I think it’s obvious that letting southern European governments collapse into insolvency would be bad for the world. But the larger issue is that while Greece combines irresponsible budgeting with a bad growth outlook, even countries like Spain whose budgeting is perfectly sound are going to collapse if they can’t grow. And they can’t grow unless they have appropriate monetary policy. So as Paul Krugman says the monetary aspects of the new European rescue plan are probably the most important part:
Announcement #2, from the ECB, changes things somewhat. It now seems that Trichet has been dragged kicking and screaming into becoming at least a semi-Bernanke, engaging in much more expansionary policies than before. (Yes, the ECB says that they’re only liquidity operations, and will be sterilized, yada yada — we can only hope that they don’t really mean it.)
A more expansionary monetary policy could make a real difference — especially if the ECB ends up accepting somewhat higher inflation. Suppose that Speece or Grain need to get relative prices down 15 percent over the next five years. If the eurozone has 1 percent inflation, that’s 10 percent deflation in the periphery. If the eurozone has 3 percent inflation, all you need is stable prices. Also, a stronger overall eurozone economy means higher GDP and hence higher revenue, making the fiscal slog less grim.
Unfortunately, my sense is that Trichet probably does “really mean it.” What’s more, the fact that its resolve is being called into question means the European Central Bank may feel compelled to err even more on the side of low-inflation, low nominal GDP growth policies.
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