Mitos e factos sobre a austeridade

Simon Wren-Lewis perdeu algum tempo a escrever uma série de posts sobre a percepção e a realidade da macroeconomia da austeridade. Ao todo são oito entradas, resumidas em Mediamacro myths. Num registo menos técnico, Paul Krugman escreveu no Guardian uma anatomia da política orçamental dos últimos cinco anos: The austerity delusion. Vale a pena ler os dois – e ter cuidado para distinguir os argumentos que valem para com acesso ao mercado dos argumentos que se aplicam a países como Portugal.

The story presented in much of the UK media is simple and intuitive. The previous government messed up: they spent too much, and it left the UK economy on the brink of financial meltdown. The coalition came to the rescue: clearing up the mess was tough at first, but now it is all coming good.

AIn previous posts I have shown that this is almost complete fiction. The increase in the government’s budget deficit under Labour was all about the recession, which in turn was created by the global financial crisis. There was no prospect of a UK financial crisis in 2010, which meant that austerity was not something the government was forced to undertake. Reducing the deficit could have been left until the recovery was secure (and crucially interest rates had risen above their lower bound), but the coalition chose to do otherwise. As a result they delayed the recovery by three years, at great cost. Even since 2013 we have simply seen a return to normal growth rates: there has been no catching up of lost ground. In that sense growth under the coalition hardly deserves the term recovery, and we have seen an unprecedented lack of growth in living standards. Productivity growth has been non-existent, yet the government has feted the employment growth that is its counterpart.

Por que não helicopter money?

Na verdade, já houve uma entrada mais lá em baixo acerca do tema (Dinheiro de helicóptero), mas acho que esta acrescenta mais um pouco. Helicopter money and the government of central bank nightmares (Simon Wren-Lewis).

Here it is perhaps easiest to talk about monetary policy as putting money into the system when inflation is too low or taking it out when inflation is too high. QE creates money when interest rates are at their Zero Lower Bound (ZLB), but that money can be taken out of the system later if need be by selling the assets that QE buys. Helicopter money also puts money into the system at the ZLB, in a much more effective way than QE, but it cannot be put into reverse by central banks alone. The central bank cannot demand we pay helicopter money back.

If the government cooperates, this is no problem. The government just ‘recapitalises’ the central bank, by either raising taxes or selling more of its own debt. Economists call this ‘fiscal backing’ for the central bank. In either case, the government is taking money out of the system on the central bank’s behalf. So the nightmare that makes helicopter money taboo is that the government refuses to do this.

What kind of government would this be? Inflation is rising, and the institution tasked with bringing it back under control makes a request that can be satisfied fairly painlessly by the government issuing some more debt. A government that refuses to do this is saying very publicly that it no longer cares about high inflation: it prefers an environment of low interest rates and high inflation and it is prepared to cripple its central bank to achieve this.

Now imagine a government with these preferences, and now put it in a world where the ICB does not need recapitalising and is selling assets and raising interest rates to do its job. Are we really meant to believe that such a government would ignore its preferences and let the central bank get on with it? Of course it would not – it would take away the central bank’s independence by forcing it to stop raising interest rates.

In other words, a government that would refuse to recapitalise an ICB is also a government that would have no hesitation in ending central bank independence. Holding assets is no protection for an ICB against this government of its nightmares. [2]

The reason we have independent central banks is not to stop us becoming like Zimbabwe. It is to stop governments taking small risks with inflation for short term political gain. Like the occasion I was told that the Chancellor (at the time) knew full well that interest rates needed to rise now to reduce inflation, but there was no way that would happen until after the party conference. But this kind of government is not the kind that would deliberately sabotage its own central bank by refusing a request for recapitalisation.

Precisamos mesmo de uma união política para salvar o euro?

Já todos ouvimos dizer que uma união monetária sem uma união política está condenada (veja-se a Zona Euro). Será mesmo assim? António Fatas argumenta em Financial crisis, the euro and the need to political union que essa conclusão não é nada óbvia, e que a crise recente da Zona Euro não tem directamente a ver com a falta de um orçamento comum. Vale a pena ler (e, se gostarem, reler o velhinho Is a monetary union without a fiscal union doomed?).

There are plenty of example where the European Union (EU) requires some serious political consensus: the EU requires partial transfers of sovereignty to a supranational authority when it comes to legislation, the EU has economic mechanisms that imply a significant transfer of income across countries (via its budget, the structural and cohesion funds). Then why is it that the EU does not require to be backed by a political union in the same way the Euro project does?

