Wynne Godley On Resolving Imbalances In International Trade

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International trade is central in Wynne Godley’s models and work. Wynne Godley not just foresaw the unsustainability of US private sector imbalances and the return of Keynesianism, he also proposed non-selective protectionism for the United States. Over time, he thought that more international efforts are needed, such as changing how international institutions are run.

In his article The United States And Her Creditors — Can The Symbiosis Last? written in 2005 (with coauthors), he said:

A resolution of the strategic problems now facing the U.S. and world economies can probably be achieved only via an international agreement that would change the international pattern of aggregate demand, combined with a change in relative prices. Together, these measures would ensure that trade is generally balanced at full employment.

In his last article Prospects For The United States And The World: A Crisis That Conventional Remedies Cannot Resolve (with coauthors), he said:

Need for Concerted Action
…
At the moment, the recovery plans under consideration by the United States and many other countries seem to be concentrated on the possibility of using expansionary fiscal and monetary policies.

But, however well coordinated, this approach will not be sufficient.

What must come to pass, perhaps obviously, is a worldwide recovery of output, combined with sustainable balances in international trade.

Since this series of reports began in 1999, we have emphasized that, in the United States, sustained growth with full employment would eventually require both fiscal expansion and a rapid acceleration in net export demand. Part of the needed fiscal stimulus has already occurred, and much more (it seems) is immediately in prospect. But the U.S. balance of payments languishes, and a substantial and spontaneous recovery is now highly unlikely in view of the developing severe downturn in world trade and output. Nine years ago, it seemed possible that a dollar devaluation of 25 percent would do the trick. But a significantly larger adjustment is needed now. By our reckoning (which is put forward with great diffidence), if the United States were to attempt to restore full employment by fiscal and monetary means alone, the balance of payments deficit would rise over the next, say, three to four years, to 6 percent of GDP or more—that is, to a level that could not possibly be sustained for a long period, let alone indefinitely. Yet, for trade to begin expanding sufficiently would require exports to grow faster than we are at present expecting, implying that in three to four years the level of exports would be 25 percent higher than it would have been with no adjustments.

It is inconceivable that such a large rebalancing could occur without a drastic change in the institutions responsible for running the world economy—a change that would involve placing far less than total reliance on market forces.

Francis Cripps, Alex Izurieta and Ajit Singh also talk of a different way to run the world, in their 2011 article Global Imbalances, Under-consumption And Over-Borrowing: The State Of The World Economy And Future Policies:

John Maynard Keynes repeatedly observed that the economy is a highly complex machine which we do not fully understand. This article and the Cambridge-Alphametrics-Model on which it is based represent an effort to appreciate the complexities of the world economy and its components and to seek avenues for international policy coordination. The main message that comes out of this exercise is the realization that the world economy is highly interdependent and increasingly needs far-reaching and very many specific interventions for it to achieve its full potential while pursuing a better distribution of income and employment. This in turn requires deeper knowledge of the functioning of the world economy and new institutions to achieve the required high levels of cooperation between nation states. At the moment the primary global institutions of economic coordination such as the IMF are, regrettably, more a part of the problem than its solution.

Not Bancor, But An International Agreement

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While John Maynard Keynes understood that trade/current account deficits can become a problem, not just for a country with it but also for the whole world, he quite underplayed the role of international trade.

(You can read about the downplaying in Nicholas Kaldor’s essay Keynesian Economics After Fifty Years, in the book Keynes And The Modern World : Proceedings Of The Keynes Centenary Conference, King’s College, Cambridge, written in 1983)

To resolve imbalances, Keynes proposed Bancor, a word which is a combination of the words ‘bank’ and ‘or’, which means gold in French, according to a paper The Eurozone: Similarities To And Differences From Keynes’s Plan by Marc Lavoie.

From the paper:

… The plan is based on a fixed exchange rate system, each foreign currency being expressed as a fixed value of the bancor …

A comprehensive explanation can be found in Marc Lavoie’s paper, which I won’t delve into here. But the important point is that there is a supranational central bank—an International Clearing Bank/ICB—like the ECB, in which national central banks hold accounts and which clears international payments.

Now Keynes proposed various rules, based on settlement balances of national central banks at the ICB, to give a sort of responsibility to surplus countries, such as fines but also that they expand their economies, so that they import more and deficit countries able to take measures such as devaluation.

But there is a problem!

The problem is that surplus/deficit etc are defined from settlement balances of national central banks at the ICB, which are not current account deficits, or not necessarily any indication for other things such as the net international investment position!

