Euro Counterfactuals (Wonkish), by Paul Krugman, in NY Times: Via The Irish Economy, a new paper (pdf) from the IMF looks at how, exactly, massive current imbalances emerged within Europe, with Germany running huge surpluses and the GIPSIs running huge deficits.
The paper shows that there were indeed huge capital flows from the European core to the periphery, in Spain largely taking the form of lending to banks, presumably by other banks:
The surprising result in the paper is that much of the rise in imbalances within the euro area involved trade with non-euro nations. Germany sharply increased exports to Asia and Eastern Europe, which had strong demand for German durable manufactures. Meanwhile, southern Europe saw a sharp increase in imports from low-wage countries.
There are two questions this result raises. First, what does it say about the causes of euro imbalances? Second, what does it say about the adjustment now required?
On the first question, should we say that external factors rather than those core-periphery capital flows were responsible for the huge imbalances? I don’t think so. If Spain hadn’t had those capital inflows it wouldn’t have had an economic boom, in fact it would have suffered mild weakness due to those rising imports from Asia, and its wages would have grown less than those in Germany, not more. (And of course if it had still had its own currency it would have seen that currency depreciate). So in a macroeconomic sense I think you still want to say that the excess confidence engendered by the euro caused the imbalances within Europe.
On the second, should we say that internal devaluation is less urgent because external factors had a role in causing the original imbalances? On the contrary, internal devaluation becomes even more necessary – and the size of the relative wage change bigger – if the euro is to survive. Think about it: if secular shifts in trade patterns are responsible, in a proximate sense, for part of Spain’s move into trade deficit and Germany’s move into surplus since 1999, what this says is that even if you get relative wages back to 1999 levels, Spain will still be in deficit and Germany in surplus – so you need to go beyond that point.
Food for thought – and for even more europessimism.