(…)

The euro facilitated flows across countries as exchange rate risks had disappeared and provided the illusion of no risk. Second, once the flows had taken place it created financial links between banks and governments across countries that made them exposed to the same risk. In addition, the ECB because its connections with banks became a central repository of that risk and a solution for some of the countries facing a credit crunch — the ECB acted like the IMF in many ways.

None of this is exactly about monetary policy, even if the ECB is involved. This is about financial risk and how financial crises have painful economic consequences. When sharing a currency the risk of financial crisis and its potential solutions bring countries and governments together in a way that a political consensus seems to be necessary because transfers might be involved and because common political solutions need to be found. And while these transfers might be smaller than the ones agreed as part of the Social and Cohesion Funds of the European Union, they come as a surprise and they are uncertain (we cannot agree ex-ante on their final size). This is what makes the Euro project a much more difficult one to manage without a sense that we all belong to the same group and are willing to work on this together.

For many, the Euro was one of the projects within the much bigger ambition behind the European Union (which came with the idea of a partial political union). But the recent financial crisis has shown that the risks associated to sharing a currency when financial and sovereign crises are possible, are a lot larger than what we thought. And these risks are much larger than the risks associated to simply sharing the same currency and the same monetary policy (yes, one interest rate does not fit all but this is not the real issue this time).

O saldo primário grego

Um post que vale a pena de Simon Wren-Lewis: Greece and primary surpluses. A ideia fundamental é que o saldo primário real da Grécia – isto é, o saldo ajustado à posição cíclica da economia – já está nuns impressionantes 7,6%. Isto devia ser mais do que suficiente para reduzir rapidamente o stock de dívida mesmo com estímulos orçamentais, porque o impacto negativo destes estímulos seria mais do que compensado pela convergência do saldo primário para o seu valor estrutural.

Não deveria ser muito difícil convencer a Troika da razoabilidade desta alternativa – este é o caso clássico de um bloqueio cognitivo condenado a desaparecer mais cedo ou mais tarde. Infelizmente, o “factor Syriza” pode ter criado bloqueios de natureza diferente: falta de confiança entre as partes e o receio de que o financiamento internacional não seja utilizado para suavizar a consolidação mas para a adiar ad infinitum.

2009 was the peak underlying primary deficit, and it was huge, representing the actions of a truly profligate government. However what followed was complete cold turkey: within two years the underlying primary balance was close to zero. A pretty conservative estimate for the impact of fiscal consolidation would reduce GDP by 1% for each 1% of GDP reduction in the primary balance. In those terms, all of the current output gap in Greece can be explained by austerity.

As I have always said, some period involving a negative output gap was inevitable because Greece had to regain the competitiveness it lost as a result of the previous boom fuelled by fiscal profligacy. But slow gradual adjustment is more efficient than cold turkey. Paul Krugman explains one reason for this: resistance to nominal wage cuts. But there is another which is even more conventional. If we have a Phillips curve where inflation expectations are endogenous (either through rational or adaptive expectations) rather than anchored to some inflation target (as Paul implicitly assumes), then competitiveness adjustment can be achieved with a much lower cost in terms of the cumulated output gap if it is done slowly. (I gave an example here, then reacting to the idea that Latvia’s cold turkey adjustment had been a success.)

There are only two serious barriers to this more efficient adjustment path. The first is the willingness of some outside body to provide the loans to fund the gradual reduction in the government’s deficit. The second is getting those outside bodies to recognise this basic macro: austerity hits output, and gradual adjustment is better. I think the second turned out to be the crucial problem with Greece: as has been extensively documented, the Troika were hopelessly optimistic about the impact cold turkey would have.

Ganância ou ignorância

Getting the german argument right, por Simon Wren-Lews. O autor toca num ponto importante, que tentei explicar aqui: estímulos monetários e/ou orçamentais a nível europeu não são um ‘mal menor’ ao qual a Alemanha deva fechar os olhos – são algo em que os  próprios germânicos têm interesse. A partir do momento em que se percebe que o realinhamento de competitividade é uma realidade, a única opção que temos é decidir se o ajustamento se faz através de inflação acima da meta na Alemanha ou via recessão e deflação na periferia. Desse ponto de vista, a posição da Alemanha é muito mais o resultado da ignorância do que da ganância.