Imagine a country such as China which has huge trade or current account surpluses and then the counterpart in the financial account of the balance of payments is the Chinese government accumulating US government bonds. The Chinese central bank’s account at the ICB hardly changes, and the balances show no indication that any surpluses are being built up, and no rules need to triggered.

So obviously Bancor cannot be the solution. The solution is diplomacy at the international level, mainly with current account deficit numbers, but other data in the balance of payments and international investment position too. With responsibilities for surplus countries.

International Trade And Demand Management

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It seems that even post-Keynesians—with rare exceptions—are largely inattentive to open economy macro. Exceptions in this century are Wynne Godley and some people highly influenced by him.

In an article Wynne Godley Calls For General Import Controls, for LRB, published in the year 1980, Wynne Godley, argued:

For growth to be sustainable, it is essential that the management of domestic demand be complemented by the management of foreign trade (by whatever policies) in such a way that the net balance of exports less imports contributes in parallel to the expansion of demand for home production

Although in pedagogy Wynne Godley used to introduce the open economy late, it is central to his ideas. For example, you can expressions such as:

GDP ≈ (G + X)/(θ + μ)

where G, X, θ and μ are government expenditure, exports, the tax rate, and propensity to import. This is to first approximation

Even many post-Keynesians—not just neoclassical economists—giving public commentary recently in the aftermath of Trump’s tariffs however seem to be saying “do nothing“.

Before the financial crisis which started in 2007, fiscal stance was tight and US exports relative to imports was also low. So the above expression was lower than the actual GDP and growth was mainly driven by private sector borrowing at a large scale. When the recession happened, the fiscal part of the expression (G + X)/(θ + μ) was relaxed, although not enough to reach full employment. The process was still unsustainable since the international trade part of the expression did not grow in parallel with the fiscal part, continuing the worsening of the US balance of payments and international investment position.

The New Tariffs

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US President Donald Trump’s new tariffs seem haphazard but to me the reaction of people—including that of post-Keynesians—seems more interesting. The general reactions seem to be that the United States does not need to do anything. Across the political spectrum, people seem to peddle do-nothingism.

The United States’ balance of payments and international investment position is on an unsustainable path.

US NIIP/GDP

United States NIIP/GDP ratio. Chart via FRED

−1.0 means −100% of GDP.

Now that is just a chart but even from a theoretical perspective one can provide an analysis such as using Wynne Godley’s models.

Since the market mechanism does not reverse the process, an official intervention is needed.

Wynne Godley worried a lot about this and had proposed non-selective protectionism for the United States.

But going by people’s reactions with even the most radical sounding people sounding like fans of free trade, it seems to me that people simply would have rejected any proposal even if it were not haphazard.

Wynne Godley’s biographer Alan Shipman says this about him in his biography:

Of all Godley’s policy prescriptions, direct import controls were the one most roundly rejected by other economists, and least likely to be adopted by politicians with any chance of gaining power. The accusation of advocating a policy that was economically illogical, politically infeasible and inadmissible in international law hurt deeply, but never crushed his belief that import quotas should be seriously considered as an additional macroeconomic instrument. The depth of the wound emerged in an unusually personal statement to a 1978 conference on ‘Slow Growth in Britain’, convened by Oxford University’s Wilfred Beckerman in Bath. ‘I am disconcerted and distressed to find myself, together with the group of people with whom I work in Cambridge, in such an isolated position. For we seem to be the only group of professional economists who entertain the possibility that control of international trade may be the only way of recovering and maintaining the prosperity of this country; that free trade may be an enemy for the relatively weak’ (Godley 1979: 226).

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References

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Godley, W. (1979). Britain’s chronic recession—Can anything be done? In W. Beckerman (Ed.), Slow Growth in Britain. Oxford: Clarendon Press.

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Talking of Wynne Godley, I found this nice autograph in his own book ‘Monetary Economics’, presumably to Lance Taylor?

Anyway, there are is one thing I wanted to address which is often made … that the trade deficit is just a reflection of the saving and investment decision of the private sector (or the country as a whole including the government) because there is an accounting identity connecting the two:

S − I = DEF + CAB

Where, S, I, DEF and CAB are private saving, private investment, government deficit and current account balance respectively.

But this accounting identity is not causation itself. Exports and imports depend on income and price elasticities, and income and price at home and abroad, so while private sector parameters of saving and investment can affect the trade balance, it is also affected by the elasticities. And if elasticities for imports are high relative to imports of the rest of the world, then that is a problem of competitiveness which the US is facing.

