The audacity Germany has shown in floating a demand to manage Greece’s finances is a window on the leaders of that country and how much perspective they’ve lost. Let’s be clear; not all in Germany agree with this narrow, insensitive stance and the uninformed and uneducated demands for austerity economics in debt-ridden and recessionary nations. For example, there are political parties in Germany that want their country to take the lead on a Marshall Plan for the periphery of the eurozone. But they are not the ones setting policy.

I am tempted to say that antediluvian economics is ruling in Germany, but it may not really be about economic theory, but rather superior pride, irrational fear of inflation, and perhaps vindictiveness. It’s as if a German version of our own Tea Party is now running economic policy in Europe. Germany reduced its unit labor costs beginning in the late 1990s, which were higher than much of the rest of the EU, but with the euro fixed, they benefited as their export prices remained low. Could they have done well without their eurozone trading partners buying more from them than they were selling? And they lent them the money to do so. Do they have no moral obligation here? Without the fixed euro, the DM would have soared.

Then there is David Cameron of Britain and his finance minister lecturing the rest of Europe about how to run their economies. Move over Monty Python. As everyone now knows, Britain’s GDP is still below its pre-recession high, its deficit is high and not falling as promised, it may have slid into recession, and often ignored, average wages are well down since a recovery supposedly began. The bombast with which Cameron proclaims the rightness of his austerity economics while his people suffer is right out of school-boy debating. This time his countrymen will lose the debate, not only him.

There are some hints that people of influence are talking sanely and recognize growth is necessary and that austerity in this environment is tragically anti-growth. Some believed there would be some actual policy initiatives in Monday’s summit, but there weren’t. Instead, the EU agreed to a nutty deficit limit for all its nations. The good news is that they won’t abide by in a crunch. Must we remind ourselves yet again that it was Germany that conspicuously violated the prevailing EU limits on deficits to 3 percent of GDP when it had problems? Some say the current limit is over a full economic cycle and therefore not that stifling, but 0.5 percent of GDP is stifling any way you size it up.

Other analysts are saying that now that Germany has won this round it will support further lending by the European Central Bank. What a group! Remember when Trichet, then the head of the ECB, actually raised interest rates in the spring of 2011? It is all a matter of confidence, he said. But trying to cut spending in the face of recession will not generate confidence; only renewed growth will.

It looks like Spain may have had enough of austerity economics. After all, it didn’t run crazy government deficits in the first place. I bet few non-expert citizens know how little government budget deficits had to do with the crisis, including in the U.S. For a long while, Spain’s leaders kept promising they would meet reduced deficits target, but slow growth and suddenly outright negative growth is reducing tax revenues far faster than expected. Spain is a dog chasing its tail, and it may finally realize it. Deficits as a percent of GDP come down a bit at the expense of a recession and high unemployment, but not nearly enough to satisfy Germany (or, apparently, bond markets) or to meet political promises. If Spain pursues further austerity, it may remain in recession for several years. What will that do to their democracy? Let’s hope they stop.

The Greeks would not stand for Germany running their country. Big surprise. Sarkozy then said no one should stand for it, and Merkel apparently backed off. Who knows if she was ever foolish or insensitive enough to believe in it? But she has some mighty thick-headed colleagues in her country to deal with. Meantime, Portugal is flailing, deep into recession, so it’s not only Greece we must worry about. Spain just reported negative growth. Ireland remains a mess, despite momentary cheers that austerity was working. Alas, GDP is still 10 or 15 percent below its pre-recession high there.

Germany wants to cure the problem by getting wages to fall — a solution it imposed on itself in the late 1990s — in Greece, Spain, Portugal and so on. It is commonly called an internal devaluation. Had everyone not been linked to the euro, some could have devalued explicitly. With an internal devaluation, these countries would allegedly reduce their European imbalances by importing less and exporting more as prices fell — and in the case of Greece in particular, attracting more tourists as prices fell. This is a long, painful process that will probably only marginally change imbalances.

Europe needs growth, but it is being handed recession by the Germans. Growth builds tax revenues. It’s just like the old days when even many economists believed a recession just cleaned out the dead wood so we could rebuild, which led to self-destructive policies in the early 1930s. Now we have learned that the ugly part of recessions is that they feed on themselves and sink economies deeper, clean out more new wood than old, have grave long-term consequences for standards of living, and can destabilize democracies.