The problem with the second argument is twofold. First, it tunes in with the popular sentiment in Germany that the country is yet again being asked to ‘bail out’ its Eurozone neighbours. Second, it implicitly suggests that the current German macroeconomic position is appropriate, but that Germany must move away from this position for the sake of the Eurozone as a whole. The obvious German response is to list all the reasons why their economy is currently on track (see, for example, Otmar Issing in the FT recently), and suggest therefore that other countries should look at their own policies for salvation. This is how we end up needlessly discussing structural reforms in France, Italy and so on.

The uncomfortable truth for Germany, which both the previous arguments can miss, is that the appropriate macroeconomic position for Germany at the moment is a boom, with inflation running well above 2%. The current competitiveness misalignment is a result of low nominal wage growth in Germany over the 2000 to 2007 period, which was in effect (and perhaps unintentionally) a beggar my neighbour policy with respect to the rest of the Eurozone. Germany’s current position is unsustainable, as its huge current account surplus and relative cyclical position shows. It will be corrected by undoing what happened from 2000 to 2007. Over the next five or ten years, German inflation will exceed the Eurozone average until its long term relative competitive position is restored.

The only choice is how this happens. From the perspective of the Eurozone as a whole, the efficient solution would be above 2% inflation in Germany, and below 2% inflation elsewhere. That is what would happen if the ECB was able to do its job, and Germany would get no choice in the matter. Normally above 2% inflation in Germany would require a boom (a positive output gap), but if it can be achieved without that fine, although I would note that current German inflation is only 0.8%. Arguments that point to currently low unemployment and a zero output gap in Germany are therefore irrelevant while German inflation is so low. The inefficient alternative solution is for 2% or less inflation in Germany, and actual or near deflation outside. Why is this solution inefficient? Because to get inflation that low outside Germany requires the Eurozone recession we are now experiencing

This is where structural reforms enter. Many German commentators say ‘why cannot other countries do what we did from 2000 to 2007’? But low nominal wage growth in Germany from 2000 to 2007 was accompanied by a recession in Germany! Furthermore, that recession was not so bad as the current Eurozone position, because the ECB was able to do its job and cut interest rates, so inflation outside Germany was above 2%. So from 2000 to 2007 many countries had to experience above target inflation because of low nominal wage growth in Germany, [2] yet many in Germany want to avoid above target inflation while imbalances are corrected.

If your starting point is what happened in Germany from 2000 to 2007, then current German arguments can look incredibly self-centred. They seem to say: we suffered a recession from 2000 to 2007 which led to a beggar my neighbour outcome, now you have to suffer a worse recession to put right the problem we created. But as I have argued before, and which comments on my recent posts and readings confirm, I think the German position is more about ignorance than greed. I also suspect there is a great deal of macroeconomic ignorance outside Germany as well, which is why Germany has been able to impose a recession on the rest of the Eurozone. Take for example this paper by Michael Miebach, who speaks from the left of centre in Germany.

Miebach presents a wide range of macroeconomic fallacies or irrelevant arguments. Germany’s fiscal position is not good (irrelevant in a liquidity trap), its macroeconomic position is not too bad (when it should have above 2% inflation, which probably requires a boom), fiscal expansion in Germany would have only a small impact on the periphery (but what we should be talking about is fiscal expansion in all the main Eurozone economies, which this paper confirms would help the periphery as well as France, Italy etc, and expansion in Germany would benefit countries like the Netherlands), and the old canard about how focusing on demand distracts attention from dealing with structural weaknesses in the Eurozone. But most revealingly we have this.

Taxas de juro artificialmente baixas

Uma reflexão interessante de Paul Krugman sobre a ideia de que as taxas de juro estão artificialmente baixas devido à acção dos bancos centrais: Knutty asset prices (nota para curiosos: o post vem na sequência de um paper do Bank of International Settlements a defender a subida das taxas de juro por motivos macroprudenciais. Sobre isto, ler também not Knut e The financial instability argument for raising interest rates).

Quite a few people — including a lot of people on Wall Street, at the BIS, and so on — look at this and say that it’s terrible: the Fed is keeping interest rates “artificially low” and thereby distorting asset prices across the board, and it will all end in grief.

But although I hear the phrase “artificially low” all the time, I don’t think many people who use it have thought through what they mean. What would a non-artificial interest rate be?

Well, we do know from Wicksell what an unnatural rate, which sounds like more or less the same thing, would be: it would be an interest rate set too low in the sense that the economy overheats and we have accelerating inflation. But that hasn’t been happening; yes, there’s a slight uptick in some U.S. inflation measures, but nothing out there that suggests an interest rate that is way too low in this macroeconomic sense.

