In “What caused the great recession in the Eurozone? What could have avoided it?” Philippe Martin and Thomas Philippon begin thus:
There is a wide disagreement about the nature and cause of the Eurozone crisis. Some see it as driven by fiscal indiscipline, some emphasise excessive private leverage, while others focus on external imbalances, sudden stops, or competitiveness divergence due to fixed exchange rates, as these quotes illustrate:
- Paul de Grauwe (2012): “The situation of Spain is reminiscent of the situation of emerging economies that have to borrow in a foreign currency…they can suddenly be confronted with a ‘sudden stop’ when capital inflows suddenly stop leading to a liquidity crisis”.
- Lorenzo Bini Smaghi (2013): “… countries which lost competitiveness prior to the crisis experienced the lowest growth after the crisis”.
- Hans Werner Sinn (2010): “The lesson to be learned from the crisis is that a currency union needs ironclad budget discipline to avert a boom-and-bust cycle in the first place”.
- Paul Krugman (2012): “… on the eve of the crisis (Spain) had low debt and a budget surplus. Unfortunately, it also had an enormous housing bubble, a bubble made possible in large part by huge loans from German banks to their Spanish counterparts”.
Most observers understand that all these ‘usual suspects’ have played a role and may be interrelated, but do not offer a way to quantify their respective importance. In this context, it is difficult to frame policy prescriptions on macroeconomic policies and on reforms in the Eurozone.
Given the scale of the crisis, understanding the dynamics of the Eurozone is a major challenge for macroeconomics today. We argue that we need a quantitative framework to identify these various mechanisms, their relations and, ultimately, to run counterfactual experiments. This is what we do in a recent paper (Martin and Philippon 2014).
The first chart they put up compares Arizona and Ireland
The employment boom and bust are almost identical up to 2010 but diverge afterwards. This suggests that the fundamental mechanisms at work in both regions were similar up to 2010 but different in later years. We argue that the key difference between Ireland and Arizona is that Arizona did not experience a sudden stop after 2010.
Below, my chart is more grouped and compares unemployment rates in the US and EZ.
Note that the divergence comes about when there was “sudden monetary stop” in the EZ, courtesy of the ECB, at the time headed by Trichet.
And they never consider monetary policy in their counterfactuals! Maybe unemployment would have continued to slowly float down (1), maybe it would go climb a bit (2). But it would almost certainly not skyrocket!
HT Matteo Marini