The Languishing Finances Of The United States

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Two recent statistical releases which needs attention: the US international investment position and the primary income in the balance of payments turning negative.

Charts from the BEA:

US NIIP

Source: U.S. International Investment Position, 3rd Quarter 2024

US Current Account and Component Balances

Source: U.S. Current-Account Deficit Widens in 3rd Quarter 2024

For an idea, the US GDP was $29.4 trillion in Q3 on an annualised basis, according to the Fed’s Z.1.

Now a lot has been written on this but I suppose rise of the US net indebtedness (the negative of the net international investment position) has been slower than anyone expected, including the great Wynne Godley. One of the reasons of course is that the primary income balance has been positive for long, which is surprising in a way. Primary income mainly consists of income from income from direct investment, dividends and interest income. Lots has been written on this too, and the connection between the two, but once the balance on primary income turns negative, the net indebtedness will rise at a faster rate.

Now, even though a lots has been written on this, mainstream economists have shooed measures such as import controls and improvement of exports. The only exception among economists was Wynne Godley.

Some measures have been taken by the United States such as tariffs, industrial policy. These have been taken in limited ways as there is a lot of ideological opposition to such things. But obviously with China on the rise and its ever expanding rise in its current account balance in its balance of payments, there is some realisation that the United States needs to do something more. The rise in China also injures other countries, so the problem is becoming more international.

Generally economists make it look like international trade is a small complication in the economic theory, and lack understanding of how it is central to the way the world works. With rising imbalances—on the negative in the United States and the other way round in China, is not good for the world in another way because a slowdown of the United States to keep its finances in check slows the growth everywhere. So from the point of view of a poor country, say India, the need to address both US imbalance and the rise of China are highly important.

A Fine Wynne Godley Article On Keynesianism From 1984

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There is a fine Wynne Godley article from the year 1984 titled Confusion In Economic Theory And Policy — Is There A Way Out? in the book After Stagflation: Alternative To Economic Decline, edited by John Cornwall, 1984, in which he discusses his worldview and how Keynesianism should work. In this he talks of how Keynesianism requires international coordination of not just fiscal policy but also management of international trade.

He starts off by how Keynesianism demand management works:

The policy makers of that era and those who advised them particularly in Britain and the United States came, generally speaking, to share a view, the authorship of which was correctly attributed to Keynes, that governments could, and therefore should, accept responsibility for ensuring real growth and full employment. And those same people also believed that the success, at that time, of the industrialized economies was the consequence of the implementation of Keynesian policies.

While the idea that governments can and should accept responsibility for maintaining full employment can be attributed to Keynes, the theoretical basis of the explicit or implicit models used in practice to underpin Keynesian policy advice was pretty crude. The essential points were as follows.

  1. To obtain real growth and full employment it was necessary and sufficient to expand aggregate demand for goods and services. Governments could achieve this by expanding their own expenditure on goods and services or releasing disposable income by cutting taxation.
  2. There might be a temporary constraint on the growth of real output imposed by shortage of physical or human capital. A constraint might also be imposed if exports did not rise sufficiently to pay for imports.
  3. Subject to these constraints, fiscal policy could safely adopt full employment as a target while disregarding any imbalance in the Budget — that is, any excess of public spending measured in nominal terms over revenue receipts.
  4. Monetary policy under this system of ideas did not matter much, the quantity of money itself being a residual number thrown up by everything else that happened which could safely be ignored. It was even the case through much of the post-war period that statistics relating to what are now called ‘monetary aggregates’ (the stock of money and various other financial assets) were not regularly available, if at all.¹

…

NOTES

  1. In other words people thought and built econometric models which were based on an ‘IS’ mechanism without any (operative) ‘LM’ process; if these models contained a representation of the financial system, that did not make any important differences to the solutions they generated.

And later:

…  I am prepared to assert that the macroeconomic theory on which policy was based in the successful post-war period was essentially correct after all.11

…

I do not for a moment accept that the post-war Keynesian consensus has been in any way confuted by events.

NOTES

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  1. In the appendix I have attempted to set out rigorously, if briefly, why this is so, and how the confusion in Keynesian macroeconomics can be resolved and why the most important change which I have had to make in my views about macroeconomic policy has nothing to do with the theory of inflation as such, nor about monetary aggregates, ‘crowding out’ etc. It has to do with the importance of the proper inflation accounting of all national-income accounting concepts i.e. stocks as well as flows. It is (maybe?) slowly coming to be realized that, to be meaningful as a measure of fiscal stance, a budget deficit must be corrected for cyclical movements. It has still to be understood that public deficits, if they are to be measures of the determinants of real demand and output, must also be corrected for the erosion of the money value of the stock of government debt (including ‘inside’ money) from inflation.

