Who's Responsible For the Euromess?

by Kevin Drum

Mother Jones
December 6, 2011

A few days ago Tyler Cowen kicked off a discussion of whether or not Germany (and the core European countries in general) have acted more virtuously than Greece (and the periphery countries in general) during the decade since the euro was introduced. It was unclear how much he was simply presenting a debating case vs. how much he actually believed his own arguments, and in that spirit I want to present a different case. This one is about how Europe got where it is today and who deserves a bigger share of the blame for its current mess. I'm not suggesting this is the only way to look at things, or even necessarily the best way, but I do think it's an instructive way. So here it is in seven easy steps.

1. The introduction of the euro made cross-border capital flows far more frictionless.

As a result, money began flowing from the sluggish economies of the core countries (mostly Germany, but also France, Benelux, and others) to the more capital-starved economies of the periphery. You can tell two basic stories about why this happened:

a) A "push" story: Investors chasing higher yields actively pushed money into the more vibrant economies of the periphery.

b) A "pull" story: Profligate national governments, addicted to living beyond their means, pulled money into the periphery via heavy borrowing, which crowded out private borrowing.

Most likely, both of these were part of what happened and both reinforced each other. But generally speaking, if the pull story were true you'd expect to see increases in nominal interest rates in the periphery. As the table above shows, that's not what happened, which means the push story is more likely to be the primary explanation. The primal sin here is that for years supposedly sophisticated investors in the core shoveled money into the periphery with abandon, ignoring the obvious risks of doing so.

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