28 October 2010

A Picture Tells Another Story

This chart appeared in The Economist last week to show how strongly Germany has emerged from the recession.

It is clear that GDP growth in Germany has recovered ahead of the 5 other countries. Looking at the early part of the chart tells another story. In 2002 and 2003 Spain, Ireland and Greece were growing much faster than Germany, France and Italy. While Germany struggled to get growth up to 2%, the three peripheral states were touching as much as 6%.

Think about interest rates. Germany, France and Italy needed low rates to stimulate their economies. Ireland and Spain need higher rates to stop their rapid growth leading to inflation. In fact, inflation in Spain and Ireland was around 4% at the time and house price inflation even higher.

All six countries are in the Euro zone and so had the same interest rate - one more attunued to the needs of the three larger economies than the smaller ones.

Higher inflation, makes countries less "competitive". (Yes, I am still on my quest.) If costs have risen then the price of exports are higher and the price of imports lower; another meaning of the word competitivness.

So when this week's EU summit talks about the competitiveness of peripheral countries in the Euro zone, there is an explanation in terms of the problem of controling inflation when monetary policy is not available to help.

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