Then Wynne Godley talks of how Keynesianism would need international coordination:

Even if I am correct in supposing that the post-war Keynesian system of ideas was a basically correct foundation for economic policy this does not, unfortunately, mean there is a simple solution to the problem of world recession by simply reverting to old ways. Even if my views about the key role of fiscal policy were generally accepted and monetary targeting were abandoned, the world economic situation has now gone so badly wrong that it would be very difficult to put things right again. To achieve sustained growth would require that countries cooperate with one another in an altogether new way, coordinating their plans as they have never done before.

…

The conclusion must be that even if we could now coordinate fiscal policies to accommodate the fact that different countries are in different degrees of recession, I am quite sure that very large current-account imbalances would emerge. So we need not only to coordinate our fiscal policies, we also need to coordinate our trade policies and payments as well. Yet, under the present system of floating exchange rates, we have been deprived of the traditional means of making balance-of-payments adjustments. Paradoxically, by having floating exchange rates we have deprived ourselves of exchange rates as an instrument of economic policy.

In sum, I believe that there is no intrinsic reason why growth and full employment in the industrialized world should not be achieved by coordinated fiscal policies in combination with an appropriate configuration of exchange rates. The difficulties are first that action and cooperation along these lines are not at all what governments at present have on their agenda; second there does not at present exist a system of information and analysis which could form the basis for such a coordinated plan of action; third, even if exchange rates could be adjusted to satisfy the long-run conditions for equilibrium, the trade responses to currency adjustment are known to be very slow so there would be a long transitional period during which potential-deficit countries would have to suffer large increases in import prices (and therefore inflationary pressure) and cuts in real income.

I am, therefore, very doubtful if, even supposing that international cooperation was attempted, it could now really be successful without some form of international trade management. By trade management I do not mean protection in the sense ordinarily understood, i.e. a situation where individual countries unilaterally protect individual weak industries without international agreement and in a way unrelated to general macroeconomic management.

What I have in mind is that deficit countries adopt the kind of protection specifically catered for in the little read and, I believe, never used Article 12 of GATT which is specifically designed to make full employment possible in countries which would otherwise be subject to a general balance-of-payments constraint. The key point of such trade management would be, first, that it would be operated as a macroeconomic instrument, in harmony with fiscal policy, so as to ensure that the balance of payments would not be any more favourable than would otherwise be the case; in other words such protection would be used entirely to make possible higher domestic production reducing the import propensity without reducing total imports themselves below what they otherwise would be. Under such conditions the rest of the world does not suffer (its exports being, by assumption, fully maintained) and the recovery of output can be much more rapid and less inflationary.

Is The US Public Debt Sustainable?

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The US public debt is rising $1 trillion every 100 days, headlines say. Is the US public debt sustainable?

Well, the US net international investment position is on an unsustainable path and that reflects on the US public debt. The solution is not fiscal contraction but using policy to address the US balance of payments.

According to the Federal Reserve release Z.1, the US net international investment position was −$19.37 trillion at the end of 2023. (Table B.1, line 24), while the Gross Domestic Product for 2023 was $27.36 trillion. (Table F.2, line 1).

Since government deficit is connected to the current account balance by an identity,

NL = DEF + CAB

where NL is the private sector net lending, DEF is the government deficit, CAB is the current account balance, it suggests a connection between the government deficit and current account balance not just as a static identity but behaviourally and there is a connection between the public debt and the net international investment position. In behavioural stock-flow consistent models, this can be seen more clearly.

The US has had high current account deficits and that has put the US economy on an unsustainable path.

And in general, there is no market mechanism to resolve imbalances. Lots of political discourse in the US has been around trade/tariffs etc. Industrial policy has also appeared. Note that many people define industrial policy as government picking winners, but that is misleading/a deceit. The aim of industrial policy is to improve competitiveness of a country and that has to do with exports and imports.

A lot of people complaining about the path of the US public debt seem to suggest that the way to solve it is via fiscal contraction. But that causes a deflation of the US economy and increases unemployment.

But sadly, the other side denies that there is any problem with sustainability/trade etc. So we have crazy politics. An important problem is the lack of understanding how economic forces operate. Or that people’s self-interests stand in the way of understanding.

