The Escape from Balance Sheet Recession and the QE Trap: A Hazardous Road for the World Economy

CHAPTER 5 Euro Crisis—Facts and Resolution

The unfolding euro crisis offers a perfect opportunity to apply the teachings of balance sheet recession theory. The concept of balance sheet recessions is essential to understanding this crisis from both a macroeconomic (weakening economy) and a microeconomic (widening competitive gap) perspective, but in Europe there are far fewer people who understand this theory than in Japan, the United States, or the United Kingdom.

The crisis erupted when Greece's fiscal profligacy was revealed. But the real tragedy was that countries in balance sheet recessions—the opposite of the state Greece was in—were forced to respond in the same way as Greece, tipping them into deflationary spirals. Events unfolded in this way for two reasons. First, the Maastricht Treaty that underlies the euro is a defective document that makes no allowance for countries in balance sheet recessions. Second, the plurality of government bond markets within the same currency zone means that the self-corrective mechanism for balance sheet recessions functions poorly, if at all, in the Eurozone.

As noted in Chapter 1, the Eurozone, too, experienced a massive housing bubble. This bubble burst in 2007, as Figure 1.2 shows, prompting businesses and households in the affected countries to begin deleveraging and triggering numerous balance sheet recessions. Fiscal stimulus is essential to overcoming such recessions, and in 2009 Eurozone governments moved to provide such stimulus ...