So what are the people complaining about artificially low rates talking about? Partly that they’re low by historical standards — but there are enough changes in the landscape, from deleveraging to demography, that this isn’t a convincing argument. But the main thing, I think, is those asset prices, which the advocates of tight money think are too high — because they wouldn’t make sense without those “artificially low” interest rates.

In case you haven’t noticed, this is a completely circular argument. Once you accept the possibility that rates belong where they are, or even a bit lower, to correspond to the Wicksellian natural rate, you also conclude that asset prices might make sense; and once you concede that asset prices might make sense, you lose the supposed evidence that rates are all wrong.

And one more thing: where is the wild exuberance that we associate with dangerous bubbles? I don’t see popular TV shows about house-flipping, and CNBC viewership is plumbing new lows.

Mainly, though, there simply isn’t any macroeconomic case for claiming that interest rates are wildly depressed relative to fundamentals, and not much reason to believe that assets in general are overvalued.

Tudo o que falta saber

As economias desenvolvidas estão presas numa armadilha de liquidez para a qual há curas fáceis e comprovadas (política orçamental expansionista e/ou taxas de juro negativas)? Ou a situação é mais complicada e os diagnósticos disponíveis devem ser lidos com algum cepticismo? A questão tem animado um excelente debate entre Paul Krugman, Simon Wren-Lewis, Tony Yates (cujo post é parcialmente citado em baixo) e David Andolfatto.

The old (but, historically, still ‘post’) Keynesian, IS/LM account of deficient demand, pretty much resembles the more modern account embedded in the rational expectations, sticky price models, dubbed ‘new’ Keynesian.  But using these models to prescribe drastic fiscal expansions that greatly exceeded what we saw is problematic.  In the UK, inflation exceeded target substantially.  In the US, it has not fallen all that much below it.  Modifications of the New Keynesian model that have a financial sector explain the recession as a dramatic constriction in credit supply that both strangles output, and creates inflationary pressure (offsetting the depressing effect on inflation coming from the fall in demand).

Following this line of argument, conventional demand-side fiscal policy was roughly on track.   You might argue that we ought to have had very great deviations of above target inflation, and much looser conventional fiscal policy.  But to do this you would have to ditch what those models say about the costs of inflation.  They contain the view that inflation fluctuations are an order of magnitude more costly than fluctuations in real activity.   So much the worse for them, you might say.  And policy makers frequently have said this.  But, with the models thus binned, you are in the dark about what should be done.  And there’s no way you can then argue that economics gives a clear answer, since you have discarded the one bottom-to-top [microfounded] answer it does give.  Granted, not everyone goes in for bottom-to-topness.  But that just reinforces my point that there is no sound economic answer.

Things are obviously worse than this, because the models that Paul Krugman is using to reason his way to arguing for a drastic further fiscal stimulus don’t contain financial sectors.  And the ones that get bolted onto the New Keynesian models to argue that policy was about right contain financial sectors that aren’t subject to systemic runs;  don’t malfunction therefore in the way that the real one did.

One of the themes of the early post crisis debate was the controversy between those like the Tory-led Coalition in the UK who warned about the possibility of a run on UK sovereign bonds, and those like PK who dismissed these concerns as opportunistic invoking of the ‘bond market fairy’.

PK would have history judge that he made the right call on this.  Certainly there were no runs on UK or US bonds.  But economics itself could not have given such an unambiguous a steer as PK claims.  The literature on optimal fiscal policy is riddled with ambiguity.  How to view what government does: wasteful, substituting, complementing private expenditure?  How to model the possibility of runs, and on what they might depend?  Whether to accept the possibility of the fiscal theory of the price level. [And whether this should be viewed as a difficulty or, as Sims sometimes suggested, an opportunity].   How to account for why people hold money.  [Without a good account of that, we can’t confidently say how they will price nominal bonds].  Whether the government can be viewed as being able to commit;  if not, whether it can acquire a reputation for good behaviour.  [If they can commit, then borrow now pay later strategies will work better].  Whether prices are sticky or not.  [This affects how much work fiscal policy should do to stabilise].  How to assess the tensions in the intergenerational conflicts over fiscal policy.  [Another take on the commitment problem].  How to produce normative guidelines for good fiscal policy that weighs concerns of competing generations.  The imponderable questions regarding how policy should deal with uncertainty, applied to the task of designing fiscal policy.  [How to weigh the unknown risks of a sovereign run, versus a deflationary spiral, for example].

