The popular story in Europe these days goes something like this: The introduction of the Euro allowed for cheap money to flow into the periphery, reducing yields, and creating voracious demand to buy German goods. This was the bubble that burst.
But then, why did the bubble form in the first place?
In his new note out, Richard Koo adds more fuel to the ‘Blame Germany’ fire, exploring the source of this bubble.
Main cause of southern European bubbles: low interest rates intended to save German economy
A careful examination of the facts shows a key cause of the housing bubbles in Ireland and southern Europe was the ECB’s decision to lower short-term interest rates to 2% to boost a moribund German economy. (Germany had fallen into a balance sheet recession after the IT bubble collapsed in 2000.)
Circumstances at the time were the opposite of what they are today: Ireland and southern Europe had sidestepped the IT bubble and were posting strong economic performances. The ECB policy rate of 2% was too low for them, leading to housing bubbles that were further exacerbated by capital inflows from German and French banks seeking higher yields.
Not only were short-term interest rates in these countries too low, but long-term rates dropped as funds flowed in from Germany and France, adding more air to the bubble.
If Germany had addressed its balance sheet recession with greater fiscal stimulus, the ECB would not have had to lower interest rates as much as it did, and the housing bubbles in Spain and Portugal would not have expanded to the extent they did.
In the event, however, Germany chose to observe the Maastricht Treaty’s 3% cap on fiscal deficits. That prevented the government from administering needed fiscal stimulus and shifted the burden onto the shoulders of ECB’s monetary policy. The ECB then lowered short-term interest rates, triggering bubbles in Ireland and southern Europe.
Meanwhile, there’s a new bubble forming, and that’s in German real estate.
This chart is eye-popping.
Click to enlarge.
Of course, it’s the result of money from the periphery rushing out of countries like Italy and Spain and into Germany. No wonder the Germans can’t bear more monetary easing.