The stock-market gyrations of the past week have been driven in part by worries that a stumbling Eurozone could drag down the global economy. Unemployment stands at 11.5 percent for the bloc. The troubled Spanish and Greek economies are growing again, but face jobless rates of well over 20 percent. Meanwhile, growth is stalling in the stronger countries. France appears to have flat-lined and Germany is on the brink of recession. Fears of a deflationary spiral are rising. Is this Europe’s new normal?

In the latest installment of their roundtable discussions on the Eurozone’s woes, JHU economists Jonathan Wright and Robert Barbera and political scientist Nicolas Jabko consider the region’s prospects and how things got this bad. David Dagan, a graduate student in political science, moderated the conversation.

Is Europe’s original financial crisis solidly behind it?

JW: I think the imminent threat of the Eurozone disintegrating because of its bad equilibrium – where Italy had to pay 8 percent (interest to borrow money) because it was in danger of going broke, and it was going broke because they had to pay 8 percent – that’s behind us.

NJ: I would add that the banking union also has become a reality and that this is also a damper to the crisis, in addition to changes in monetary policy.

What is the problem now?

RB: They’ve banned the notion of stimulative fiscal policy (and) they have enormous difficulty doing anything that actually is stimulative with monetary policy. It’s very hard to imagine a monetary-policy card that (ECB Chief Mario) Draghi could play that will make demand grow more rapidly. So you’re stuck in the mud, inflation looks like it may soon become deflation, and you’ve got unprecedented unemployment rates throughout the south and up towards the center (of the continent).

JW: The worry now is going the way of Japan, except with a much higher level of unemployment.

Right – we’ve heard a lot of concern that the Eurozone will go into deflation, as Japan did during its “lost decade.” Just for background, what’s the problem with deflation?

JW: Deflation is going to get you into a spiral. It’s happening in the context of an economy that’s weak. With deflation, your real interest-rates (are forced to be) positive, whereas you would like them to be zero or negative. Positive real interest-rates are going to weaken your demand even further. And, this is in a situation where you really would like to transfer assets from the creditors to the debtors, (but) you’re going to have exactly the opposite. In a deflationary world, the real value of debt is going up. Deflation is just making those imbalances worse.

So how likely is this to happen in the Eurozone?

NJ: You could have stagnation without deflation. It would be pretty bad still. So it may not be Japan. But it may still be very bad.

RB: If you have stagnation without deflation, but you’re doing it from a 14 percent unemployment rate instead of 4, it’s much worse than Japan.

JW: It’s not hard to see how you get the Eurozone as a whole into outright deflation mode – significant odds of that. And parts of the Eurozone are already there.

What are the prospects for fiscal stimulus to give the economy a shot in the arm?

NJ: The problem is that the fiscal situation is very uneven across the member states. The one member state that would be most able to do stimulative fiscal policy is Germany – yet is it the member state that is the least likely to do it because the economy is doing a lot better than the other member states from the perspective of unemployment. And most importantly, any kind of fiscal deficit in Germany is very unpopular. None of the other member states is able to do significant fiscal stimulus because they don’t have as much as fiscal maneuvering room as Germany. Germany is the only country that could do significant fiscal stimulus and yet they don’t.

Of course, European Central Bank chief Mario Draghi recently intervened in this debate, urging Eurozone governments to spend more.

NJ: Yeah, exactly, which was a first because the central bank had never said that. And usually they say quite the opposite. And this time, Draghi said there should be more spending – or, more time for fiscal consolidation, which in practice means more spending now. It turns the tables against Germany, so that now Germany is no longer the model that everybody needs to imitate. Germany is in the seat of the accused, and that is a completely new development.

Meanwhile, Draghi has been busy tinkering with monetary policy. For one thing, he recently loosened the terms on which the European Central Bank would lend money to commercial banks. Where did that go?

RB: What he said was, you can borrow for four years at today’s overnight interest rate. So you lock in zero for four years. But the banks didn’t touch it.

NJ: The reason why the banks didn’t really buy into this was that in exchange for doing that they had to promise that they would lend that money to households and businesses.

RB: I’ve heard a different (explanation). If you go in and take that money then you get a disproportionately large amount of inquiry about what you’re doing. So it was a desire to not feel that you’re at the beck and call of the authorities.

JW: Perhaps because a bank stress-test is coming up. You don’t want to blow your balance sheet up just in advance of a bank stress-test.

So the attempt to increase bank-lending failed. What did Draghi do next?

