Economic Crisis: US vs. European Solutions

Moderator: Michal Vít

Guests: Luděk Niedermayer, Jan Švejnar

 

 

The main topics of the discussion with Professor Jan Švejnar and former Vice Governor of the Czech National Bank, Luděk Niedermayer, were the comparison and analysis of European and American approaches in reaction to the current economic crisis. The event was co-organized by Cafébabel, a European online magazine.

 

Both panelists agreed that the two approaches to the economic crisis differed the most in their timing and coordination. Whereas the United States implemented the stimulus in accord, Europe was unable to find a common language. In his presentation, Jan Švejnar also discussed the character and extent of the measures adopted and put forward; that the American reaction proved to be much more vigorous in comparison to that of Europe. Jan Švejnar searched for explanations for this in the differing levels of state integration, the social and economic environments, and also in the different experiences acquired during the Great Depression of the 1930s.

 

Luděk Niedermayer noted that the financial crisis affected Europe in a way similar to the United States, particularly because of its connection to “complicated financial structures.” He also emphasized the light-mindedness of some of the politicians who were claiming that “some crisis on Wall Street cannot affect Central European states.”

 

Jan Švejnar sees the progression of the crisis on the two continents as distinct. In the US, it began as a financial crisis brought about by the creation of new financial instruments, dramatic lowering of interest rates, and thereby “blowing up the bubble” in the real estate sector, accompanied by the failure of regulatory mechanisms. The situation in Europe was comparable, although to a lesser degree, having to face a sharp decrease in demand, spreading the crisis to otherwise non-affected states.

 

According to Luděk Niedermayer, the origins of the crisis lie, among others, in the high consumption/low production ratio in the US, a deficit trade-balance and a low volume of reserve funds. He also described the problem of overrating of assets, which contributed to the fall of many financial institutions. The situation in Europe was worsened by the short-sighted fiscal policies of certain countries, focused on stimulating higher demand and promoting economic growth for political reasons, rather than introducing reforms to create sustainable long-term growth.

 

Jan Švejnar summed up the American reaction to the current crisis as replacing the individual and business demand with that of the state with the aim of removing negative expectations. This move should in turn bring the economy back to its feet, despite elevating the state budget deficit as high as 10%. However, such drastic measures are more feasible for the United States given the dynamic character of the economy, which enables it to recover more quickly. The decision was also motivated by the US experience during the Great Depression, when it became necessary to quickly prevent the fall into deeper recession.

 

Europe, on the other hand, relied more on automatic stabilizers to avoid the dramatic rise of price inflation levels. Germany, according to Jan Švejnar, representing the current European approach, experienced hyperinflation in the 1930s and has since maintained a careful approach. The European economy is generally more regulated and its policies have to take into account “high levels of social cohesion” in contrast to greater tolerance of wealth inequality in American society.

 

Diversity among European countries made coordination on the European level more difficult, agreed both speakers. Jan Švejnar pointed to the fact that despite Europe having a strong central bank for the Eurozone, its approach had to be harmonized with the individual state ministries of finance. Moreover, the American Fed has wider competences with regards to the economy in comparison with the European Central Bank, which is preoccupied only with maintaining price stability.

 

Jan Švejnar noted that in reaction to the economic crisis, the Czech Republic had to take into account the size and openness of its economy, and therefore had only limited options on its table. Taking any major steps independently of the rest of Europe could have negative consequences on the way investors perceive the Czech Republic. The cornerstone of the Czech approach is supporting employment, which is, according to Jan Švejnar, a good move given the fact that unemployment will continue to rise in Europe as a consequence of the crisis. However, the time it took for the decision to be made only proved the level of unpreparedness of institutions for such a crisis, which should have been expected, noted Luděk Niedermayer.

 

With regards to the present crisis situation, Jan Švejnar assumes that, “we do not know where we are,” but the first wave of panic has been averted and there are indications of economies slowly picking up. However, further development is hard to predict as it is not yet known whether this improvement is only the result of the measures adopted. Jan Švejnar emphasized that economists during the Great Depression failed to predict the extent of the consequences it had in the end. According to Luděk Niedermayer, up until now for many countries this crisis has meant a step back of two to three years, but added that the economic cycle is not “dead.”

 

Due to the global character of the economic crisis, we are now “in the same boat,” stated Luděk Niedermayer. He also added that the world will not go back to the “light-headedness” of bankers and that the United States will have to re-orient itself from consumption to production. However, it has to be taken into account that any such change can have repercussions on the production in China and consequently in Europe. According to Jan Švejnar, the ideal approach of dealing with the crisis would be based on close coordination among the United States, Europe, and Japan.