Nobel Prize-winning economist Paul Krugman last week set out his policy prescriptions for saving the euro. He calls for more expansionary monetary policy by the European Central Bank and expansionary budgetary policy in the euro area's largest and best performing economy, Germany.
It's hard to argue with these prescriptions, though there seems little chance at the moment that European leaders will follow them.
To be fair, the ECB has stepped up to the plate recently with €1trn of long-term loans that have reduced stress in debt markets. The ECB has also cut interest rates over recent months. Given mounting concerns about Spain and the weakness of the euro area economy, however, Krugman is right to suggest that the ECB needs to go further. Interest rates could be cut again, but significant additional monetary policy support will probably have to rely on more unconventional methods, such as outright quantitative easing as in the UK and US. These tools have so far been ruled out.
Unlike in the crisis economies, Germany's public finances are in relatively good shape. The German budget deficit is projected to be less than 1 per cent of GDP this year, while the national debt is forecast to decline to below 80 per cent of GDP.
The German government can borrow from debt markets at interest rates close to zero. This gives Germany room to stimulate growth at home and across the euro area by spending more and taxing less.
Moreover, Germany is running a large surplus on its balance of payments -- the counterpart to the crisis countries' large deficits. Fiscal stimulus in Germany would help to shrink these imbalances.
The problem is that Berlin doesn't see it that way. German policymakers point to their aging population and associated future budget pressures and are loath to give up hard-won competitiveness.
Arguably, a politically more palatable strategy might be a targeted euro-area- wide programme of investment. I recently suggested that revenues could be raised at European level by taxing the financial services industry to help leverage borrowing for European smart energy initiatives.
European leaders might also usefully begin to give some thought as to how best to make transfers to countries with unsustainable external debts.
But such policies do not mean that crisis countries with large budget deficits and uncompetitive economies can abandon reform efforts. A country cannot keep borrowing and growing its national debt forever. The inescapable fact is that ongoing fiscal consolidation is necessary in countries with large fiscal deficits, especially in countries with sizeable structural deficits like Ireland.
But Krugman is right that an appropriate macroeconomic stance at the federal level is critical, because along with reforms at home, the crisis countries require favourable external conditions to resolve their problems.
Dr Alan Ahearne is an economist at NUI Galway and a former economic adviser to Finance Minister Brian Lenihan