Relatively Easy Solutions for Europe

Obviously if there were a really easy solution to Europe’s economic problems they would be solved already, but I don’t think we should go too far down the path of “no easy solutions” here.

The best short-term solution, as outlined by Jay Shambaugh in a great Brookings Papers on Economic Activity essay (PDF) involves three new steps:

1. A pro-exports tax swap in peripheral countries where payroll taxes are slashed and the money is made up with higher VAT.


2. A pro-consumer tax swap in the core countries, where VATs are slashed and the lost revenue is made up with a combination of bigger deficits and higher payroll taxes.

3. A higher inflation target from the European Central Bank.

One advantage of this mix of policies is that unlike random acts of austerity, it would actually help solve the problem! Another virtue is that while it’s far from a pure win-win it at least gets us out of zero-sum international transfers. German export-oriented firms and their workers won’t like this idea, but it’s a huge win for German retirees and some classes of service sector workers. It gives Ireland, Spain, Italy, and Portugal a fighting chance to get out of debt not through “bailouts” but through a continent-wide policy mix designed to create jobs and raise incomes. There would still be plenty of long-term issues in play, but it would buy breathing space during which long-term reforms could be debating constructively as possible ways to raise living standards in Southern Europe rather than appearing as a plot imposed by shadowy actors in Berlin and Frankfurt.