Two weeks ago I have attended the Summer School of Post-Keynesian Economics which was very interesting. One of the questions that came up was why the current account mattered in the case of first private sector, then sovereign debt crisis. The answer goes something like this. A country that has its own currency is not really in risk of sovereign default. It can “print” its currency to pay off debt, which will worsen the exchange rate but solve the debt problem. Creditors get their money back, but bear the whole exchange rate risk. Also, the public sector can bail out the private sector to full extent if a real estate boom has caused hundreds of billions of loans to turn sour/toxic. Now, the euro zone is a different beast.
In the euro zone, countries cannot “print” their own money. Their debt is nominated in euros, which is equivalent to a foreign currency. In order to bail-out the financial sector sovereign debt has to be emitted in foreign currency and cannot be absorbed by domestic central bank operations. Of course, the ECB can act as a lender of last resort and give liquid funds for financial assets that are “distressed” – there is no buyer at all, or not enough buyers, or the price is too low, or all of these. In order to help the economy repay euro-denominated (foreign) debts, a positive current account would be important to secure an inflows of euros above what is needed to pay the import bill. That is why, in short, the current account matters in the euro zone’s indebted nations.
If the ECB would guarantee to provide (unlimited) funding for all euro zone governments, the financial troubles would go away. That is why the discussions on euro bonds and a partial hair-cut are on the agenda every other week. The financial aid would be necessary until price levels have been moved so that those countries with problems of foreign debt are in a position to repay it. This position would be the position of a net exporter. Euro bonds and/or a partial hair cut are hence a way to buy time in order to let the price levels adjust to sustainable positions. That means a relatively higher price level in Germany, and a relatively lower one for almost all of the rest. It would help if Germany would inflate a bit, but that is not what the designers of the euro zone intended. They wanted governments to increase their economy’s productivity and thereby lower their price levels through economic reforms. It has turned out that 4 years into the financial crisis these adjustments are still not coming along at the required pace, or are they?
External balance of goods and services, seasonally adjusted, in % of GDP (source: Eurostat)