Evan Soltas
May 25, 2012

Eurocrisis = NGDP Crisis

Paul Krugman wrote a post a while back in which he looked at the data for debt-to-GDP ratios and government spending as a percentage GDP and effectively no explanatory relationship there for what's happening in the Eurozone, contrary to popular narrative. Instead, Krugman argued, Europe had a balance of payments problem.

I don't disagree with him, but I see the balance of payments problem as fundamentally driven by nominal GDP gaps, which differ strikingly between the different Eurozone nations, as monetary policy at the ECB cannot obviously stabilize on a path trend -- or keep growing even at roughly the trend rate -- nominal GDP in the 23 Eurozone nations.

The result is massive, unfathomably large nominal recessions in countries like Spain, Portugal, and Greece -- depressions, really -- amid nominal booms above trend in Germany, Belgium, and Austria. (Remember where the Eurozone is in its business cycle, and you should recognize that to be running even a small positive NGDP gap at this time amounts to a huge positive gap in normal times.)

What's going on in the Eurozone is ultimately not a debt issue, nor an issue of structural government spending. Those have undoubtedly slowed growth in the Eurozone over the long run -- but this is not a structural problem, it is a cyclical problem, a nominal problem. (See this post of mine for more on this.) Instead, these structural problems surfaced because of the nominal problem.

Note: An earlier version of this post failed to include Portugal; I redid my analyses for several of the countries to confirm that my data had not been mislabeled, but everything appears alright now. Please let me know in the comments if anything else seems faulty. Thanks. -- ES