Nobel laureate says euro zone 'on edge of meltdown'

Nobel laureate says euro zone 'on edge of meltdown'
By Euronews
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As the Nobel Awards are about to be handed out in Stockholm, Sweden euronew’s Isabelle Kumar caught up with Economics Prize winner Professor Christopher Sims, who has been recognised along with fellow professor Thomas Sargent. Both are from the US and received the prestigious award for the research they carried out independently back in the 1970s and 1980s on cause and effect in the macro economy.

Isabelle Kumar, euronews: “Christopher Sims, many thanks for joining us on euronews. Sadly Thomas Sargent cannot be with us today due to illness but I think you can speak for him also when you tell me briefly why you were jointly awarded a Nobel prize.”

Professor Christopher Sims: “Tom was awarded the prize for his work on an idea called rational expectations, which is the idea that people look to the future when making decisions today. And at the time that he did his work this apparently common sense notion was not actually incorporated in the models that were being used to guide policy. And this really changed the way models for economic policy were done.

“What I did was not really related to rational expectations, except indirectly. At the time that I wrote, there was a controversy between people called monetarists and people called Keynsians – these are two branches of economics. The monetarists thought that the money supply drove the economy and that recessions and economic fluctuations were largely caused by mistakes in monetary policy. The Keynsians thought that monetary policy was not the main force pushing the business cycle. I did work that helped develop statistical methods that would untangle this issue.”

euronews: “Let’s zoom out now and look at the euro zone crisis which is obviously dominating headlines and has done so for months; in your opinion how close is the euro zone to meltdown?”

Professor Christopher Sims: “I think it’s on the edge. I wrote a paper in around 2002 and it talked about the likelihood that there would be a crisis like this. At the time I said and I think it is still true, that even though we don’t know the answer to the question, the question will be do people want to preserve the euro enough that they are willing to construct, on the fly, the fiscal institutions that are necessary, or is the euro weak enough in its political support that it’s going to fall apart.”

euronews: “Anything that takes place in Europe takes some time to be put into place – it moves quite slowly, so what if in the meantime Italy just becomes insolvent – what would be the knock-on effect from that?”

Professor Christopher Sims: “The ECB can prevent Italy from becoming insolvent, what it can’t prevent is the ECB from becoming insolvent. The ECB couldn’t actually become insolvent because they can print money, but if their balance sheet goes bad, they could be forced to inflate. The ECB can raise money by printing money, but if the ECB is forced to do that it could cause inflation which is what the Germans are worried about.”

euronews: “So, we don’t know how long it will take us to emerge from this crisis, but as we do emerge, are we going to see a new world order settle into place where the once dominant nations of the world, are going to be put on the back foot as we have these strong emerging markets.”

Professor Christopher Sims: “No I don’t think so, China is growing very fast but its workers are nowhere near as well educated, its political system is primitive in many ways, and we have the history of other countries who have grown fast as they catch up with the West and then slow down. And there can be terrible adjustments as things slow down, as in Japan. Now in the euro area, there could be big changes according to whether this becomes a dividing line between a period when it’s moving towards union, and a period when it’s moving apart again. I think as it moves towards greater union in Europe, Europe could be tremendously more powerful and would benefit.”

euronews: “It’s said that when the US sneezes the rest of the world, including Europe, catches a cold, It seems now that the boot is on the other foot, and the US is tremendously worried about the unfolding euro zone crisis. What’s at stake for the States?”

Professor Christopher Sims: “If the euro area crashes there will be more big losses. Many banks and financial institutions will be in trouble, and we just don’t know how much that will translate into trouble for US financial institutions.”

euronews: “What’s your take on the situation?”

Professor Christopher Sims: “My take is I have no idea what is going to happen. And I am worried that it could create, for example, a double dip recession in the US if there were a European collapse because it would probably have knock-on effects on US financial institutions.”

euronews: “You teach university students – the next generation of decision-makers in years to come. How do you see their world?”

Professor Christopher Sims: “When we compare the situation of young people today to the situation of young people 80 or 100 years ago, there is nothing to complain about. There’s lots of good things that have happened in the world since then and I think people will go on being ingenious and finding ways to create new political institutions, and new technologies, so I’m optimistic.”

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