Some, like Krugman, have argued that the European crisis is a technocratic failure, the result of quasi-religious beliefs in mythical creatures ("the Confidence Fairy") held by Very Serious People in government and the commentariat. If only they would just abandon their heresies and follow the One True Keynesian path, everything would be fine. The optimal policy is obvious and Pareto-improving -- more monetary stimulus, possibly combined with debt rescheduling and the end of fiscal austerity -- so all that is required is the fortitude to implement it.



Others, like me, have argued that the European crisis is a political crisis, the result of a disjunction between the interests of the Eurocore (esp Germany) and the Europeriphery. Rather than postulate cognitive dissonance or willful ignorance (or something more sinister), I focus on distributional issues: either the Europeriphery's creditors are re-paid or they are not; either the Eurozone's macroeconomic imbalances are addressed by adjustment in Eurocore or by adjustment in the Europeriphery. Ultimately these are political questions, and political questions are generally decided by those with the most political power. In the case of the EZ crisis, any resolution must involve the European Central Bank, and the ECB has traditionally been influenced by Germany more than other member nations. There is no Pareto-improving policy -- what helps some countries hurts others -- so this is not a technocratic problem.



Look at this picture (via Niklas Blanchard) and tell me which view best explains the European Central Bank's policy calculus, and thus outcomes in Europe:





Germany is running above its nominal GDP trend; everyone else is below it. That means that further monetary stimulus will increase real GDP growth everywhere but Germany, which will instead experience higher inflation*. Germany does not want that to happen, because Germany does not like inflation. Germany has disproportionate control over the monetary authority of Europe. Therefore, the Europeriphery does not receive the monetary support which they want, because it would cause inflation in Germany.No parsing of myths necessary; it works without them. Also no moral lesson. Just normal distributional politics.UPDATE: Fixed some typos and poor wordings, which were both more common than usual (I think) and more egregious, and thus more likely to lead to misunderstanding.*Added at the same time as typo-fixing: Arguably an increase in German inflation would not facilitate the sort of adjustment which is needed anyway. Higher German inflation would depreciate the real exchange rate of Germany vis-a-vis the other members of the eurozone, thus increasing Germany's competitiveness in export markets relative to, say, Spain. Movement in the opposite direction is needed. Because Spain cannot devalue externally through a fall in its currency, it will have to adjust to a rising real interest rate with an even larger internal devaluation. That means even lower wages, and probably more fiscal austerity.If I'm right about that it's a potentially very interesting point which I've seen no one else mention.