Will Germany Swallow Inflation to Save the EU?

Will Germany Swallow Inflation to Save the EU?


This weekend’s G-8 summit at Camp David, the U.S. president’s retreat, marks a big step for Europe in several different ways. After a couple of weeks of waffling, German Chancellor Angela Merkel now appears ready to deal on a new European economic strategy -- something beyond the one she has shaped and enforced over the past two years.

Related to this, the EU is now committed to developing a combination of policies that balance fiscal responsibility and the need to stimulate growth and job-creation. The communiqué after the gathering called this “imperative,” marking a dramatic policy shift.

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Finally, it looks as though European leaders have taken a step back from the hot-and-heavy insults and brinksmanship that were gaining momentum—notably between Athens and Berlin—before the G–8 met.

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All in, the Camp David gathering counts as an important advance. What is more, it gives President Obama a credible voice as an honest broker in his dealings with both Merkel and François Hollande, France’s new Socialist president. Obama met with both separately in the course of the weekend.

There was little in the way of specific measures disclosed at the G–8 session, but there never is on these occasions. We can look forward to policy details emerging quickly, however. There is a dinner of EU leaders in Brussels this week, and a full-fledged summit scheduled for June. It is likely, after this weekend, that we will see more than a new policy in outline by the June summit: We will see the guts of it.

Questions arose this weekend. The most important: whether stimulus or austerity will get top priority in the EU’s new policy mix. At Camp David, Obama talked of “an emerging consensus” on jobs and growth. Hollande said the same thing. But it is better not to count this chicken before it is hatched.

Merkel is on the record saying she will discuss such policies and sees the need for them; she is also on the record saying she has no intention of stepping back or easing off on the stringent debt-relief and fiscal policies the EU now has in place. 

The G–8 leaders also made it unanimously clear that they were committed to keeping Greece in the currency union. There is simply too much havoc and damage in store if the Greeks return to the drachma.

The question here: what this will mean for Greece as it goes to the polls again June 17. The Coalition of the Left, or Syriza, is favored to win, and its leader, 37-year-old Alexis Tsipras, has been talking a tough game. But while he wants to repudiate the bailout terms now in force, he appears ready to talk about adjusted terms.

It’s a baby-and-bathwater question. Now that the rest of the eurozone is in motion on this issue, how will voters and Tsipras respond when new policies are proposed? The wise course: The EU should have something attractive on the table by the time Greeks go to the polls.

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What might that look like? No one is sure, but there are a few tea leaves to read. First, Germany is likely to accept a higher inflation rate—in the range of 4 percent or more—so that troubled economies such as Greece, Spain, and Italy can effectively devalue their currencies and thus enhance their competitiveness. This is key, and the signs are good.

Even as Merkel was meeting at Camp David, Germany’s largest union, IG Metall, negotiated a 4.3 percent wage increase -- its highest in two decades and a benchmark for other unions. It looks to me like a signal from Berlin to Paris and other European capitals that Merkel’s government is indeed flexible.
Second is the need to stretch out repayment schedules and fiscal targets. Everyone knows the peripheral European economies are desperate for this. Lately not even the nations that set the targets can meet them. The Netherlands missed a few weeks ago. Now the European Commission estimates that France’s 2013 budget deficit will come in at 4.2 percent of gross national product—nearly half again the 3 percent target Hollande inherited from Nicholas Sarkozy, the outgoing French leader.

Finally, there is the European banking crisis, which has escaped much attention as Greece teeters toward elections that are effectively a referendum on the euro. The nexus here is Spain, where the central bank said this week bad loans jumped by more than a third in the past year, to $189 billion. It indicates the contradiction between a common currency and national law—in this case banking regulations. Solution: The European Central Bank needs to act more like the US Federal Reserve, and this implies closer political relations among EU members.

This brings us to a concluding point. Obama’s participation in talk on the European crisis was a graceful reminder that the EU has a model to follow to whatever extent it wishes to. The US is not in Europe’s fix right now because it stimulated -- not enough, but enough to avoid what we are seeing across the Atlantic.

Equally, the European crisis is made of bad loans, sovereign debt, and teetering economies. But it cannot be solved unless the Continent takes large political steps -- steps that lead to a more closely confederated union.