RB: He came out and he said that they were going to meaningfully increase the European Central Bank’s balance sheet by buying billions of asset-backed securities. But when we looked at the definition of the securities he was willing to buy, they as yet weren’t there in any size. They’re private-sector securities that are not robust markets now.

NJ: The ECB had previously justified not doing what they’ve announced they would do now by the fact that European finance is mostly bank-based lending as opposed to financial-market operations. So they focused on bank lending earlier. That didn’t work. So now they’re trying desperately to expand their balance sheet.

Is there a chance that the mix of assets Draghi is willing to buy will change?

JW: He can buy a weighted basket of Eurozone government bonds. In fact, the current level of yield (in the bond markets) is almost pricing in the expectation that he will. (But) today, I don’t see how monetary policy can pull the Eurozone out of this rut.

We’re talking a lot about Draghi’s options. But how much responsibility does the European Central Bank have for getting the Eurozone into this mess in the first place?

RB: I think you have to look back to policy decisions in the immediate aftermath of the Great Recession. A strong case can be made that the former ECB head, Jean Claude Trichet, made a catastrophic error, amid the Greek crisis. Trichet insisted he had no power to help ensure access to funds for European nations. But we now know that is categorically not true. Mario Draghi, soon after his taking of the reins, invented means to make it clear to the world that he would, de facto, be Europe’s lender of last resort. And sovereign borrowing costs for Spain, Italy, Portugal and Ireland plummeted.

But the two year debt crisis that Trichet ignored forced many nations to attempt to tighten their fiscal belts amid deep recessions. This reinforced economic weakness and did little to improve government finances. Europe has important structural problems that no central banker can remedy, but Trichet’s tenure,made a bad situation much worse than it had to be.

NJ: I agree with Bob that Draghi has been more effective than Trichet, but I also think that the circumstances became a lot more favorable over time for Draghi. First, the ECB does have to abide by EU law, in this case the “no-bailout clause.” Strictly speaking, and even under Draghi, the ECB has not lent money to the member governments, but to commercial banks. For this to happen on a massive scale, a case had to be made that the private sector in the periphery has no access to the ECB’s cheap credit. That was not so obvious before the crisis engulfed banks in the periphery, as well as governments. Second, the internal politics of the ECB considerably changed. Trichet had to work with many hawkish members of the ECB governing council – he couldn’t easily overrule them, that’s not how the EU works. As the crisis got worse, the ECB became more active and two very hawkish German central bankers resigned. So perhaps the situation had to get worse before it could get better.

How does the global economic outlook factor into all this?

RB: The data in China looks really bad. And beggar thy neighbor is very hard to do if all the neighbors are having a tough time. So there’s an interesting dynamic here. As a potential additional confusion, if China does very poorly, you will import deflation from China, as they dump stuff on your economy. And it will also make the U.S. much less compliant, in terms of being on the flipside of a big Euro decline.

NJ: That’s also a ray of hope, paradoxically because Germany is not doing well. During the Great Recession, Germany was doing relatively well, because it was basically exporting its way out of Europe’s trouble. Although Europe and the US were in recession, many emerging markets were still growing strong. Now if these countries start not doing so well, or being hit by export restrictions in the case of Russia, then German exports to these countries go down, and the economy goes in a dip, which is a new factor. And if that happens, then it is at least conceivable that the German government might become more open to fiscal stimulus, in a way it was not before. But they probably will not call it that.

Any last words?

RB: Politicians know it rarely pays to admit you erred. But I have to believe that behind closed doors, faith in the virtues of fiscal belt-tightening has to be somewhat shaken in Europe. Nicolas, is there any reason to expect that Europe can be more sensible about budget issues going forward?

NJ: Yes. Jean-Claude Juncker is about to become president of the new European Commission. Many observers have hopes that he will be more active than (his predecessor, Manuel) Barroso, who was widely criticized for his lack of leadership. Juncker has called for a €300 billion Europe-wide investment plan to be funded by the European Investment Bank (EIB) and the private sector. In addition, Pierre Moscovici, a French Socialist, is now becoming the commissioner for economic and financial affairs. As the official who oversees member states’ adherence to the growth-and-stability pact, he obviously cannot afford to favor France or other states struggling to remain within the deficit limits of the pact. However, he is also expected to act with more pragmatism than his predecessor.

RB: Well, that might well give Draghi something to think about. If the (EIB) raises a small sum, perhaps the ECB can find a way to reinterpret rules and lend aggressively to the EIB. And the timing of such a plan?

NJ: No doubt at least a year.

RB: Uh-oh. It doesn’t feel like the world has another year’s worth of patience.