Note that “r < g” is not a condition for sustainability.

The resolution of the problem lies in the US asking the rest of the world to increase growth by more fiscal expansion (which would increase US exports and reduce US imports relative to GDP), use protectionist measures and industrial policy and then work toward a system of planned/regulated trade where international trade is generally balanced.

R.I.P., Anthony Thirlwall

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Anthony Thirlwall has passed away. His work is highly important in Post-Keynesian economics. Here is what one of his ex-students Mohammed Nureldin Hussain said about the Thirlwall Law in The Implications Of Thirlwall’s Law For Africa’s Development Challenges in the book Growth And Economic Development: Essays In Honour Of A.P. Thirlwall:

The Professor started to work out the mathematics of his manuscript. The good old blackboard notwithstanding, the identities and equations of the model were animated, left-handedly, in a manner that competes easily with Bill Gates’ PowerPoint facilities. The model contained three basic equations representing the growth of imports, the growth of exports, and a dynamic expression of the overall balance of payments equilibrium. He substituted the first two equations into the third and the model was solved to yield an elaborate expression of the growth rate of real gross domestic product (GDP). When the terms of trade were assumed to be constant the elaborate equation collapsed into an expression containing three symbols: y = x/π. ‘The rate of growth (y) of any developed country in the long run is equal to the growth rate of the volume of its exports (x) divided by its income elasticity of demand for imports (π)’, he explained.

Our eyes were fixed on the blackboard, attempting to digest the meaning and internalize the implications of this tri-legged animal. That job was not easy. For the animal distilled volumes of legendary work in economic development, encapsulating all of them in a small-sized anti-underdevelopment pill. The teaching of Engel’s law, which implies that the demand for primary goods increases less than proportionally to increases in global income; the Harrod foreign trade multiplier which put forward the idea that the pace of industrial growth could be explained by the principle of the foreign trade multiplier;3 the Marshall– Lerner condition which implies that a currency devaluation would not be effective unless the devaluation-induced deterioration in the terms of trade is more than offset by the devaluation-induced reduction in the volume of imports and increase in volume of exports; the Hicks super-multiplier4 which implies that the growth rate of a country is fundamentally governed by the growth rate of its exports; the Prebisch–Singer hypothesis which asserts that a country’s international trade that depends on primary goods may inhibit rather than promote economic growth; the Verdoorn–Kaldorian notion that faster growth of output causes a faster growth of productivity, implying the existence of substantial economies of scale;5 Kaldor’s paradox which observed that countries that experienced the greatest decline in their price competitiveness in the post-war period experienced paradoxically an increase in their market share and not a decrease; the literature on export-led growth which asserts that export growth creates a virtuous circle through the link between output growth and productivity growth – all of these doctrines were somehow put into play and epitomized within this small-sized capsule. Not only that but the capsule was sealed by the novel and powerful ingredient of the balance-of-payments constraint: ‘in the long run, no country can grow faster than that rate consistent with balance of payments equilibrium on current account unless it can finance ever-growing deficits which, in general, it cannot’.

The time for class discussion came and all the debate seemed to linger around one basic query: if growth could be explained by a rule which contained two variables only, what was the relevance of the many other socio-economic variables that could also influence the growth process? What about the role of policies and economic management? What about the role of capital, labour and technical progress? The answers of the Professor were convincing to some students, but confusing to many others. In an attempt to relieve our baffled faces he concluded the discussion by saying, in a pleasant fusion of smile and speech: ‘Simple laws make good economics’. And as he was leaving the classroom, his smile turned gradually into a laugh that engulfed his remark: ‘if this rule came to be known as Thirlwall’s Law, I will retire’. Less than one year after the publication of the manuscript in 1979 the rule was crowned as ‘Thirlwall’s Law’. But, retire? He did not. I suppose genuine philosophers like this man will never retire even if they wanted to.

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NOTES

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  1. See Kaldor (1978).
  2. See McCombie (1985).
  3. See Kaldor (1975).

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REFERENCES

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Kaldor, N. (1975), ‘Economic Growth and the Verdoorn Law – A Comment on Mr. Rowthorn’s Article’, Economic Journal, 85(340), December, 891–6.

Kaldor, N. (1978), ‘The Effects of Devaluation on Trade in Manufactures’, in N. Kaldor, Further Essays on Applied Economics, London: Duckworth.

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McCombie, J.S.L. (1985), ‘Economic Growth, the Harrod Foreign Trade Multiplier and the Hicks Super-multiplier’, Applied Economics, 17(1), February, 55–72.

