Private Sector


What next for the eurozone? Macroeconomic policy and the recession

18 April 2013 | Minutes

Please note that the powerpoint presentations and video of this event are available on the CEPR website. Note that the below are Bretton Woods Project’s summaries of the discussion, not the speeches of the participants.


Jo-Marie Griesgraber, New Rules
Prakash Loungani, IMF Research Department
Mark Weisbrot, CEPR

Prakash Loungani

The outlook remains dire. Currently unemployment rates are not pretty, with a few exceptions. Changes in unemployment rates since the start of the crisis it is almost uniformly increasing, e.g. Spain over 15% increase, also with Greece. The ITUC report Frontlines tells the story of how many people’s lives are being ripped apart through the job loss. The paper I co-wrote with the ILO documented what was known prior to the great recession.

Is this unemployment merely cyclical, or is it a reflection of structural problems? The IMF’s overall view tends to believe that European unemployment is largely cyclical, which makes logical sense when you examine the change in unemployment dynamics – as it’s hard to imagine that the 2007 massive increase could be accounted for by a sudden structural problem, irrespective of what you may believe about structural problems in the labour markets. This has been stated both in management speeches and subsequent World Economic Outlooks. The problem is therefore of inadequate demand, though other factors can be stressed, e.g. the argument that labour market institutions impede reallocation of jobs and labour.

Therefore the unemployment level during the great recession was due to an initial increase in cyclical rather than structural, which largely remains true. This is based on a number of observations, including the fact that the relative proportion of vacancies and job-seekers remains stable, usually a very strong sign of cyclical rather than structural unemployment phenomena. Other parallel measures of mismatch reinforce this interpretation. Finally, the lack of deflationary pressure – often used to argue that unemployment levels are close to their ‘natural rate’ – is not borne out. Note the chapter 3 in the latest WEO: Ch. 3 The dog that didn’t bark which assesses this and reflects the stability of inflation expectations which have built up over the last decade and a half.

This also implies that jobs will return if growth returns – work I’ve done with co-authors has also suggested this expectation. IMF advice on labour markets has been framed by this analysis, and has led to encouragement of especially rich northern countries to avoid frontloading cuts or austerity and to focus on targeted interventions, to help some vulnerable groups, to extend unemployment benefits (with some exceptions), and we have advocated moving away from duality with workers being hired on temporary contracts, rather than permanent. We do believe that there are countries which have had to seek to restore competitiveness, though we suggest it should occur via national tripartite agreements, though this has often not been the case leading to very high human costs, such as the huge increases in unemployment rates with tragic consequences.

Mark Weisbrot

There really isn’t much of a debate, and perhaps we have some arguments over policy. Until the final component, of what the IMF has actually emphasised or implemented. The emphasis of Prakash on human impacts of employment is welcome.

I want to focus on policy mistakes that led to this situation.

The conventional wisdom that what has occurred is a debt crisis, and hence the focus on deficit reduction is flawed – what most of us know is that this was not a debt crisis, but rather it was a private sector crisis underpinned by bubble growth.  This shows up in current account balance dynamics, e.g. the favourable position of Spain vis-à-vis Germany. Spain and Ireland ran fiscal surpluses.

The depth of European recession results from pro-cyclical policy, despite this we have in Europe much stronger unions, socialist parties and well-developed welfare states yet they have far more right wing fiscal and monetary policy, so why the discrepancy in policy and outcome.

Why? The central bank and Troika, which of course includes the IMF signing off, have caused this mess by forcing procyclical policies in the Eurozone area. E.g. Greece’s structural balance was reduced by 18.7% – imagine the depression that an equivalent $2.9 trillion cut would lead to in the US! Real GDP projections in Greece have consistently overshot. Interestingly, would a Greek euro exit have been more painful than this – almost certainly not. The strategy imposed in absence of euro exit is internal devaluation, to push down real effective exchange rates, but these have failed to fall sufficiently to pull the economy out of recession, e.g. to provoke an export boom, especially given the massive losses in aggregate demand which resulted from the fiscal tightening and spending cuts. That notwithstanding the decision to reduce the interest burden on Greece is a step in the right direction. Recall the degree of impact on world GDP growth that Europe represents, though not entirely to blame it has certainly played a part.

So what is occurring? The Troika sees the crisis to re-write the European social contract – at any point in the last three years the Troika, via the ECB, could have put an end to the crisis through addressing the increasing interest costs in Italy and Spain – but they elected instead to force through changes which democracies would never have voted for. This has been stated publicly by senior ECB officials, such as Jorg Asmussen, who argued in September that reform had to be used to put pressure for reform.

This contradicts some of what Prakash has said, as in our paper which examined numerous article IV consultations, which showed a consistent pattern of procyclical advice which focused on reducing social protections, reducing labour’s share of national income, possibly increase poverty, social exclusion, and social inequality.

Recent history shows that the last three years demonstrate recurring crises, leading the Troika to move to do something that they did not want to do. The truth is that a very small amount of money could have resolved the crisis in 2010 but choosing not to do so led to a policy error of gigantic proportions. A central bank which is even a little bit accountable to the general public, as in the US, is a key difference to the ECB – which at every single point and with the need for very little money to overpower sovereign bond markets, but they chose not to do so.

There are alternatives to this. The ECB could allow for expansionary fiscal policy in Greece and the Eurozone, note that the ECB has created similar amount of money as the Fed, but almost none of it went to the public sector, very little. In the US it was used for QE to depress interest rates, and in order to give the government fiscal space which it has not used.

One option = the Argentine – is default and exit, a commonly misunderstood success story. E.g. they had only one quarter of continued recession, followed by rapid growth, with pre-crisis GDP achieved within GDP, it also allowed a two third reduction in poverty and extreme poverty – it also enabled large increases in social spending and reduced inequality – a huge success up until at least the beginning of the world recession. Misunderstandings include the fact that Argentine growth was not a commodities boom, in fact it was not even export led, rather than being in any way a devaluation led recovery it was the capacity to increase domestic consumption and investment – plus the return of much capital that had fled – the key was therefore policy shifting from procyclical to pro-growth. Note also that Greece has twice as big an export sector, more potential sources of borrowing and a more developed banking system, so it would start in a better position.


When Draghi made the statement which was interpreted as a commitment to stabilise Italian and Spanish bond rates, which succeeded in ending the acute aspect of the crisis. The US with its own central bank and currency, unlike in the Eurozone where citizens have lost democratic input and unfortunately they gave the power over their economy to the wrong people and the wrong institutions, who had a whole different agenda – shown when the need to change course emerged. These groups have not been interested in reversing recession, but rather to force unpopular economic reforms.

My disclaimer about the IMF is that as the subordinate partner in the Troika, hence I would say that they’re not really the most responsible for European policies, ultimately European governors and directors on the board are more responsible. On the other hand, they do sign off on this stuff which doesn’t indicate a particularly good track record.  Our independent central bank in the US is nonetheless accountable, and can suffer pressure of others, e.g. the audit, which requires the Fed to think about its relative unpopularity.

Thus the European crisis is stuck due to the lack of a credible threat to leave the Euro – lack of democracy is key, and without the threat it remains impossible to be anything but subject to Troika decisions, thus high unemployment and needless suffering will continue for many years or until the Troika is forced to retreat.