Economic divergence and intra-euro imbalances are amongst the pessimists’ main arguments why EMU can not survive in the long-run. But divergence – in alternating roles – is also by definition an intrinsic part of monetary union, as our European economist Giovanni Zanni illustrates below:

The current divergence in GDP growth and (real) rates within the euro area cannot be understood fully if it is not viewed in the context of a cycle within a monetary union (different from – and longer than – the business cycle).

Spain experienced higher growth and lower real rates for a decade or so, and is now likely to experience low growth and higher real rates for a prolonged period of time. Germany is in the opposite situation.

To some extent, we can view the change within the euro area by picturing Germany becoming Spain (let’s call it ‘Alemania’) and Spain becoming Germany (or ‘Spanien’). Alemania will be more reliant on consumption and credit, and would see some degree of inflation and rising house prices after 10 years of zero nominal growth, losing some relative competitiveness in the process. Symmetrically, Spanien should undergo a period of poor economic growth and inflation, in a context of relatively high real rates, slowing down its consumption and allowing it to regain relative (price) competitiveness in the process (click diagram to enlarge):

We have described these dynamics in a number of articles over the years, but maybe it is most interesting to see how these dynamics might play out over time, the key point here being that the forces at play are centripetal rather than centrifugal. In other words, we think that in the medium to long term they contribute to the stability of the euro area more than to an unstable equilibrium. Clearly, these dynamics need to be accompanied by consistent fiscal policies, limiting the phases of overcooling and overheating, and possibly complemented by at least some form of fiscal solidarity, in our view. The creation of the EFSF/ESM is a key positive development in that context.

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Jonathan Wilmot, chief global strategist at Credit Suisse Investment Bank and team are blogging at FT Alphaville for the day.

Please read this Credit Suisse small print.

This entry was posted by Guest writer on Wednesday, December 1st, 2010 at 12:38 and is filed under Capital markets. Tagged with euro, eurozone, gdp, germany, Spain. Edit this entry.