The Europeans and Stimulus

In response to a question about this comment at The Baseline Scenario: Pay Back Time?

The upcoming G20 meeting threatens to be either raucous or a typically weasel worded non-event. there are huge policy differences between the US/UK and Europe on how to deal with the current crisis. In fact the European response seems to indicate that there is no crisis.

Just this week the Czech leader, who is simultaneously President of the European ‘government’ at the moment criticized the US stimulus package as ‘the road to hell’. There doesn’t seem to be much common ground there.

The Europeans, especially the Germans, are taking a very different tack to solving the problem. This is mainly due to two things: 1] they have a much larger social safety net, so as unemployment rises their government deficit automatically rises, which is a kind of stimulus. 2] their economy is export driven so they can wait fro the US to recover and then allow exports to the US to bring their economy back to life. Europe is in a different political situation also: it has a coordinated monetary policy through the European Central Bank, which is pursuing fairly conservative interest rate policies currently. But fiscal policy remains in the hands of the various member countries of the EU with the major constraint being the treaty obligation not to run government deficits above 3% of GDP – by contrast ours will be well above 8% this year because of the stimulus.

I don’t agree with the European approach of course. I am too much of a Keynesian, and prefer the idea of fiscal stimulus to augment monetary policy. The risk the Europeans are running is that their period of poor growth is very long. Plus they surrender control over its length by being more passive.

I don’t think is ‘payback’ so much as ‘disagreement’. The US has blown a lot of its international credibility over the last few years and so the Europeans feel as if they can assert their own way of doing things. And don’t forget this whole crisis began here: it is our obsession with housing that started the bubble and then the collapse.

Nonetheless the G20 meeting is our next best opportunity to get better regulation over the financial system. Companies like AIG are very difficult to fix without international coordination as the recent fiasco has demonstrated. The Europeans are very keen on getting tighter regulation, so this may be the only bright spot as far as international financial diplomacy is concerned for quite a while. The potential breaking point being the regulation of hedge funds: the Europeans are pressing for very tight regulation whilst both the US and the UK are looking for something less onerous.

Meanwhile the diplomatic air between Europe and the US is decidedly chilled. Which is doubly frustrating since the crisis is international in scope and will take coordinated response to fix quickly.

Let’s hope Obama can work some magic at the G20. Otherwise we are in for a much longer haul than necessary.