Here is the complete conversation I, the not-famous Econophile, had with the famous Martin Wolf, much lauded and awarded dean of economics writers and chief economics correspondent for the Financial Times. This is our second exchange and I have to admit I enjoy them. He drives me nuts, but I very much respect the guy even though he is neo-Keynesian in his world view.

He recently wrote what I thought was a nonsensical article whereby he thought the cure to the southern eurozone’s problems was for the Germans to spend more. You can read the article at the Financial Times. You need to register, but they give you 9 articles per month free.

Here’s the conversation. I think you will enjoy it.

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Dear Mr. Wolf:

I just read your article on “Europe Needs German Consumers.” You say, among other things:

So long as the European Central Bank tolerates weak demand in the eurozone as a whole and core countries, above all Germany, continue to run vast trade surpluses, it will be nigh on impossible for weaker members to escape from their insolvency traps. Theirs is not a problem that can be resolved by fiscal austerity alone. They need a huge improvement in external demand for their output. …

What would happen if governments also slashed their spending? In an economy without monetary or exchange-rate offsets to austerity, any reduction in spending is likely to lead to at least an equivalent short-run reduction in output (a “multiplier” of one). …

Germany needs to return the favour. …

If the aim is to avoid disaster, the answer is temporary fiscal support for the struggling countries, robust aggregate demand in the eurozone as a whole and a substantial rebalancing of that demand, led by Germany. The fiscal support would be designed to prevent a short-term confidence collapse from triggering a default. In return, weak countries would need to commit themselves to falling nominal wages and a programme of fiscal retrenchment. …

So, punish Germany for doing well and reward Greece for fiscal insanity?

I cannot make sense of what you are getting at here, Mr. Wolf. We all know that Greece will be bailed out by Germany and France and that Greece won’t structurally change as will be demanded. Why would they if they know their getting bailed out?

In what way does the ECB “tolerate” weak demand? Or, to put it another way: how can they increase demand? I suppose by some Keynesian magic.

According to your Keynesian theory, AD=C+I+G — [Aggregate Demand (GDP) = consumption + gross investment + government spending]. Are you suggesting that all we have to do is “increase” C? How? By increasing G? Can you tell me how that works or has ever worked?

If government (G) takes money from the consumer (C) and spends it, how has that helped the economy? Yes I know it increases AD (GDP) but no wealth has been created, no organic growth. You should understand that GDP measures only spending, not the creation of wealth in an economy. Otherwise have G spend everything and see how fine things would be.

Are you suggesting that the good Germans go out and buy stuff from Greece to be patriotic? And what “favor” are they returning? Germany produces goods the rest of the world wants and Greece doesn’t, not to mention that 25% of Greece’s working population works for the government. There’s a formula for success. What favor have the PIIGs done for the Germans other than having nice beaches?

How about letting them fail? Moral hazard and all that. Why drag down the rest of the eurozone so they can suffer along with the PIGS?

With all due respect, you don’t make any sense here at all.

Econophile

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This wasn’t about Greece. It was about all of southern Europe. Germans wanted these people in the eurozone. I don’t see the sense of using it as a machine for serially bankrupting all their partners.

What is it with this US desire to rerun the Great Depression. Wasn’t destroying civilisation once enough for you?

Martin Wolf … Continue reading Another Conversation Between Econophile and Martin Wolf