Friday, May 25, 2012

Eurocrisis = NGDP Crisis

Paul Krugman wrote a post a while back in which he looked at the data for debt-to-GDP ratios and government spending as a percentage GDP and effectively no explanatory relationship there for what's happening in the Eurozone, contrary to popular narrative. Instead, Krugman argued, Europe had a balance of payments problem.

I don't disagree with him, but I see the balance of payments problem as fundamentally driven by nominal GDP gaps, which differ strikingly between the different Eurozone nations, as monetary policy at the ECB cannot obviously stabilize on a path trend -- or keep growing even at roughly the trend rate -- nominal GDP in the 23 Eurozone nations.

The result is massive, unfathomably large nominal recessions in countries like Spain, Portugal, and Greece -- depressions, really -- amid nominal booms above trend in Germany, Belgium, and Austria. (Remember where the Eurozone is in its business cycle, and you should recognize that to be running even a small positive NGDP gap at this time amounts to a huge positive gap in normal times.)

What's going on in the Eurozone is ultimately not a debt issue, nor an issue of structural government spending. Those have undoubtedly slowed growth in the Eurozone over the long run -- but this is not a structural problem, it is a cyclical problem, a nominal problem. (See this post of mine for more on this.) Instead, these structural problems surfaced because of the nominal problem.

Note: An earlier version of this post failed to include Portugal; I redid my analyses for several of the countries to confirm that my data had not been mislabeled, but everything appears alright now. Please let me know in the comments if anything else seems faulty. Thanks. -- ES


  1. Even if the ECB could raise NGDP across the entire Eurozone, what's the mechanism by which that would cure the balance of payments problem? How much and in what proportion (real GDP vs inflation) would NGDP need to grow in each country? How could you guarantee those proportions?

  2. Do you have data for NGDP for Estonia?

    Did you forget Portugal?

    Leaving out Estonia, Malta and Cyprus, and looking at the 2000 through the end of 2007 trend, I see the Eurozone having a 9% NGDP gap.

    The first pass assumption is that closing the gap would be distributed proportionately. This would put the Netherlands and Italy close to trend and France above.

    Who knows what the split between output and prices would be for the Eurozone as a whole, much less each country. Trying to fine tune both output and inflation is foolish. Focusing on one and ignoring the other is foolish. That is why NGDPLT is the least bad alternative.

  3. @BillWoolsey: I think something happened with my data. I did Portugal... My apologies, as I don't have the time right now to redo the analysis. The NGDP data for Estonia comes from the World Bank:

    @Woj: The point isn't to raise NGDP across the board. That would help, given the average NGDP gap of the Eurozone, but the underlying problem is that the NGDP gaps widely differ. That in itself I see as the strongest argument against the euro in the long term. NGDP would grow along the aggregate supply curve, which determines the price-output response.

  4. Hi Evan;

    Doesn't your bar chart just show the degree to which the single currency has been too strong for the countries on the left and beneficially weak for Germany, Austria, etc??

    BTW: Where does Finland fit in? To the right, I would bet.

    Superb work you are doing on this blog!!

  5. The above post is revised to say that Ireland's dismal standing should be adjusted to account for the special case of its housing/banking crash.

  6. I was trying to check how was Brazilian NGDP growth other day, and decided to check the NGDP gap for all countries in the World Bank database.

    I noted that my results were strikingly different from yours. Even differences in what years we were using to calculate trends couldn't explain such a difference.

    I think i figured out what is going on.
    Clicking at your Estonia data link, i noted the the only NGDP figure is in dollars. I was using LCU.

    But i think the LCU data is better for this kind of analysis. (Although in eurozone to make a trend you will need to use an exchange rate for countries that entered recently, like Estonia).

    Otherwise currency devaluating is contractionary, prices are not stick (Unless in US), and Japan is doing one of the most expansionary policies in the world.

    I would send you the figures in LCU, but i can't now. I'll try to send you till the end of the week. I don't know how to make this beautiful graphs you do.