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After Draghi (Wonkish)

Summary:
Mario Draghi’s term as president of the European Central Bank ends in October. It has been a tumultuous tenure; among other things, he very clearly saved the euro from collapse in 2012-13, which arguably makes him the greatest central banker of modern times.But I come not to celebrate Draghi but to ask about the state of the euro as the age of Draghi draws to an end. This isn’t a rant. I’ve long been a euroskeptic, and there has been immense suffering in Greece, and to a lesser extent in Spain and Portugal. But Europe’s overall performance since the 2008 crisis has been better than I believe most U.S. observers realize.The big problem now, I’d say, is the extreme fragility of Europe with respect to any future shocks. In the years since Draghi came in, the euro area has done surprisingly

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Mario Draghi’s term as president of the European Central Bank ends in October. It has been a tumultuous tenure; among other things, he very clearly saved the euro from collapse in 2012-13, which arguably makes him the greatest central banker of modern times.

But I come not to celebrate Draghi but to ask about the state of the euro as the age of Draghi draws to an end. This isn’t a rant. I’ve long been a euroskeptic, and there has been immense suffering in Greece, and to a lesser extent in Spain and Portugal. But Europe’s overall performance since the 2008 crisis has been better than I believe most U.S. observers realize.

The big problem now, I’d say, is the extreme fragility of Europe with respect to any future shocks. In the years since Draghi came in, the euro area has done surprisingly well in restoring growth and regaining employment losses. But this success rests on extremely low interest rates and an undervalued euro.

What this means is that Europe has essentially no “monetary space” – there is nothing more it can do if something goes wrong. If there’s a Chinese recession, or Trump slaps tariffs on German cars, or whatever, what can Europe do? The ECB can’t significantly ease monetary policy. Fiscal expansion could help, but it would have to be led by Germany, which seems implausible.

Still, it seems worth talking about how things have gone so far, which is better than many imagine.

Start with growth in the euro area. Here I show real GDP growth since 2007, compared with growth in the US:

ImageAfter Draghi (Wonkish)
Saving the euroCreditFederal Reserve of St. Louis

Three things seem obvious. First, Europe took a major wrong turn in 2011, partly because of the debt crisis, partly because Jean-Claude Trichet’s ECB made the incredibly bad decision to respond to rising commodity prices by raising interest rates despite high unemployment. Second, things stabilized once Draghi said his famous three words – “whatever it takes” – and implemented a sustained policy of monetary expansion. Third, overall European growth has nonetheless fallen far behind the U.S.

This last point, however, is largely an illusion. Europe has much slower growth in its working-age population than the U.S. does, and once you adjust for the difference in demographics the performance of the two economies doesn’t look that much different:

Image
Demography!CreditFederal Reserve of St. Louis

Finally, while European unemployment is consistently higher than that in the U.S., there’s a growing sense that measured unemployment is a problematic measure, that it’s better to look at prime-age employment. And by that measure Europe has done almost exactly as well as the U.S.:

Image
Jobs, jobs, jobsCreditFederal Reserve of St. Louis

So Europe has done better than most Americans imagine. But it has done so only thanks to two things: incredibly low interest rates – literally negative for some assets; and a large trade surplus due to that undervalued euro.

Again, what if something goes wrong? America’s situation isn’t great, but in the face of a recession the Fed has some room to cut, and Congress might enact some fiscal stimulus. The ECB has no such room; the trade surplus probably can’t get bigger; Europe has no government to provide fiscal stimulus. There is some fiscal space for expansion in Germany, but it might as well be on the far side of the moon.

So what future for Europe after Draghi? The continent is doing OK right now, to an important extent thanks to Draghi’s actions. But there are no reserves of strength, no ammunition to fire, to deal with anything bad. And bad things happen.

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Paul Krugman
Paul Robin Krugman (born February 28, 1953) is an American economist, Distinguished Professor of Economics at the Graduate Center of the City University of New York, and an op-ed columnist for The New York Times. In 2008, Krugman won the Nobel Memorial Prize in Economic Sciences for his contributions to New Trade Theory and New Economic Geography.

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