Moreover, even under this optimistic scenario, the problem of the current-account deficits of Italy, Spain and the other peripheral countries will remain. Differences among the eurozone countries in growth rates of productivity and wages will continue to cause disparities in international competitiveness, resulting in trade and current-account imbalances.
Germany now has a current-account surplus of about US$215 billion a year, while the rest of the eurozone is running a current-account deficit of about US$140 billion.
Italy, Spain and France all have current-account deficits equal to 2 percent or more of their GDP. As they come out of their cyclical recessions, incomes will rise, leading to increased imports and even larger current-account deficits. Those deficits must be financed by net inflows of funds from other countries.
If Italy, Spain and France were not part of the eurozone, they could allow their currencies to devalue — weaker exchange rates would increase exports and reduce imports, eliminating their current-account deficits. Moreover, the increase in exports and the shift from imports to domestically produced goods and services would strengthen their economies, thereby reducing their fiscal deficits as tax revenues rose and transfers declined, and a stronger economy would help domestic banks by reducing potential bad debt and mortgage defaults.
However, Italy, Spain and France are part of the eurozone and therefore they cannot devalue. That is why I believe that those countries — and the eurozone more generally — would benefit from euro depreciation. Although a weaker euro would not increase their competitiveness relative to Germany and other eurozone countries, it would improve their competitiveness relative to all non-eurozone countries.
If the euro falls by between 20 percent and 25 percent, bringing it close to parity with the US dollar and weakening it to a similar extent against other currencies, the current-account deficits in Italy, Spain and France would shrink and their economies would strengthen. German exports would also benefit from a weaker euro, boosting overall economic demand in Germany.
It is ironic that the ECB’s offer to buy Italian and Spanish debt has exacerbated external imbalances by raising the value of the euro. Perhaps that is just a temporary effect and the euro will decline when global financial markets recognize that a weaker exchange rate is needed to reduce current-account deficits in the eurozone’s three major Latin countries. If not, the ECB’s next challenge will be to find a way to talk the euro down.
Martin Feldstein, a professor of economics at Harvard University, was chairman of former US president Ronald Reagan’s Council of Economic Advisers and is a former president of the US National Bureau for Economic Research.
Copyright: Project Syndicate