Deflation in the euro zone: The euro zone needs a history lesson

Posted: January 17, 2014 in economy
Tags: , ,

Rounding off the contributions to our round-table discussion of the risk of deflation in Europe is Kevin O’Rourke, professor of economic history at Oxford University.

In a recent column in the Financial Times, Wolfgang Münchau discussed the set of choices that appear, as of now, to have been made by Europe’s policy-making elite. These are: to preclude any form of debt mutualisation; to have individual debtor countries pay off their existing debts; and to have them adjust macroeconomically via austerity and deflation. In Münchau’s words, “If you look at this with a knowledge of economic history, this is an awe-inspiring set of choices, to put it mildly.” He’s right.When economic historians teach the history of international monetary relations they often start with the classical gold standard of the pre-1914 period. Under this system, periodic deflation was a feature, not a bug. Deficit countries were supposed to adjust by following the “rules of the game”, raising interest rates and reducing the money supply, thus lowering price levels, depreciating real exchange rates, and improving trade balances. (Alternatively, Humean gold flows could have sparked the same adjustment process automatically.) If such an adjustment mechanism was suitable to any period, it was the decades before World War I. Relatively flexible wages and prices meant that deflation was more feasible …

via Economic Crisis http://ift.tt/K9jBdB

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