I’ve written about the need for looser monetary policy in the United States, but the situation is even worse in Europe. For one thing, as Ryan Avent points out looser money would help the European periphery regain competitiveness:
But the key to a relatively painless internal revaluation is inflation in tighter markets. And it’s here that the European Central Bank could play a particularly useful role. Were the ECB to adopt a looser monetary policy, we would expect inflation to pick up first in the markets with the least excess capacity, and that would obviously mean rising prices for Germany.
The situation is kind of bitterly amusing. The Germans hate the idea of paying for bail-outs across Europe. They want peripheral countries to buckle down, slash their deficits, and accept as much of the pain of adjustment as they can. But the best thing Germany can do to facilitate this process is to allow the ECB to pursue a monetary policy that makes internal adjustment easier — by increasing inflation in Germany. And that’s maybe the one thing Germans hate more than writing cheques to the Irish government.
But it’s hardly all about inflation. Looser money would spur higher real output in Ireland, Spain, Greece, etc. all of which would make the deficits in those countries smaller. By contrast, it’s not really clear what the “German” solution is supposed to look like — if debtor countries are going to borrow less, then either saver countries need to consume more or else world output needs to fall.