Monday, December 15, 2008

Paper money and paper tigers

Krugman wants the Germans to play nice:

We start from the proposition that Europe is, or soon will be, in a position where interest rates are up against the zero lower bound. This means both that fiscal policy is the only game in town, and that we can use ordinary multiplier analysis.


You can play with these numbers, but I don’t think that conclusion is very sensitive to the details as long as you keep the large intra-EU trade effects in there. The lesson of this algebra is that there are very large intra-EU externalities in fiscal policy, making coordination really important. And that’s why German obstructionism is such a problem.

Strip away the wonkery, and the bottom line is the Germans, 80 years after hyperinflation, are caught up in Austrian School, "government spending is worse than useless, it's bad" style economics. But. They are locked into the Euro along with everyone else in the EMU. I don't know the intricacies of the EMU bank well enough to be sure, but it seems to me they could force the Germans to play ball by threatening them with their greatest fear: the devaluation of the money supply. Either they go along with fiscal expansion like everyone else, or the rest of the EMU, trying to compensate for (not punish, of course) Germany's recalcitrance, revs up the printing presses. I imagine the Germans would shit saurkraut and brats, swallow hard, and start spending, because from their inflation phobic perspective, it's better than the alternative.

Really, all this makes me wonder how long the EMU will hold together, though. A union that requires constant threats and arm twisting to make it act like a union isn't much of a union. Maybe the Brits et al were right to steer clear. And if they're like this now, with an economic crisis on hand the likes of which we haven't seen in 70 years, how would they be if they had to militarily cooperate? Talk about a paper tiger.