The monetary nature of the problem vividly described

For a long time market monetarists have argued that the Fed´s evasive monetary policy is the major force keeping the economy down and out. Keynesians, notably Krugman, argue that the solution requires much more forceful government spending. That´s because, given the extremely low level of interest rates, the economy is in a liquidity trap. That idea follows from a very narrow view of what monetary policy is about (for more on that see this Tim Lee post).

But with regards to the Eurozone, even Krugman acknowledges it´s primary a monetary problem:

So what does ail Europe? The truth is that the story is mostly monetary. By introducing a single currency without the institutions needed to make that currency work, Europe effectively reinvented the defects of the gold standard — defects that played a major role in causing and perpetuating the Great Depression.

In “Silent Movie” I only put up this picture:

It shows a bunch of thirsty people, made so weak that they´re unlikely to make it to the ‘oasis’. And ‘leader Merkel’ appears indifferent to their suffering, indicating that´s the only way to reach ‘nirvana’.

The chart below compares and contrasts two countries, Spain and Sweden. The first is struggling to keep going, despite extreme “thirst”. The other is enjoying the luxury of having plenty of ‘food and water’. One does not enjoy the luxury of having its own ‘reservoir’ from which it can get ‘water’ as needed. The other does.

Some months ago David Beckworth showed a version of the picture below, which I think is the most vivid representation of the cyclical monetary problem (that overlays the structural one associated with single currency flawed monetary system that exists independently).

According to David:

This figure shows that ECB’s failure to stabilize and restore nominal spending to expected levels–as proxied by the 1995-2006 trend–during the crisis as the real culprit behind the Eurozone crisis.  This failure to act has been devastating because it means nominal incomes are far lower than were expected when borrowers took out loans fixed in nominal terms.  European borrowers, both public and private, are therefore not able to pay back their debt and the result is a fiscal crisis.

And how come ‘leader Merkel’ appears so ‘strong and healthy’? As the next chart shows, Germany is well ‘watered’, enjoying a spending level close to the trend that prevailed during 1992 – 2005.

You shouldn´t ask ‘thirsty’ people to stay away from ‘water’ by way of ‘fiscal austerity’. The solution requires that the ECB ‘placate the thirst’ by restoring nominal spending to a level that allows the most affected countries to ‘get up and walk’!


2 thoughts on “The monetary nature of the problem vividly described

  1. Thanks for revisiting the ‘silent movie’ in detail, which screamed the point so loud of course that it just made me angry! Sometimes (macro) economics cannot help but get political and moralistic. But when illustrated such as this, one sees how so much moral posturing is completely beside the point.

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