I don’t know what economics PK has read.  But the miserably small quantity of serious reading I have managed on the above issues leaves me thinking that economics does not offer the clear advice PK claims.   PK seems to be backing away from all these intractable debates about the detail, and saying that we can ignore it.  Big picture, demand was weak, public demand had to be stronger.  Politicians did not get this message clearly enough, and were able to ignore it.  End of story.  Well, maybe.  Maybe not.  Perhaps only great minds can see the wood for all these unfinished modelling trees.  But to me it looks like a mess that many decades of future research may not sort out.

I think a plausible account of public policy failure is  that our economics profession had not yet come up with clear answers.  And in the absence of this politicians were free (or perhaps had no choice but) to be guided by their baser political imperatives.

Tiros ao lado

Frustrations of the heterodox, por Paul Krugman. Ler também When economics students rebel, no Mainly Macro.

(…) the heterodox need to realize that they have, to an important extent, been working with the wrong story line.

Here’s the story they tell themselves: the failure of economists to predict the global economic crisis (and the poor policy response thereto), plus the surge in inequality, show the failure of conventional economic analysis. So it’s time to dethrone the whole thing — basically, the whole edifice dating back to Samuelson’s 1948 textbook — and give other schools of thought equal time.

Unfortunately for the heterodox (and arguably for the world), this gets the story of what actually happened almost completely wrong.

It is true that economists failed to predict the 2008 crisis (and so did almost everyone). But this wasn’t because economics lacked the tools to understand such things — we’ve long had a pretty good understanding of the logic of banking crises. What happened instead was a failure of real-world observation — failure to notice the rising importance of shadow banking. Economists looked at conventional banks, saw that they were protected by deposit insurance, and failed to realize that more than half the de facto banking system didn’t look like that anymore. This was a case of myopia — but it wasn’t a deep conceptual failure. And as soon as people didrecognize the importance of shadow banking, the whole thing instantly fell into place: we were looking at a classic financial crisis.

What about the lousy policy response — austerity and all that? The key point here was that policymakers weren’t basing their decisions on conventional economics. On the contrary, they decided to blow off textbook macroeconomics and embrace exotic doctrines like expansionary austerity and a mysterious growth cliff at 90 percent debt relative to GDP. The disastrous policy responses that have perpetuated the slump are the result of mainstream economics having too little influence, not too much.

Now, to be fair, there is a civil war within academic macroeconomics, and what I’m calling “mainstream” is the saltwater side of that civil war. But the critics want much more than to boost saltwater macro at the expense of the new classical guys — they want to drive people like me out of the temple, too. And the thing is that they want to do this even though, as Wren-Lewis says, Keynesian macro has actually performed very well since 2008.

What about the new respect given to heterodox thinkers like Minsky, and heterodox ideas like secular stagnation? I agree that mainstream economists didn’t pay enough attention to such people — way back, one of my principles for working in economics was “listen to the Gentiles.” But it’s hard to claim that such work is deeply incompatible with mainstream economics when Janet Yellen embraces Minsky and Larry Summers becomes a secular stagnationist.

And what about inequality? Some people are annoyed at Thomas Piketty by presenting his data and ideas in a form that is fairly comfortable for conventional economists, at least those of eclectic disposition. But doesn’t that show that conventional economics is indeed capable of accommodating big concerns about inequality? You fairly often find heterodox economists insisting that to accept the idea that capital and labor are paid their marginal products, even as a working hypothesis to be modified when you address things like executive pay, is to accept that high inequality is morally justified. But that’s obviously not the case: there are plenty of economists who are willing to use marginal-product models (as gadgets, not as fundamental truth) who don’t at all accept the sanctity of the market distribution of income. So this complaint is, in its own way, as much of a distortion as the right-wing claim that anyone who so much as mentions inequality is a Marxist.

How should the crisis and the reemergence of very high income inequality affect how we do and teach economics? For sure, it says that we need to do a lot more history, including deep history. Events have also reflected very badly on the style of economics that prizes “microfoundations” based on ultra-rational behavior over evidence, and rules any kind of ad hockery out of bounds. But the heterodox want more than that; they want to interpret recent events as a refutation of the kind of economics Wren-Lewis, or Janet Yellen, or Larry Summers (as economist, not public official), or yours truly does. And that interpretation just doesn’t work. By all means, advance heterodox ideas if you believe they’re right. But don’t claim vindication from events that didn’t actually follow the script you wish they did.

