Will Currency Devaluation Fix the Eurozone?

[Renew Deal]

The NYU professor of economics Nouriel Roubini said in Davos, Switzerland, on January 25, 2012, that tight policies are making the recession in the eurozone worse. According to Roubini what Europe needs is less austerity and more growth. In particular, the NYU professor is concerned about the deep recession in the eurozone's peripheral countries: Spain, Portugal, Greece — all are on a strict regime of austerity. For instance, in Spain the yearly rate of growth of government outlays stood at minus 12.4 percent in November against minus 15.7 percent in the month before. In Portugal the yearly rate of growth stood at minus 3.6 percent in December against minus 2.5 percent in November. In Greece the yearly rate of growth fell to 2.9 percent in December from 6.2 percent in the prior month.

A visible tightening is also observed in the two major European economies of Germany and France. Year-on-year government outlays in Germany stood at minus 1.6 percent in November versus minus 1.7 percent in October. In France the yearly rate of growth stood at minus 12.4 percent in November against minus 12.3 percent in the prior month.

According to Roubini and other experts, a tighter stance undermines already-depressed eurozone economic activity. The yearly rate of growth of real GDP eased to 1.3 percent in Q3 from 1.6 percent in Q2 and 2.3 percent in Q3 in 2010. Also the growth momentum of industrial production displays softening. Year on year, the rate of growth fell to minus 0.3 percent in November from 1 percent in the month before and 8.1 percent in November 2010.

Roubini is making the point that austerity won't let eurozone countries grow their way out of their predicament. What is now urgently required to improve the eurozone's economic situation is to devalue the euro by 30 percent, argues Roubini. Note that the price of the euro in terms of US dollars fell from 1.48 in April last year to 1.29 in December — a fall of 12.8 percent. Yet despite this depreciation of the euro, the yearly rate of growth of industrial production has fallen from 5.4 percent in April to minus 0.3 percent in November. So why then should a depreciation of 30 percent as suggested by Roubini revive the economy?
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http://www.marketoracle.co.uk/Article33059.html

[Yo_Mama]

1. Very often it does not, but it depends on your ratios

The expected effect would be different for different countries.

Take country 1, which is a country with a good range of existing exports which did not need to import that much of the basics (generated most of its own energy, grew most of its own food, had an existing domestic industry supplying clothing and many consumer products). In such a country, you'd expect real domestic production to rise, thus stimulating the economy and producing a growing cycle of production and expansion. Since external consumer goods would inflate in relations to imported consumer goods, the domestic industries supplying consumers would grow as well. Jobs would grow and consumers might be a bit pressed by inflation, but more consumers would be working which would have an offsetting effect. Because the country generates most of its own fuel, the products of domestic industries could be exported for less in comparison to countries without the devalued currency.

Take country 2, which has a predominantly consumer-led economy, some exports, imports a lot of its energy, imports 30% of its food, and imports most consumer goods. The rise in import energy costs would cause a rise in internal energy costs which would push inflation up across the board and cut company profits. All of the food, consumer energy, and many consumer goods would get more costly, cutting real incomes for most of the population. This would impose austerity on consumers. For such a country, a recession would result. Over a decade or so perhaps domestic industries would grow to supplant some of the costlier imports, but in the first few years the result would be to steeply deflate the real incomes of consumers. Also, if this country has a high ratio of public spending for social welfare, these expenditures would rise far more rapidly than its tax increases from its enhanced exports, so the government fiscal balance would get worse. A country with low public debt could carry that for years, but a country with high public debt would have to cut real social benefits, which would inflict another round of austerity on the population.