Any good news? As recession hits, talk has increased that austerity is not working, as noted above. If Germany itself begins to suffer some pain because it can’t sell its exports, the nation may indeed wake up. The self-righteous there may at last be overwhelmed by the rational and sensitive.

Europe, and most importantly Germany, needs to encourage its central banks to lend more. It needs to build its rescue fund, and ultimately it needs to sell eurozone-backed bonds to generate more rescue money and enable it to transfer funds to needy countries as they scale back on spending so that citizens do not suffer so much. The U.S. does just this. There is no mystery, except one. That mystery is how nations repeat their follies so regularly in history.

For all I’ve said, I am not completely pessimistic. I see the glimmer of a horizon of hope. I think most of Europe believes in the euro and a united continent. I think they will save the day, but just by a hair’s breadth. And that’s too close for comfort. There is a chance the ship will sail too close to the horizon and fall off the earth.

This piece was originally published at New Deal 2.0.

In an article in Newsweek, Niall Ferguson argues that, the main reason why Americans should care about the European debt crisis is that “what is happening in Europe today could ultimately happen here.”

I have news for Professor Ferguson.  He has his diagnosis the wrong way around.

An important reason why Europe is in its current debt crisis is because for decades it has been emulating the US example of creating a permanent “culture of debt”.

I use the term “culture” here deliberately.  The global debt crisis is not just about the growing government debt burdens of economies, nor about the financial liquidity crisis plaguing banks.  The true debt crisis is much deeper than that.  It involves entire economies and societies evolving towards a mind-set in which more and more benefits are expected today –  but any costs are either increasingly postponed to the future, or preferably, dumped on others.

The problem with such a mind-set is that it ultimately leads to economies creating debt rather than wealth.

In a previous blog post (Can’t Pay? Won’t Pay!) I posed the question: What do the worldwide debt crisis and global warming have in common?

They both represent economies drawing down assets faster than they can replenish them.

In the case of the debt crisis, economies are spending more wealth than they are accumulating.  In the case of global warming, we are using up nature’s capital and its vital services at an alarming rate.  Rather than adding to wealth – both financial and natural – economies are squandering it.  This is not a new problem but has occurred throughout history, as I pointed out in Scarcity and Frontiers: How Economies Have Developed Through Natural Resource Scarcity, although this tendency has accelerated in recent times.

Which economy has led the way in creating both types of debts?

The United States, of course. For decades.

Until recently overtaken by China, the US economy was for years the number source of global greenhouse gases, followed closely by the European Union.  US households have carried the largest debts of all consumers, although evidence suggests that UK households may now be the biggest debtors.  Other European consumers have been quick to imitate this pattern, too.  The US economy has been running chronic trade deficits since the 1960s, and paying for it by selling financial assets, property, US government bonds and any other domestic economic assets available to foreign investors.  And, we all know what that global financial deal led to in 2008-9!

Our culture of debt also extends to management of our other two vital economic assets – human and natural capital.

Average student loan debts incurred by US graduating college seniors in 2010 $25,250, which is 5% more than the previous year.  Yet, 2010 graduates experienced an unemployment rate of 9.1% , and the average pay for those with jobs is $50,034.   A highly skilled workforce is valuable to the US economy and its prospects for growth.  But higher tuition costs, lower funding and expensive student loans means that we are forcing our most skilled laborers – university graduates – to go into debt before they even begin to put their human capital to work and collect any rewards for it.  Now, of course, the Europeans are also emulating the same student loan system that is at the heart of the human capital problem.  Caveat emptor!

We are also running down our natural capital rather than protecting or restoring it.  As I argue in my book Capitalizing on Nature: Ecosystems as Natural Assets, we are quickly entering into an Age of Ecological Scarcity.   Over 60% of the world’s major ecosystem goods and services have been degraded or used unsustainably. The demise of key global ecosystems include mangroves (35% either lost or degraded), coral reefs (30%) and tropical forests (30%).  Over the next 50 years, global biodiversity loss will accelerate, leading to the extinction of at least 500 or the 1,192 currently threatened bird species and 565 of the 1,137 mammal species.  Given these trends, it is unlikely that the world is ever going to “balance its budget” when it comes to managing ecosystems, biodiversity and other critical natural assets.

The “culture of debt” is certainly not just a European problem. Nor is it solely an American disease – although the US is clearly its main poster child.

The culture of debt has become a global issue, and it is not just financial, but defines how every society and economy now interacts with respect to their fundamental economic, human and natural assets.

