Financial Times
November 6, 2011
Economists have bigger brains than ordinary mortals. Whereas most people are flummoxed by dilemmas, economists wrestle with trilemmas. Nobel laureates Robert Mundell and Marcus Fleming, for instance, famously observed that it was impossible for a country simultaneously to maintain a fixed exchange rate and an open capital account while keeping inflation under control.
Europe’s crisis has thrown up another impossible trinity. The Germans have three ardent desires. First, they want the single currency to survive. Second, they wish to limit Germany’s financial contribution to any bail-out. Third, they insist that the European Central Bank keeps inflation low. These demands are mutually incompatible. Until Berlin relents on one of them, the euro crisis is likely to rumble on.
If Germany was to leave the euro, its banks – which have made loans across the eurozone – would collapse. Germany would also risk ejection from the EU. Furthermore, a revived Deutschemark might become overvalued on the foreign exchanges, like the Swiss franc, which would be bad news for German exporters. All this means Berlin cannot afford to walk away from the solvency and liquidity crisis that is afflicting the so-called peripherals (Portugal, Italy, Ireland, Greece and Spain). Hence, the latest bail-out package announced on October 27.
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