Belfast Telegraph

Saturday 29 August 2015

Let's find answer before question changes again

By Brendan Keenan

Published 15/05/2012

The Bundesbank admits Germany could have a future inflation rate above the rest of Europe
The Bundesbank admits Germany could have a future inflation rate above the rest of Europe

The Irish Question was very difficult. Every time the English found the answer, the Irish changed the question."

That's according to comic history book 1066 and All That. And so it is with the Eurozone Question. Every time the Germans come up with the answer, the Club Med changes the question. Now the French and Dutch are doing it, too.

We might even do our own little bit to complicate the question, with a 'No' vote in the referendum, but events are moving too fast for the result to matter much to Europe - although it might still matter to us.

The less humorous description of this process is the "ratchet effect" where a move one refused to make a year before is ineffective made a year later. A bigger one is now required.

The intriguing thing last week was that central bankers, of all people, were leading the way. The media largely treated the speech by Central Bank Governor Patrick Honohan, where he said that, if banks need capital the money should come, not from their home governments, but from the eurozone rescue funds, as if he had come up with this idea himself.

Perhaps he did, in his previous life as an academic economist, but it, and others, have been touted by economists - and even the IMF - for some time, as solutions to the euro crisis. However, they deserved the headlines the got, because they were coming, not from an academic, but from a central bank governor.

Such a scheme would have been awfully useful for the Irish Government, which was forced into the bailout so that it could borrow money to re-capitalise the banks. Now the issue is becoming urgent in Spain, where the government put €4.5bn into the third largest banking group last week.

Estimates of the total capital needs in the Spanish banking system range from €100bn to €250bn. If anything like that upper figure were to land on the Spanish exchequer, it could tip the country into bailout, which would test the whole euro system to its core.

It is not impossible that the European Stability Mechanism (ESM) could be wheeled out to refinance Spanish banks, although that does seem hard to credit (no pun intended). European taxpayers, rather than Spanish ones, would own a chunk of the banking system. The principle established would then apply in theory to German and French banks which, most analysts think, need even more capital than their Spanish counterparts.

Still, something just as hard to credit actually did happen last week. In written evidence to the German parliament, the central bank, the Bundesbank, said: "Germany could in the future have an inflation rate somewhat above the average within the European monetary union."

It's as if the Pope had ceased to be a Catholic. The whole point has always been that Germany should have lower than average inflation. The statement is an acknowledgment that less competitive countries in the single currency cannot be expected to restore competitiveness if Germany tries to keep its own inflation below 2%, which is the eurozone target for the average.

German exports hit a record in March, even though global conditions are weak. It is not easy to sell the idea that your country should sell less abroad and buy more, even though that would increase domestic living standards.

It is even harder in Germany, where domestic living standards have long taken second place to financial and economic stability, but preferable, as Chancellor Merkel said, to more government borrowing.

The opposition social democrats have taken the view for some time that Germans should permit themselves more consumption. Today's election in the largest state, North Rhine Westphalia, may show that many voters agree with them.

This may all be a sign that the dangers of the ratchet effect are being recognised. Previous "solutions" to euro crises were the minimum which could stave off disaster, but each one had to be bolder than the last as disaster loomed again.

Each potential disaster is also more threatening than the last. It would have cost relatively little to re-capitalise Greek, Irish and Portuguese banks, and share the burden of debt through "federal" bonds. Such a "firewall" might have made a Spanish or Italian crisis less likely - but only if they were committed to budget discipline and structural reform.

Something like the fiscal treaty has to come first. It should have come earlier, but better late than never, provided the other side of the ledger is also going to be dealt with.

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