Former Chief Economist John Llewllyn (of the Organisation for Economic Cooperation and Development, OECD) comments on what's different now than during his tenure. He currently runs London-based Llewellyn-Consultancy.com. John writes about the error of relying on German-style supply-side reform to reflate Euroland economies:

For the extended period leading up to the crisis, Germanic policy, with its emphasis on the supply side, its skepticism about fine-tuning, and its inherent aversion to deficits and inflation, served the German economy and others which trod a similar path, relatively well, most of the time.

There are occasions, perhaps once every fifty or so years, when, rather than dealing with relatively modest perturbations, policy has to grapple with something more serious: a major, confidence-sapping, debt-augmenting, demand-destructive shock. Under these circumstances, a more radical response is required than mid-noughties conventional wisdom. And in that special circumstance the Germanic policymaking doctrine can be found seriously wanting, if not counterproductive.

This, in our judgement, looks increasingly as if it is becoming the situation in Europe. Six years on from the initial crisis, the Continent is suffering from a chronic deficiency of aggregate demand. That is not to say that the supply side does not matter. Nor is it to deny that supply-side reform is important – essential even – if the recovery, when it finally arrives, is to prove durable. It is simply to say that, right now, Europe’s over-riding problem lies on the demand side.

The level of real GDP, particularly around the periphery, remains below its previous cyclical peak and far removed from its pre-crisis trend. Germany aside, labour markets and other measures of macro resource utilisation are acutely depressed. Current account surpluses in the stronger and more fiscally conservative European economies are at historically high levels when expressed as a proportion of national output. Inflation is well below target, and in some cases is negative. Inflation expectations are gravitating downwards. Interest rates are historically low.

Over the period 2011-13 [almost] all countries tightened fiscal policy, and those around the euro area periphery by very large amounts.

Monetary policy responses were mixed. While the US, the UK, and Japan continued with variations on the theme of quantitative easing, the ECB [European Central Bank], true to the Germanic policy making tradition, was determined to remove the patient from intensive care and return to normality to move policy rates away from the zero-bound, and begin to rein in its balance sheet.

This proved premature, [in] peripheral euro area[s]. Rather than progressively returning monetary policy to neutrality, the ECB ha[d] to do an about-turn and ease further, belatedly taking official rates down to their irreducible minimum and seeking to re-inflate its balance sheet.

On the basis of OECD calculations, the current and announced policies of the majority of countries are for continued fiscal restraint. IMF calculations, by contrast, portray the majority of fiscal stances as nearly neutral. Crucially, however, neither institution evaluates current and announced fiscal policy for 2014 and 2015 as in any measure expansionary.

The rhetoric from Germany is that continuation of the present fiscal policy is the only option.

This is a wrong prescription. It stems from a policy recipe that applies most of the time, particularly to economies small enough to export their way out of aggregate demand deficiency by capturing some of the domestic demand of others. But it will not work to increase aggregate domestic demand in a region as large as the euro area. It is extraordinarily difficult for an economy to deflate its way out of a debt problem, [or] export its way out of an aggregate demand problem. A policy prescription of seeking to reduce deficits through tight fiscal policy when an economy is in recession generally makes the existing problem worse.

More seriously, it is indicative of a failure to grasp the severity and potential implications of the current situation. It is the voice of those who, despite the last six years, see Europe’s current problem as still predominantly on the supply side.

[Here is how John thinks the circle can be squared:]

Assembling a conventional fiscal expansion, [via] tax cuts and expenditure increases, would be difficult. It would take time to agree even the principle. The policy would have to be differentiated across countries: hard to devise, even harder to coordinate. Such packages usually end up doing too little too late.

The challenge will be for policymakers to coalesce around a necessarily German-sponsored package that supports aggregate demand while meeting objections to classic Keynesian deficit finance. Politically, the package [would have to be presented as increasing] productive potential longer term.

It would be ideal if it could also meet other broader and over-riding policy objectives too and can be sold, as in the past (the 1980s), as a supply-side policy to help small firms.

Our best guess – only a guess – is that it could take the form of a pan-European infrastructure investment Special Purpose Vehicle, perhaps under the auspices of the European Investment Bank, and financed at least in part by the ECB (albeit with indemnification against losses by member state governments). It could be oriented principally towards the geo-political goal of reducing Europe’s dependence on energy imported from Russia, now uppermost in the minds of many European leaders, not least Mrs Merkel.