The Premonitory Five: Godley, Wray, Forstater, Mosler and Bell

from Edward Fullbrook

The neoclassical mainstream won infamy for remaining oblivious of the impending Global Financial Collapse, whereas Keen, Roubini, Baker and Hudson won fame for analytically foreseeing it and giving ample warning.  Now a “policy note” from the Levy Economics Institute documents analytical warnings of the European Union’s current debt crisis given separately a decade or more ago by five economists:  Wynne Godley (1997), L. Randall Wray (1998), Mathew Forstater (1999), Warren Mosler (2001) and Stephanie Bell (2002).  Below are relevant passages from each of the five.  These two huge examples illustrate how economics could serve, rather than dis-serve, society if the profession were to become in the main science-based rather than faith-based. 

Wynne Godley (1997):

[I]f a government stops having its own currency, it doesn’t just give up “control over monetary policy” as normally understood; its spending powers also become constrained in an entirely new way. If a government does not have its own central bank on which it can draw cheques freely, its expenditures can be financed only by borrowing in the open market in competition with businesses, and this may prove excessively expensive or even impossible, particularly under “conditions of extreme emergency.” . . . [I]f Europe is not to have a full-scale budget of its own under the new arrangements it will still have, by default, a fiscal stance of its own made up of the individual budgets of component states. The danger, then, is that the budgetary restraint to which governments are individually committed will impart a disinflationary bias that locks Europe as a whole into a depression it is powerless to lift.

L. Randall Wray (1998, pp. 91–92):

Under the EMU, monetary policy is supposed to be divorced from fiscal policy, with a great degree of monetary policy independence in order to focus on the primary objective of price stability. Fiscal policy, in turn will be tightly constrained by criteria which dictate maximum deficit-to-GDP and debt-to-deficit ratios. . . . Most importantly, as Goodhart recognizes, this will be the world’s first modern experiment on a wide scale that would attempt to break the link between a government and its currency. . . . 

As currently designed, the EMU will have a central bank (the ECB) but it will not have any fiscal branch. This would be much like a US which operated with a Fed, but with only individual state treasuries. It will be as if each EMU member country were to attempt to operate fiscal policy in a foreign currency; deficit spending will require borrowing in that foreign currency according to the dictates of private markets.

 

Mathew Forstater (1999, p. 33):

Under the EMU, if investors are at all hesitant about any one member’s debt, they can buy another member’s debt without incurring currency risk, since there is no exchange rate variability among the currencies of member countries. Because member nations now are dependent on investors for funding their expenditure, failure to attract investors results in an inability to spend. Furthermore, should a member’s revenues fail to keep pace with expenditures due to an economic slowdown, investors will likely demand a budget that is balanced, most likely through spending cuts. In other words, market forces can demand pro-cyclical fiscal policy during a recession, compounding recessionary influences.

Warren Mosler (2001):

History and logic dictate that the credit sensitive euro-12 national governments and banking system will be tested. The market’s arrows will inflict an initially narrow liquidity crisis, which will immediately infect and rapidly arrest the entire euro payments system. Only the inevitable, currently prohibited, direct intervention of the ECB will be capable of performing the resurrection, and from the ashes of that fallen flaming star an immortal sovereign currency will no doubt emerge.

Stephanie Bell (2002):

Countries that wish to compete for benchmark status, or to improve the terms on which they borrow, will have an incentive to reduce fiscal deficits or strive for budget surpluses. In countries where this becomes the overriding policy objective, we should not be surprised to find relatively little attention paid to the stabilization of output and employment. In contrast, countries that attempt to eschew the principles of “sound” finance may find that they are unable to run large, countercyclical deficits, as lenders refuse to provide sufficient credit on desirable terms. Until something is done to enable memberstatesto avert these financial constraints (e.g., political union and the establishment of a federal [EU] budget or the establishment of a new lending institution, designed to aid member states in pursuing a broad set of policy objectives), the prospects for stabilization in the Eurozone appear grim.

References 

Bell, S. 2002. “Convergence Going In, Divergence Coming Out: Default Risk Premiums and the Prospects for Stabilization in the Eurozone.”Working Paper No. 24. Kansas City, Mo.: Center for Full Employment and Price Stability. April.

Forstater, M. 1999. “The European Economic and Monetary Union: Introduction.” Eastern Economic Journal 25, no. 1 (Winter). 

Godley, W. 1997. “Curried Emu—The Meal that Fails to Nourish.” Observer (London), August 31. 

Mosler, W. 2001. “Rites of Passage.” Epicoalition.org, May 1. 

Wray, L. R. 1998. Understanding Modern Money: The Key to Full Employment and Price Stability. Northampton, Mass.: Edward Elgar Publishing.