to 3% or more.

This may sound bad, but its how the euro is supposed to work. In fact, its the way it has to work. If youre going to share a currency with other countries, sometimes youre going to have above-average inflation. In the years before the global financial crisis, Germany had low inflation while countries like Spain had relatively high inflation. Now the rules of the game require that the roles be reversed, and the question is whether Germany is prepared to accept those rules. And the answer to that question isnt clear.

The truly sad thing is that, as I said, the euro was supposed to bring Europe together, in ways both substantive and symbolic. It was supposed to encourage closer economic ties, even as it fostered a sense of shared identity. What were getting instead, however, is a climate of anger and disdain on the part of both creditors and debtors. And the end is still nowhere in sight.

Paul Krugman