FX MONETARY POLICY
versus the periphery over the last decade. This view could also entail a competitiveness loss in the Euro area versus the rest of the world, as higher overall inf lation could erode the competitiveness of northern Europe (under the assumption of a stable nominal exchange rate). This is where the debate over ‘good’ and ‘bad’ def lation links up with the discussion over the Euro area current account surplus. The ‘bad’ def lation camp wants that current account surplus to fall as Germany imports more from the p er i p h er y and
loses
competitiveness vis-à-vis the rest of the world. The ‘good’ def lation camp argues
that the
German current account surplus hardly comes at the expense of the periphery or intra-European adjustment and therefore wants to preserve it.
The debate over ‘good’ and ‘bad’ deflation links up with the discussion over the Euro area current account surplus
And it is hard to dispute that structural reform in the periphery needs
to aggressively.
Like in most economic debates, there is merit to both sides. Of course, strong German competitiveness and the German
46 FX TRADER MAGAZINE January - March 2014 be pursued more Indeed, periphery
gains in price competitiveness have often lagged impressive gains in wage competitiveness because product markets in the periphery still suffer from barriers to entry.
current account surplus hardly prevent the periphery from pursuing needed structural reforms.
Economy Minister pointed
Indeed, as Spain’s out
at the end of December, strong German growth indirectly benefits manufacturing in the periphery via Europe’s manufacturing chain.
At the same time, there are good reasons to support the case of the ‘bad’ def lation camp. First, although periphery interest rates have
fallen since the famous
“whatever it takes” sentence from Draghi in July 2012, there is little doubt that nominal and real interest rates in the periphery remain very high. Periphery d e f l a t ion would raise real interest rates, un w in d in g some of the recent progress in
easing
fi n an c i a l c ond i t ion s . Second, Japan’s experience in recent years shows
that
c u r re nc y markets tend to reward high real interest rates with a stronger exchange rate. Def lation
in
the Euro area and rising real rates
could
result in higher EUR/USD, tightening financial conditions on a broader basis even further (and beyond the periphery). Third, the kind of internal devaluation seen in Ireland may simply not be politically feasible in the rest of the periphery. There is little doubt that resistance to further
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