The discussion with Servaas Storm on German wage moderation continues (see also here, here and here). Bibow starts his latest contribution by writing that Storm means it well: Storm is alarmed that the eurozone’s official strategy of ‘internal devaluation’ might do more harm than good by unnecessarily forcing countries that have lost their competitiveness into deflation. This is a very real concern indeed. But Storm goes astray in seemingly dismissing any role for unit labour cost competitiveness and German wage moderation in causing the eurozone crisis. At the heart of the whole confusion is Storm’s attempt to attribute to those who emphasize German wage moderation as a key causal factor in the eurozone crisis the view that ‘expenditure switching’ would explain 100 percent of the eurozone’s internal current account imbalances. Needless to say, this peculiar view is held by none of the protagonists in this debate. Bibow writes that Storm sets up a straw man that he then defeats with flying colors, not realizing that his arguments are self-defeating and make a mess of the whole analysis of monetary union.
In Storm’s view, the cost competitiveness factor is associated with expenditure switching and, given that Storm attributes to his opponents the view this explains 100 percent of current account imbalances, he takes the opposite view that cost competitiveness explains nothing at all. In his mind, the income effect alone explains it all. But this cannot be right. Wage moderation could hardly have dampened domestic demand in Germany, easing financial conditions across the eurozone, without simultaneously also boosting Germany’s cost competitiveness. Proponents of the “wage moderation hypothesis” do not hold the view that cost competitiveness and expenditures switching explain 100 percent of any intra-eurozone current account imbalances. Their argument is that German wage moderation provided an important exogenous cause of those imbalances.
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