Nunc Lento Sonitu Dicunt, Morieris.
No man is an island, entire of itself; every man is a piece of the continent, a part of the main; if a clod be washed away by the sea, Europe is the less, as well as if a promontory were, as well as if a manor of thy friend's or ofthine own were; any man's death diminishes me, because I am involved in mankind, and therefore never send to know for whom the bell tolls; it tolls for thee.
John Donne, from Meditation XVII
Over the past month, a number of commentators have opined on the implications of the Cyprus situation on the euro. The decision to impose capital controls, they contend, however necessary to prevent the flight of deposits from troubled banks, represents a de facto exit from the euro zone. After all, a euro in Cyprus does not have the same command over resources as a euro in any other member of the eurozone.
At the same time, the use of fiscal austerity in the Eurozone has also come under scrutiny. Of course, countries that have lost access to bond markets have no alternative. But, as Paul Krugman and others point out, for countries that retain access to capital at record low interest rates, pursuing austerity in the face of stagnating economies, high unemployment and growing social and political cleavages ignores lessons from history and theory.
The role of Germany in enforcing fiscal "discipline" in the euro zone in the face of continuing euro zone difficulties has come under special attention. The European Commission in Brussels argues that Germany need not undertake fiscal expansion given that it is not faced with high unemployment or output below its "potential" level. This might make perfect sense had Germany and the rest of Europe national currencies linked only by flexible exchange rates, in which case Germany's relative strength would result in an appreciation of its currency that would help spread the burden of adjustment.
Sadly, this is not the case. Just as "no man is an island," no country in a currency union (with integrated capital markets) is "entire of itself." Alas, Europe has created full monetary union before completing the governance arrangements needed to support that union.
Most important, is the need for close coordination between the monetary and fiscal authorities. In this respect, while euro zone members delegated monetary policy to a single authority (the European Central Bank), fiscal policy was largely retained by individual members, consistent with the principle of "no taxation without representation."
This has led to the current impasse in which Germany is unwilling to use fiscal policy to support euroland growth, fearing that this would only delay the restructuring needed in the peripheral countries. German taxpayers should not, the argument goes, subsidize the consumption of citizens of other countries unwilling to undergo the hardships of structural reforms needed to enhance competitiveness.
Germany did indeed implement difficult measures to deal with the challenges of reunification. But what is missing from the argument is an appreciation of the difference between competitiveness and demand. While one country can increase its competitiveness against others, not all countries can simultaneously become more competitive. For the avoidance of doubt, this should not be read as a repudiation of structural reforms, which increase productivity and produce more and better goods. The problem is that, if there is insufficient demand, those goods will pile up on shop floors, revenues will fall, and employees will be laid off. That is the story in Europe, where unemployment in some countries is at Great Depression levels.
To this point at least, Germany has avoided the worst of the euro crisis. And may, perhaps, have benefited from the depreciation of the euro, which has helped fuel exports. That said, with the rest of Europe trapped in stagnation and growth slowing elsewhere, German officials should heed Donne: "Send not to know for whom the bell tolls. It tolls for thee."