The World Economics Association’s forum for the open review of proposed articles for the World Economics Journal and for Economic Thought is now open. 19 submissions have been posted so far. It is located at http://discussion.worldeconomicsassociation.org/.

The World Economics Association has been founded in spring 2011 and has so far attracted more than 7000 members from around 120 countries. The Journals of the association are committed to a policy of inclusiveness, openness and transparency. You are encouraged to read and comment on submitted papers that interest you. Editors will also make public comments to make their final decision making process transparent and to allow readers and authors to react and interact.

Papers submitted to the World Economics Journal include:

Microfinance and the Illusion of Development: from Hubris to Nemesis in Thirty Years, by Milford Bateman and Ha-Joon Chang

Incorporating the Rentier Sectors Into a Financial Model, by Michael Hudson

External Fragility or Deindustrialization: What is the Main Threat to Latin American Countries in the 2010s? by Roberto Frenkel and Martín Rapetti

Pension Liabilities: Fear Tactics and Serious Policy, by David Rosnick and Dean Baker

Grass Roots War On Poverty, by Alice H. Amsden

Papers submitted to Economic Thought include:

Mathematical Modelling and Ideology in the Economics Academy: competing explanations of the failings of the modern discipline?, by Tony Lawson

On the Limits of Rational Choice Theory, by Geoffrey M. Hodgson

An Evolutionary Efficiency Alternative To The Notion Of Pareto Efficiency, by Irene van Staveren

Norbert Häring is editor of the World Economics Journal.

Emerging markets have fallen victim to unstable capital flows in the wake of the financial crisis. In an attempt to mitigate the accompanying asset bubbles and exchange rate pressures that come with such volatility, a number of emerging markets resorted to capital controls. Although these actions have largely been supported by the International Monetary Fund, some policy-makers and economists have decried capital controls as protectionist measures that can cause spillovers that unduly harm other nations.

Recently-published research shows that these claims are unfounded. According to the new welfare economics of capital controls, unstable capital flows to emerging markets can be viewed as negative externalities on recipient countries. Therefore regulations on cross-border capital flows are tools to correct for market failures that can make markets work better and enhance growth, not worsen it.

This work has been developed by economists Anton Korinek, Olivier Jeanne, and others, and is summarised by Korinek in the August issue of the IMF Economic Review. According to this research, externalities are generated by capital flows because individual investors and borrowers do not know (or ignore) what the effects of their financial decisions will be on the level of financial stability in a particular nation. A better analogy than protectionism would be the case of an individual firm not incorporating its contribution to urban air pollution. Whereas in the case of pollution the polluting firm can accentuate the environmental harm done by its activity, in the case of capital flows a foreign investor might tip a nation into financial difficulties and even a financial crisis.

This is a classic market failure argument and calls for what is referred to as a Pigouvian tax (named after the 20th century Cambridge economist Arthur Pigou) that will correct for the market failure and make markets work more efficiently.

Of course, economists such as Keynes argued long ago that capital controls are important to prevent crises and to maintain an independent monetary policy that can strive for full employment and financial stability. This new work however elegantly models capital flows and capital controls in a broader contemporary economics context and thus could be seen by some to be a more rigorous justification for policy action on capital flows.

This work is not just for the blackboard. With quantitative easing, and as interest rates were lowered for expansionary purposes in the industrialised world between 2008 and 2011, capital flows returned to emerging markets at an alarming rate, where interest rates and growth were relatively higher. With eurozone jitters in the final quarter of 2011, capital flight occurred to the “safety” of the US and beyond. This has caused significant asset and exchange rate volatility that has made for an uncertain environment for policy-making and investment alike.

In response, many nations deployed capital controls to regulate the negative effects of cross-border capital volatility. Like earlier studies confirming that capital controls can change the composition of inflows, make for more independent monetary policy, and ease exchange rate tensions, new studies are emerging that show how nations such as Brazil, Taiwan, and South Korea have been at least moderately successful as well.

In addition to the cries of protectionism by Gordon Brown and others, some have also argued that controls create negative spillovers to neighbouring nations. MIT economist Kristin Forbes and colleagues examined Brazil’s numerous taxes on capital inflows from 2008 to 2011 to test whether such measures were harming Brazil’s neighbours.

