Sunday, October 2, 2011

How To Save Europe

The Baseline Scenario has a neat piece on the Eurozone crisis. The key passage is the following:

Greece and some other countries have serious budget difficulties. But most of the European periphery also faces a current account crisis – something has to be done to increase exports or reduce imports or both. If the exchange rate can’t depreciate, wages won’t be cut, and “fiscal devaluation” proves unworkable, activity in these economies will need to slow down a great deal in order to reduce imports and bring the current account closer to balance – unless you (or the Germans) are willing to extend them large amounts of unconditional credit for the indefinite future.

And as these economies slow down, their ability to pay their government debts will increasingly be called into question.


So, it's a colossal loan or the end of the Euro. Johnson identifies Italy in particular as a problem, since under low growth and high interest rates its debt could grow pretty quickly, and it's already at the upper limit of what's sustainable. But how happy will Germans be to bail out Italy under its current leadership?