The new political economy of the Eurozone
I might be boring the pants off you with my European Central Bank Posts – but what’s happening in Europe is going very fast and it’s important. Power (lots of it) is shifting towards Frankfurt and Brussels. How will this power be used?
First, the shift. A quote from a recent speech from José Manuel González-Páramo, member of the board of the European Central Bank:
In other words, the euro area is responding to the crisis by creating a new and more comprehensive model of economic governance. This is aimed at preventing imbalances in all policy areas before they can trigger crises – and managing crises more effectively when they do arise. In many ways, this response is sui generis and departs from the template we associate with political federations. For example, the “two pack” gives the Commission the power to demand the kind of reforms that the U.S. federal government could not demand of a U.S. state. Moreover, the federal government would not be able to sanction a state if, for example, its tax code was leading to a local housing bubble. This is now not excluded in the euro area under the Macroeconomic Imbalances Procedure.
The reason for this is political economy. According to economic textbooks, nations have the ability to conduct monetary policy, fiscal policy and exchange rate policy. But the Eurozone has neither. As Eurozone countries may not be in the same phase of the business cycle, monetary policy is sometimes just not an option. Unified fiscal policy is hard to achieve. And exchange rate policy is also not an option for an area as large as the Eurozone, as it will lead to repercussions of the USA and China. This was clear from the beginning, but for quite some time we chose to believe that low inflation would solve all problems. To quote José Manuel González-Páramo again (with theory he of course means Lucas/Greenspan/Bernanke style neo-classical economics):
From its conception the euro was and has been a unique and ambitious project. It combined a centralised monetary policy with decentralised economic policies, and to paraphrase Tommaso Padoa-Schioppa, created a currency that did not belong to a single nation-state. A key finding for the euro area, arising from the crisis, is that this construction was not complete. In particular, the euro area did not have certain institutions we associate with political federations and that act as shock-absorbers against the negative effects of imbalances. The key lesson from the crisis, therefore, is that the euro area needs to compensate for these “missing institutions” by establishing a much stronger economic and financial union. A central area where the absence of shock-absorbing institutions has been felt is via intra-euro area current account imbalances. These imbalances existed for many years prior to the crisis, but were largely ignored as theory told us that they could always be financed through cross-border financial flows. However, it is now clear that current account imbalances – while not being the only proximate causes of the crisis – are not benign and imply vulnerabilities which can be transmitted to the euro area as a whole.
And if things still go wrong, we always will have the European heads of state to save us (read the thing)!
But how will this power be used? Well, at the moment, while the present crisis is not yet solved, the official position still seems to be that for instance in a country like Spain 23% unemployment can be solved by, at the same time, contracting the economy and reforming the labor market (read: more power for mediocre managers). Now, I can understand that being able to fire somebody at will is a token of manhood in the USA – but this kind of flexibility did not lead to high job growth in the USA, post 1998. To solve Spanish unemployment we will have to think of something slighty smarter, like investing in a modern economy and real flexibility of labor, i.e people who for instance have the right to part-time work.