Posted by: Dirk | January 23, 2018

The Euro – Evolution and Prospects (2001/2018)

Having just taken a quick look at the CEPR publication “Reconciling risk sharing with market discipline: A constructive approach to euro area reform” (link), I am reminded that many economists still do not grasp the functioning of the fiscal and financial system. The paper is full of theoretical flaws and the policy advice hence is mistaken. Instead of letting markets have more power and government less, I think that we should do one of two things:

  1. Give sovereignty back to national governments by allowing them to finance their spending in a way that bankruptcy is not an option.
  2. Create a European fiscal institution – or Treasury – which sells bonds that are risk-free and that deals with unemploymnt in the Eurozone, filling in the role of deficit spender.

I have just read the 2001 book “The Euro – Evolution and Prospects” by Philip Arestis, Andrew Brown and Malcolm Sawyer. The authors write on page 121:

The euro has, of course, ushered in a single monetary policy. At the same time it has constrained national fiscal policy (via the Stability and Growth Pact) and it has made exchange rate revaluation impossible for the individual EMU countries. It is widely recognised that this arrangement requires a high degree of convergence of the patently very diverse economies of the Eurozone. Without such convergence, it will enforce inappropriate economic policies on its member states, constrain automatic and discretionary fiscal stabilisation, and negate room for manoeuvre in the face of economic asymmetries. In addition, a heavy burden of co-ordination is placed upon the European Central Bank (ECB) and the Eurosystem, through the need to pursue a coherent monetary policy, and to be perceived as so doing. The question of the performance of the Eurosystem and the ECB will first be addressed below, then the issue of convergence will be taken up.

This seems to me a prescient analysis, which of course does not square at all with the proposals that the authors of that CEPR paper make. It is time to give more freedom to the fiscal parts of the Eurozone institutions, not less. If you are not thinking in that direction, I believe that nothing good can come out of it.

Europe is not about risk-sharing with market discipline. It is about ensuring the economic and social well-being of its citizens. We tried risk-sharing with market discipline, and we failed. Governments should not be punished by financial markets, but by voters. Time to move on. The authors of that book write on their last page:

[P]olicy must be enabled to play its vital role in overcoming aggregate demand asymmetries and uneven processes of cumulative causation through coordination of fiscal and omnetary policy, within a transformed institutional setting.

That’s what we need to do.

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