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Appreciated/referrred by Anthony Thilwall himself in his article Balance Of Payments Constrained Growth Models: History And Overview from the year 2012.

Trump Proposes A Ring Around The Collar

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In a recent interview with Larry Kudlow, Donald J. Trump has proposed a 10% tariff on all goods and services produced by nonresident economic units which he calls “a ring around the collar”.

Trump has a chance to be reelected the President of the United States and it’s noteworthy not just because of that but because there is hardly anyone proposing the same. I think that the US balance of payments and hence its financial position is in an unsustainable path and it has to take such measures.

It is important to realise that Trump was using protectionist measures in his Presidency, he faced ridicule from supposed experts. But soon when Joe Biden became the President, Biden not only continued Trump’s policy but also did more to try to improve the US’s net international investment position.

But instead of acknowledging this, the expert class obviously has its narrative. It’s partly to do with the fact that they don’t want to acknowledge that they were wrong and the rest with the fact that they want to return to the old world order of free trade once the US presumably improves its economic/financial position.

Paul Krugman has a Twitter thread and an article in The New York Times on this. It’s a tribe defense, plus a plan to keep this as it is after a small change, with the assumption that it will succeed.

The Euro Area Crisis As A Balance-Of-Payments Crisis

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In a recent blog post Revisiting The Euro Crisis, J. W. Mason argues that the current account imbalances in balance of payments isn’t a/the cause of the Euro Area crisis.

This is completely wrong!

Current account deficits have an effect on the government budget balance and a higher current account deficit would lead to a higher budget deficit than otherwise. This is not just a matter of accounting but true behaviourally. The large current account deficits ultimately caused a large public debt and investors in government debt became nervous and there was a crisis in the government bond markets of the Euro Area. Since lot of government debt is held by foreigners, as it is difficult for residents to hold all that debt (when there’s large net international indebtedness), the sale and the movement of funds abroad after the sale also resulted in a banking crisis, as banks went heavily overdraft at their NCBs and didn’t have sufficient collateral.

The crisis in banking and government bond markets caused more crisis in private debt markets and fiscal retrenchment, fall in GDP and that leading to more crisis!

As simple as that!

One of Mason’s arguments is that since lending by foreigners needn’t arise out of prior saving, the result liabilities owed to foreigners isn’t really debt. But how does it follow that one thing implies the other? If foreigners transfer a large amount of funds to accounts in their home countries, there would be a banking crisis as banks would find it difficult to post collateral to their NCB (National Central Bank). The government would have to rescue banks adding to public debt and making investors nervous.

Greek banks endogenously creating money doesn’t mean that a purchase of a German product by Greek residents doesn’t reduce Greek’s net asset position or increase its net indebtedness to Germany.

Mason says:

 Many people with a Keynesian background talk about endogenous money, but fail to apply it consistently

Perhaps he is the one failing?

Take a simpler example: loans make deposits. But it’s also true that deposits are funding banks. The fact that banks created funds doesn’t imply that the created deposit isn’t a liability or debt.

Mason also discusses how the TARGET2 system works with the ECB/NCBs. The NCBs have  unlimited and uncollateralised overdrafts with each other and unlike the arrangements prior the formation of the Euro Area, there isn’t an equivalent worry about central banks running out of reserves. But unlimited overdrafts for the NCBs does not imply unlimited overdrafts for the whole country! It’s just that the crisis is seen elsewhere, like in banking and the government bonds markets.

Mason also takes issue with phrases such as “capital flight”. But investors can sell assets and move funds to another country and that can put pressure on banks. How is the phrase not helpful in describing what is going on?

The problem with the Euro Area is that with exchange rates fixed irrevocably and with governments prevented from making overdrafts at their NCBs, governments cannot devalue their currency or take independent fiscal action than allowed by markets. Fixed or floating, the problem is there, and the Euro Area setup makes it worse. Doesn’t remove the problem altogether!

You can see from the data from Eurostat that Euro Area countries with the worst net international investment position were the ones seeing the worst crisis. The net international investment position is accumulated current account balance plus revaluations/holding gains/”capital gains”.

Of course, the solution of the crisis isn’t wage deflation (sometimes referred to as internal devaluation), but the formation of a central government. With the central government, there are fiscal transfers with some Euro Area countries receiving more from the government than what they send in taxes. This would improve the current account balance of those countries, keeping imbalances in check. A central government would both be able to take independent action and keep imbalances in check.