On the one hand, Forbes and colleagues found that Brazil’s controls were meeting their stated objectives. However, in some attempts the authors did find that Brazil’s actions impacted other emerging market nations. Some of these spillovers were positive — some fund managers steered away from not only Brazil but from other nations that have regulated cross-border capital in the past. In other cases global investors did indeed increase their allocations to neighbouring nations.

These mixed findings miss some of the broader context, especially when seen in the light of the new welfare economics of capital controls. First, Brazil’s taxes can be seen as Pigouvian measures to correct against the negative spillovers generated from quantitative easing and the dollar/real carry trade. Second, the ‘costs’ that Forbes et al find to a small number of nations are not juxtaposed with the benefit of preventing a crisis in Brazil — one only has to look at Brazil’s 1999 crisis to see its contagious effect on the region then.

Over a dozen  years ago, prominent trade theorist Jagdish Bhagwati reminded us that capital account liberalisation is not analogous to trade liberalisation and that measures to regulate capital flows are not inherently evil.  The new welfare economics of capital controls further show that such measures can be seen as the new “correctionism” rather than the new protectionism — at exactly a time when nations need as many tools in their crisis preventing arsenal as possible.

This piece was originally published at the Financial Times. It is based on Gallagher’s new working paper, ‘The Myth of Financial Protectionism:The New (and old) Economics of Capital Controls’.

The Obama administration has launched a “21^st Century” trade negotiation with a number of pacific-rim nations referred to as the Trans-Pacific Partnership (TPP).  While the full details of the proposed treaty are yet to be made public, early estimates show that the economic benefits of the agreement will be relatively small and the regulatory costs could be significantly high—especially for the emerging market and developing countries engaged in the negotiations.

The gains of the agreement may be a mere $20 billion, or just over one percent of GDP on average for the nations involved.  To get those small gains nations will have to trade away the ability to use measures to prevent and mitigate financial crises, to develop a growth-based innovation system, to protect public health and the environment, and more.

That’s right, according to a study by the East-West Center, at best the agreement will bring a one-time boost in GDP to participating countries of just over one percent. The accompanying table to this note shows how these gains would be distributed.



Vietnam and Malaysia seem to stand to gain more than half the benefits of the treaty, but those two countries would likely have to bear the most in terms of regulatory cost.  Both of these nations are significant low-wage assembly manufacturers that would export more goods to the US and Australia, and also import more intermediate goods for final assembly from those and other TPP nations.

These gains should also be seen as gross over-estimates as well.  The models deployed by the authors have estimates not only for goods trade, but also for services trade, and for the amount of foreign direct investment flows to the region.  The methods for the latter two estimates have little traction in the economics profession and are often not reported in official reports by the World Bank and others. Indeed, work by myself and others show that such models should be viewed in a very critical manner.

These over-estimated but still small benefits need to be juxtaposed with the costs.  The provisions for investment and intellectual property will bring significantly high costs to these nations.  What is more, the treaty will divert trade that probably should occur among others worse off.

In terms of investment, the treaty would rob the ability of parties to deploy regulations on the flow of cross-border capital flows to prevent and mitigate financial crises.  Such regulations are a cornerstone of Vietnam’s exchange rate and export policy.   Malaysia’s regulation of capital outflows in the wake of the Asian financial crisis is credited with making Malaysia among the least worse off due to that crisis.  If these tools were used, the treaty’s “investor-state” dispute system that allows private firms to directly sue host country governments would kick in.

The agreement will also make it harder for nations to establish the appropriate innovation policies that are necessary to diversify the economy toward higher value added goods.  While nations like Brazil and China—with only commitments under the WTO and not a deal with the US—are free to learn from foreign firms and spur domestic industries, this will be much more difficult for nations under its deal with the US.

Finally, the agreement will make other area nations worse off.  The treaty will distort markets in the Asian region such that Indonesia, the Philippines, Thailand, Japan, China, and South Korea would all be worse off.

Prominent trade theorist Jagdish Bhagwati has said that if TPP nations accept this deal they will truly be “bamboozled.”  When looking at the potential gains and the real costs it is hard to come up with a rival conclusion.

One year ago, Gerald Epstein and Jessica Carrick-Hagenbarth, two economists at  the University of Massachusetts Amherst, organised an open letter to the American Economic Association urging the organisation to

“adopt a code of ethics that requires disclosure of potential conflicts of interest that can arise between economists’ roles as economic experts and as paid consultants, principals or agents for private firms”.