 

Desigualdade e os 1%

Understanding ever-increasing executive pay, por Simon Wren-Lewis.

So what is the alternative story to the argument that executive pay reflects the market rewarding the rising productivity of CEOs? The first obvious point is that executive pay is not determined in anything that approximates an idealised market where prices are set to balance supply and demand. Instead it is set within a bargaining framework between employer (the firm) and employee (the CEO). Even if we imagine the employer in this case to be someone that genuinely reflects the interests of shareholders, the costs associated with losing your CEO, together with informational problems in assessing their true worth (which can lead to the age old problem of judging quality by price, and the ‘arms race’ that Chris describes), mean that the CEO potentially has substantial bargaining power.

Yet this situation did not suddenly arise in the 1980s, and it will be true in most countries, and not just in the US and UK. So why did executive pay start taking off in the 1980s in these two countries? Well something else happened at the same time: tax rates on top incomes were also substantially reduced. Why does reducing the tax rate on top incomes lead to a rise in those incomes pre tax? With lower tax rates, the CEO has a much greater incentive to put lots of effort into the bargaining process with the company. They, rather than the tax man, will receive the rewards from being successful.

This is the idea set out in this paper by Piketty, Saez and Stantcheva [3]. They call this a “compensation bargaining” model. The paper backs up this theoretical model with evidence that there is a “clear correlation between the drop in top marginal tax rates and the surge in top income shares”. In addition, they present microeconomic evidence that CEO pay for firm’s performance that is outside the CEO’s control (i.e. that is industry wide, and so does not reflect personal performance) is more important when tax rates are low. (Things like stock options).

Now one reaction to this model is that it ignores many other social/economic factors that may also have been important. Things like changing social norms and political changes (loosely, the rise of neoliberalism), reduced union power, changes in financial regulations, growing financialisation etc. I think this reaction is correct, but as the authors themselves say, such explanations are “multi-dimensional and it is difficult to estimate compellingly the contribution of each specific factor”. Economists like simple models that can be tested against the data. That is what the compensation bargaining model set out by Piketty et al does. I don’t think it is too much of a stretch to think about bargaining effort as a proxy for all these other factors.

Uma forma diferente de ver os desequilíbrios da Zona Euro

A emergência de desequilíbrios externos na Zona Euro é geralmente apresentada como um caso de países que aumentam a sua despesa interna e estimulam assim enormes défices comerciais. Mas há outra forma de formular a questão. Nesta narrativa, são os países do centro que contraem a sua procura interna e, ao fazê-lo, geram pressões deflacionistas que ‘obrigam’ o BCE a descer a taxa de juro para garantir uma inflação de 2%. Esta descida, por sua vez, alimenta bolhas na periferia, que assim se torna deficitária. Em Eurozone Morality Plays, Simon Wren-Lewis mostra que a segunda história até encaixa melhor nos factos do que a primeira. A ler.

So which story is right? We all know there was excess in some parts of R, either by governments (Greece) or banks (Ireland), but both countries are small. One way of discriminating between the two stories would be to look at real interest rates. If the ECB was having to react to excess demand in R, we would expect to see high real interest rates. If instead the ECB was having to offset deflation in G, we would see low real interest rates. Here is what actually happened.

From 2000 to 2007 the ECB kept inflation pretty close to 2%. But it did not achieve this by raising real interest rates. Instead interest rates fell in 2003, so that real short rates were close to zero from 2003 to 2005. This seems much more consistent with the story where G tries to undercut R, and the ECB has to cut rates to keep average inflation at 2%, forcing inflation in R to 3%. Sure enough, 2003-5 were years when the output gap in Germany was significantly negative (OECD estimates -1.4% 2003, -1.7% 2004, -1.9% 2005).

Both the ‘undercutting by G’ story and the more traditional ‘excess in R’ story still contain much too much pseudo morality for my taste. The German government did not deliberately engineer zero growth in domestic demand from 2003-5, any more than governments outside Germany (Greece excepted) tried to stoke up excess demand. In an ideal world both could have used fiscal policy more effectively, but the system hardly encouraged that. But this evidence does suggest that seeing the competitiveness imbalances in the Eurozone as simply the result of excess outside Germany is at best only half the story, and at worst not a very realistic story at all.