Tags: Krugman | europe | Inflation | Euro

Krugman: ECB Intervention, Inflation Will Save the Euro

Monday, 02 July 2012 01:16 PM

Measures taken by the European Union last week to firewall and extinguish the debt crisis will fall short, as only heavyweight monetary stimulus measures taken by the European Central Bank will lead to more lasting recovery, says Nobel economist Paul Krugman.

Last week, European leaders voted to give their rescue facility, the European Stability Mechanism, the power to recapitalize banks as well as authorization to buy government bonds to ease credit conditions in troubled countries like Greece, which has teetered on the edge of abandoning the euro.

Such moves, which drew widespread applause from financial markets, won't work alone, Krugman writes in his New York Times column.

Only the European Central Bank can save the currency by stepping in and buying government debt with money printed out of thin air.

Such a policy, known as quantitative easing, will fuel inflation but that's just what the continent needs, as rising consumer prices would signal economic growth.

"Germany gave a little ground, agreeing both to easier lending conditions for Italy and Spain (but not bond purchases by the European Central Bank) and to a rescue plan for private banks that might actually make some sense (although it’s hard to tell given the lack of detail). But these concessions remain tiny compared with the scale of the problems," Krugman writes.

"What would it really take to save Europe’s single currency? The answer, almost surely, would have to involve both large purchases of government bonds by the central bank, and a declared willingness by that central bank to accept a somewhat higher rate of inflation," Krugman adds.

"Even with these policies, much of Europe would face the prospect of years of very high unemployment. But at least there would be a visible route to recovery."

Quantitative easing is a tool used to stimulate the economy when interest-rate cuts alone won't work.

The U.S. Federal Reserve has rolled out two rounds of quantitative easing, pumping $2.3 trillion into the economy to create jobs and spur recovery, though critics say the U.S. central bank is planting the seeds for inflation down the road.

The Fed argues that its policies adhere to its duel mandate of controlling prices while creating conditions for optimum employment rates.

The European Central Bank, however, adheres to one mandate — to control prices — and has expressed reticence to jolt the economy via large-scale bond buybacks from banks.

European monetary policy authorities say governments must do their part to end the debt crisis.

"Fiscal instruments must be used to address fiscal issues. Don’t mix the central bank with the fiscal authorities," Benoît Cœuré, a European Central Bank executive board member, tells the Financial Times.

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Monday, 02 July 2012 01:16 PM
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