I’ve been talking to some people I respect about the fate of the euro, and specifically yesterday’s column, and it seems to me that the key issue here involves the balance of risks.
Think of it as Scylla and Charybdis. On one side, there is the risk of seeing European economies dashed against the rocks of debt crisis; on the other, the danger of seeing Europe pulled down into a vortex of deflation.
For the past four years European policy has been dominated by a completely one-sided assessment of these risks: imminent debt disaster (90 percent omg), and nothing to worry about from austerity — the Confidence Fairy will take care of it. But there is a more sober, serious position which considers the shoals of debt a serious risk, and the vortex of deflation not yet too threatening.
As you might guess, I have a different view. Now that the ECB is willing to do its job as lender of last resort, the debt threat is much less pressing than previously portrayed — and I have been arguing all along that for non-euro countries it’s not a threat at all. Meanwhile, I’m terrified about that vortex; Europe may still be circling the drain fairly slowly, but inflation expectations have become unmoored, actual inflation is falling, the recovery, such as it was, has stalled. And by the time the downward spiral becomes undeniable it may well be irreversible.
Could I be wrong? Of course. But economic policy always involves balancing risks, and I think we should be much more afraid of a European depression than we are of fiscal crisis.