More than 300 economists signed the letter, among them Nobel laureate George Akerlof and Christina Romer, a former advisor to US president Barack Obama.

Almost exactly one year later, the American Economic Association in fact agreed on a new disclosure codex. (Luigi Zingales also presented an interesting paper on the “Capture of Economists”.)

What do the authors of the open letter make of the new guidelines? I did an interview with Gerald Epstein, who wasn’t involved in the discussions about the new rules.

Olaf Storbeck: Gerald, what do you think about the new AEA disclosure guidelines? Are you satisfied?

Gerald Epstein: I think the AEA guidelines are a very big step forward. They make very clear the importance of disclosure of potential conflicts of interest by economists and set out in detail the types of conflicts that should be disclosed. In some ways these guidelines are stronger than i had expected.

For example?

They require disclosure with respect to publication in AEA journals, rather than just recommend it. And they require such disclosure with respect to a broad range of possible conflicts including those connected to groups that might have an ideological interest in the outcome of the article and not just material or financial. While this cuts a broad area, I think it is healthy.

The guidelines also suggest that these same criteria for disclosure apply to all other publications, including non academic publications, media appearances and testimonies. By suggesting their application to these areas, as well as by requiring such disclosures for AEA publications, these guidelines will help to set norms of behavior that colleagues, the press, students and citizens can help hold economists accountable to.

Is there anything missing?

One could quibble about the $10,000 limit. For an economist who makes a low salary, smaller amounts would have a significant impact. Still, I think that as a bench mark, the $10,000 figure is fine since it will catch most of the economists for whom such kinds of activities are an important part of their work.

What should happen next?

These guidelines should be widely promoted and reported on in the press and it would be important for journalists, students and others to try to see if such guidelines can be broadly implemented for other publications, TV and radio appearances, etc. The point would be to make such guidelines a broad norm that are widely implemented .

Will these guidelines have any impact?

I do think they will have an impact in terms of providing information to the public. it is very difficult to predict whether it will have an impact on the professional activities of economists. It will take five  years or so to see that.

Would you recommend economic associations abroad to adapt similar guidelines?

Yes. Absolutely. I think this would be a good starting point for other associations. If they do not have publications, then they could still recommend the broad guidelines as indicated in point 7 of the guidelines. In fact it would be good to start with point 7 and then if they have publications, then require that they apply to the organizations’ publications.

This interview was originally published at Economics Intelligence.

On the last day of 2011, a headline in The Wall Street Journal read: “Spain Misses Deficit Target, Sets Cuts.” The cruel forces of poor economic logic were at work to welcome in the new year. The European Union has become a vicious circle of burgeoning debt leading to radical austerity measures, which in turn further weaken economic conditions and result in calls for still more damaging cuts in government spending and higher taxes. The European debt crisis began with Greece, and that nation remains the European Union’s most stricken economy. But it has spread inexorably to Ireland, Portugal, Italy, and Spain, and even threatens France and possibly the UK. It need not have done so. Rarely do we get so stark an example of bad—arguably even perverse—economic thinking in action.

Over the past two years, the severe 2009 recession, which started in the US but spread across Europe, have imperiled the finances of one European country after another. As a result, Portugal, Ireland, Spain and Italy are coming under pressure from the EU to cut government spending and raise taxes to reduce their deficits if they wanted to qualify for a bailout. All have done so. Ireland and Portugal sharply cut spending and still had to take tens of billions of euros to help meet financial obligations as of course did Greece. The European Central Bank bought the bonds of Italy and Spain. Britain’s Conservative government led the way in ruthless government cutbacks in 2010. France has adopted its own austerity package, and even Germany, the supposed economic leader of Europe, has planned to cut its deficit by a record 80 billion euros in 2014.

Proponents of austerity claim that as nations take control of their finances businesses become more convinced that interest rates will not rise and that growth will resume. Their reasoning has been abetted by the financial markets, which drove up rates on Greek debt and soon enough on the debt of nations like Portugal, Spain and Italy. Should these nations not be able to pay their debts, bond buyers wanted a high enough interest rate to compensate for the risk.

But this is pre-Great Depression economics. How could the EU so misread history and treat with contempt the teachings of John Maynard Keynes, who argued that during recessions governments must expand economies through spending and tax cuts, not the opposite? In practice, making large-scale budget cuts or raising taxes, as Keynes showed, will reduce demand for goods and services just when an increase is needed. Faltering sales will undermine the confidence of businesses far more than fiscal consolidation will embolden them. By ignoring this, European policy makers will deepen, not solve, the financial crisis and millions of people will suffer needlessly.

