Karl Smith -- Assistant Professor of Public Economics at UNC-CH & Blogger at Modeled Behavior
Last year when the European crisis was heating up, I floated the idea that the if the European Central Bank were able to contain the bank meltdown, its insane monetary policy would actually be fairly simulative for the US.
Now, it looks like that scenario may be playing out. As George Wannabee points out, Germany is increasingly turning Japanese:
Much has been written about the US Economy going Japanese and there are indeed some worrying signs. And for all the Bernanke bashing, that is one thing he really understands and will fight aggressively.
Unfortunately, Euro zone policymakers and the Germans' inflation phobias are making all they can for Europe to get into an entrenched deflationary spiral.
The critical issue - as Wannabee points out near the end of the post - is that this scenario will drive up the value of the euro. If the euro zone gets caught in a deflationary spiral, real European interest rates will rise and the euro will tend to appreciate.
Under this scenario, Eurozone exports become increasingly less competitive against American exports. At the same time, the struggling European economy will likely reduce it oil imports.
This creates dual positive pressure for the United States which would see cheaper energy at the same time as more robust demand for manufactured goods.
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