Explanation of Europes Mess and What needs to be Done to Solve It

From Paul Krugman in his blog. 

Paul Krugman has a great way of explaining some complicated issues in pretty simple terms.  In his blog post "Hard Hearts, Soft Heads," Professor Krugman explains what needs to be done in Europe and the mess that the region is in.  He says:

Let’s think about the current problems of the euro are in terms of perfectly ordinary, textbook macroeconomics.

First, take the aggregate view. The euro area as a whole has record high unemployment and record low inflation. By any normal standards, this says that monetary policy is too tight. Yes, there’s a problem getting traction, because the ECB is close to the zero lower bound — but that’s a problem of implementation. On what possible grounds could you argue that printing money is not at least a partial solution to the crisis?

Next, look at the internal adjustment problem. The big capital flows from north to south during europhoria have left Spain etc. overvalued , and in need of “internal devaluation”. But there is now completely overwhelming evidence for downward nominal wage rigidity: it’s much easier to get Spanish wages relative to German wages in line through rising German wages than falling Spanish wages. Germany’s own internal devaluation from 2001 to 2007 was accomplished through inflation abroad, not deflation at home. But a too-low overall euro inflation rate pushes the burden onto deflation in debtor countries. Again, on what possible grounds could you argue that a somewhat higher inflation rate — remember, it’s now running at just 0.8 percent — would do nothing to help solve the crisis?

Finally, to the extent that debt levels are a problem, low inflation makes this problem much worse, for all the usual reasons.

The whole blog entry is worth a read as it explains why Europe is such a mess and why it will remain a mess due to their policies and the German frame of mind.