Indeed, austerity economics has not worked in one single case in Europe in the last two years. When David Cameron’s government imposed a first round of harsh spending cuts in 2010, it utterly failed to revive the British economy as promised. To the contrary, it probably cut a budding recovery short. Unemployment and the deficit as a percent of GDP remained high. Some pro-Conservative observers I met at the time assured me that the Cameron team, led by George Osborne, the Chancellor of the Exchequer, was pragmatic and would reverse course on austerity if it wasn’t working. Yet when growth basically ground to a halt in late 2011, the Cameron team only doubled down, making further cuts. We need more of the same medicine, they told their citizens, a record number of whom are unemployed. Britian is a hair’s breadth away from outright recession only two years after its last one.

In November, meanwhile, Spaniards voted out of office a once-popular Socialist government, in part for its failed austerity program of the past year. The Socialists had earlier presided over a boom and even built a budget surplus. But then the housing and banking crises struck and private Spanish banks ran amok. In response, in 2010 the Socialists sharply reversed an earlier stimulus policy, cut spending, and raised taxes to the tune of about 5 percent of GDP. Government debt is still not high in Spain, and interest rates have not risen the way they have in Italy. But economic growth stalled after these measures were implemented, because reduced public spending weakened the demand for goods and services, pure and simple. With Spain’s official unemployment rate now 21.5 percent, the Socialists lost the election badly—paradoxically pushing voters to elect a conservative leadership that is calling for more austerity. In Spain, recession is now inevitable.

And then there is Ireland. The recent experience of this once booming country should be deeply embarrassing to those who advocate austerity economics. For six months early last year, its national income started growing again after a couple of years of dramatic collapse following its own financial crisis. Ireland guaranteed all the debt of its over-aggressive failing banks to appease investors and then paid for it by cutting social spending sharply. Ireland’s leaders said with almost religious authority that this painful self-discipline was necessary to right the economy, and officials in Ireland and across Europe hailed the country’s brief rebound in 2011 as proof that it works. But then the Irish economy plunged in the third quarter of 2011 at its fastest rate ever. The upturn in the economy proved only temporary under the restraints of austerity economics. It may yet need another bailout.

Climbing out of the morass left by the financial crisis and now the European debt crisis would not be easy even if the right steps had been taken as they unfolded. While the American economy has gathered a little strength, recession in the peripheral nations and possibly Britain could take down France and other stronger nations—particularly in the absence of a coherent policy beyond austerity.

There is a far better solution. And it would not require the failure of the euro. The eurozone and perhaps the entire EU must act like a unified country, ready to recognize that it must take responsibility for the drastic social effects of rapid spending cuts. The US is no shining example of enlightened policies, but the European Central Bank must guarantee the debt of its members just like the Federal Reserve guarantees the debt of the US Treasury. It can then force restructuring of debt in these nations, with some private investors taking losses. A financially unified Eurozone must then issue bonds to raise the money to pay back debts but also to provide a social net for the people of nations that are cutting back their spending on social programs to meet their remaining financial commitments. (This is what the US does, for example, by sending Social Security checks and aid for the unemployment to every state in the union.) This can be accompanied by demands for reforms in nations like Greece where taxes must now be collected more efficiently and unusually excessive public spending stopped.

Germany has the financial wherewithal to lead this rescue. But it is blocking the fiscal union from acting like a single nation with compassion for all Eurozone citizens. It is also refusing to underwrite a substantial new fiscal stimulus—good-old fashioned Keynesianism. Is this a new national arrogance? I hope not. So far, Germany is benefitting from the crisis as investors buy German bonds as safe havens from the turmoil. In fact, the failure to act will soon affect the German economy. It will take financial losses on its banks’ loans to the peripheral nations and its export markets will weaken. The bond buyers who are now gobbling up German debt, thus keeping rates low while they rise in Italy, Greece, Portugal, and Spain, will likely stop doing so.

The EU leaders must get over their obsession with eliminating deficits. They now want to reduce every country’s deficit to less than 0.5 percent. This is disaster. It will lead to very slow growth for a long time. Instead, they must use temporary deficits to restart growth. Rarely has policymaking been this poor. Sooner than later, the citizens of these nations will say, No more!, and political instability will result.

This piece was originally published at The New York Review of Books Blog.