Saving Portugal and Spain: Solutions(2)

In this next post in the series on the Iberian peninsula, I will deal with economic solutions that can be taken by outside actors. By which I mainly mean the European Union but also some specific member states.

The first solution is in fact remarkably easy: create an higher inflation by some form of quantitative easing. If one looks at most member states in the EU, nominal debt (loans, mortgages, government debt etc.) is a serious issue. Here I say nominal because this debt is nominated in euros. Also certain prices such as those on houses and those of wages are incredibly hard to bring down. By instilling inflation this would be done automatically and most markets (mainly housing) could find better equilibriums.
The inflation that could be a solution here should be not incredibly high but somewhere in the range of 4-6%. This is because an inflation that is to high will have more stronger negative effects.  The disadvantage of this solution is that inflation often hits lower and middle classes very hard, since they don't own many non-monetary assets (houses) and their wages/entitlements won't go up. It could also create a dereciation in the euro because investors will trust the euro a little less.

The second solution is to spend more money in the northern states to fuel the economy in there. This strategy would not only be beneficial for the people in the north, who would get more spending power; it would be also good for the southern countries since these countries can export more goods if the north is booming. The effect would be much larger than an increase in the world economy because  the European economy is very connected. In my research on Portugal I found that all its main trading partners are within the EU (and are specifically Germany and Spain). Therefore the better the EU economy operates the better Portugal can get out of the debt crisis. I have no doubt that the same will hold for Spain.

Finally a solution that I would prefer the most: investing in these countries. Instead of lending hundreds of billions in bailouts, investing fewer billions would be better. This is because investing has a number of additional benefits.  It creates jobs and it stimulates the economy. It also raises tax revenue directly and it will provide a continuous money source for the investor.  Just plain borrowing of money to pay of government debt will not do this (except for the last effect). In the case of Portugal and Spain the investments could be used to reform and transform their economies so they can join a better Euro Zone. Naturally this should not be a simple bailout, through investments, because that would create moral hazard and it is necessary to avoid a to big to fail notion for countries.

These are three proposals that I think should be implemented by the EU. In my next post in this series I will discuss the investment option in more detail.