Europe Free Rides, Again

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If you spend much time in the finance/policy-wonk community, you spend quite a bit of time listening to complaints about Europe's wussy little stimulus package and relatively tight monetary policy.  The Europeans defend this on the grounds that they have all of these automatic stabilizers, like generous welfare benefits and unemployment insurance, which provide stimulus on the dips.

Well, sort of.  As Paul Krugman points out, they're overselling this:

On the social front, there's a quantum difference. For given depth of recession, the human suffering in America -- where losing your job means losing your family's health insurance, and unemployment benefits are minimal at best -- is vastly greater than in Europe.

On the macroeconomic front, however, the strength of Europe's "automatic stabilizers" has been exaggerated. Yes, government is about 12 percentage points of GDP larger; so each 1 percent fall of GDP automatically increases deficits by more than in the US. But unless the slump is much deeper than even pessimists expect, that won't be enough to offset the stronger US discretionary action.

The IMF has tried to incorporate the automatic stabilizer effect; by their estimates, it still comes up short.

But as multiple people have blogged, this isn't just a matter of the infamous tight-fistedness of Germany's fiscal and monetary policy, born out of the ashes of Weimar; it's genuinely harder for Europe to run a stimulative policy.  For one thing, they can't coordinate a broad European policy, which means that any government will see substantial amount of any stimulus "leak" abroad--and also that there is great temptation to free ride.  For another, they aren't the world reserve currency, so they can't borrow on the same lavish, practically interest-free scale as the US Treasury.  And taking on massive debt is very complicated when you're facing a shrinking population:

Mrs. Merkel has exerted discreet but stubborn leadership in Europe to prevent the kind of overspending that could lead to inflationary pressure on the euro.

It is not, she pointed out, simply a philosophical difference. Borrow and spend today, repay down the road, is a particularly difficult proposition for a country with a shrinking population, she said.

"Over the next decade we will undergo a massive demographic change, and, therefore, borrowing is a greater burden for the future than in a country with a much more continuously growing population, as in the United States of America," Mrs. Merkel said.

That's a real problem.  But how sympathetic is the US taxpayer supposed to be?  We pay for their military protection, we pay for the profits that develop the drugs and consumer goods they happily consume, and now we're supposed to pay for their economic bailout too.  Europe could liberalize its markets, let in immigrants, develop a real military, instead of just critiquing the way we do it.  We'll continue to let them free ride, because there's no way to stop it.  But I'm starting to think we should rub it in a bit more.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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