The existence of the euro is threatened and its collapse could inflect vast damage on the world, yet European leaders aren't foing enough to stop it, economist Paul Krugman writes in The New York Times.
Europe's rescue attempts are doomed to fail, according to Krugman, without more expansionary fiscal and monetary policies in Europe's stronger economies.
Instead, the Europeans have offered stop-gap financing and imposed severe austerity measures to slash public spending in debtor nations.
That won't work in Greece, which has more debt than it can realistically repay, and probably won't work for Ireland and Portugal either, Krugman predicts. It might work in Spain and Italy – if leaders make the right decisions.
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Private demand has plummeted, and public-sector spending has been severely cut. That leave exports, especially to other European countries, as the only way Greece and other debtor countries can return to economic health.
"But exports can't boom if creditor countries are also implementing austerity policies, quite possibly pushing Europe as a whole back into recession," Krugman writes.
The solution is to create inflation in stronger European countries, namely Germany, he argues. If debtor countries had low or zero inflation, they could cut their prices and costs relatively to stronger nations with higher inflation.
"But the European Central Bank," he writes, "has a deflationary bias – it made a terrible mistake by raising interest rates in 2008 just as the financial crisis was gathering strength and showed that it has learned nothing by repeating that mistake this year."
So the market expects low inflation in Germany and that, he says, means peripheral countries will see deflation that will worsen their recessions and increase their debt burdens, ensuring that rescue efforts will fail.
Stock markets responded positively to the latest efforts of European leaders to control the crisis. Under one proposal, private lenders with Greek bonds would take bigger losses, which would help Greece cut its debt, according to the Associated Press.
"For now at least, it looks as if markets are giving some credence to a firm plan on how to tackle the debt crisis beginning to emerge," Ben Critchley, a sales trader with IG Index, told the AP. "But if recent experience is anything to go by, this patience is unlikely to last too long if details are not forthcoming."
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