This is a syndicated repost courtesy of The Baseline Scenario. To view original, click here. Reposted with permission.

…The recently concluded G20 summit is being interpreted as shifting the balance away from the “austerity now” group, at least to some extent.  But both sides of this debate are missing the important issue.  As a result, the euro area continues its slide towards deeper crisis and likely eventual disruptive break-up.

The underlying problem in the euro area is the exchange rate system itself – the fact that these European countries locked themselves into an initial exchange rate, i.e., the relative price of their currencies, and promised to never change that exchange rate.  This amounted to a very big bet that their economies would converge in productivity – that the Greeks (and others in what we now call the “periphery”) would in effect become more like the Germans.  Alternatively, if the economies did not converge, the implicit presumption was that people would move – i.e., Greek workers go to Germany and converge to German productivity levels by working in factories and offices there.

It’s hard to say which version of convergence was more unrealistic.

In fact, the opposite happened.  The gap between German and Greek (and other peripheral country) productivity increased, rather than decreasing, over the past decade…

Read the rest of this post at The Baseline Scenario. View original post.

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