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Economy in Brief

PPIs in EMU Settle Down But the Zone Itself Still Does Not
by Robert Brusca  March 5, 2013

The EMU PPI for January is up by 1.9% year-over-year. Spain, Belgium and Finland have higher year-over-year rates of change. Over 12-months the weakest inflation is in Greece- of all places. This is, of course evidence that austerity is working and not very surprising since the pain in Greece is so great.

The table provides another way to understand why Europe continues to have such great difficulties in addressing its problems. We can look at the -0.2% inflation rate in Greece as evidence that Europe is making progress especially when measured against the 1.7% rise in the PPI in Germany. Greece has gained back nearly two percentage points of competitiveness loss Vs Germany over the past 12-months. And, to some, that is reason for optimism on European progress. But the cost of that progress has been great pain and the far right hand column shows us the extent of the competiveness gap that is yet to be closed. Greece still has 34.5 percentage points of competiveness loss to make up against Germany. At this rate Greece only has 17 more years of this sort of pain to go. Is anyone really betting on the end result being a 'success?'

For Europe there is still a long way to go, at least for some EMU members. The table makes that clear. And the table is only for the small set of countries whose PPI data are updated through January 2013.

The time-series chart shows that for all of EMU capital goods prices are still undergoing a slow inflation reduction. Intermediate goods appear to have had an up-thrust reversal in inflation. Consumer goods show a slow but relatively long live continuing reduction in the pace of consumer goods inflation. Only consumer goods inflation is above the 2% mark among the three main sectors.

All in all the inflation data more or less sum up the dilemma of Europe. Europe has allowed inflation to permeate the Zone even as the ECB has controlled the overall pace. The problem, as is apparent, is that inflation has infested only certain nations but now even as it is arrested and reversed we see the very long road that lies ahead.

The ECB controlled and maintained the overall inflation rate and it had no tool or mandate and took no interest in inflation differences in various regions - only in the aggregate. But since regional inflation also coincided with various national boundaries, it was not a wise decision to ignore it. EMU is not the same sort of political area as is the United States where inflation and price level differences can exist and endure. In EMU there has been no national-level fiscal discipline and none on the regional level either. There is agriculture where a system of price supports transcends national boundaries but no real EMU-wide transfer system. Rogue regional fiscal imbalances helped to spur and sustain price inflation differences which spawned price level differences of overwhelming dimension. But the current policy of using this same mechanism, set in reverse, to put the toothpaste back in the tube will be difficult, mostly because it is already proving so painful. It is hard to believe that this sort of barbaric method could be used to the completion of the project. And that is the very clear message from the countries that are under the boot-heel of this austerity.

To this observation Europe, so far, has no answer. The ECB is offering to back stop banks and governments in its own way when problems flare up but it should be clear that what is wrong is not being fixed and that the ECB has set an unending task for itself.

As I have noted that, with respect to the US, denial may provide a way to cope but denial never fixed anything. Europe is in a deep state of denial over what is wrong and what it will take to put things back in order. Some nations are not in denial as much as they are using denial as a tactic to not face up to huge scope of their mission. Some realize the immense scope of the adjustment required and hope by use of denial to get countries to take repeated small steps not knowing how long the journey may be.

The alternative would be to use currency depreciation to realign price levels 'instantaneously, and to then employ better policy to control the feedback effects from depreciation and deal with the financial fall-out. After a currency realignment Europe could try to re-unite with a deeper understanding of the risks and hopefully better vigilance and more regional control. The lesson of the Zone is that macroeconomic targets are not enough.

Europe does not want to do this because this approach involves delinking the now-linked and poorly managed EMU system. That currency union is considered such an important part of EMU to the point of thrusting unacceptable costs on certain members in the wake of EMU mismanagement. And I prefer to call it that since for the Greeks (for example) to get in the trouble they required complicity from the banking systems of the more affluent EMU nations who over-lent. If EMU's political union is not strong enough to withstand a reset of its economics after a period of what can only be regarded as bad management, then maybe the union is not really going to be strong enough to endure anyway. This is another thought Europeans refuse to think. Or they dismiss it as a possibility to put others in denial of it so that others will not think it or explore its logical implications. After all Europe's far-reaching union is named for the currency not for the political mind-meld that does not exist.

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