Can Economic Policy Be Changed?

On 16 September 2015, at the Chamber of Deputies in Rome, there was a seminar on “Greece, the Euro, Alternatives for Italy”. After papers by Giulio Marcon, Mario Pianta and Marica Frangakis there were two sessions on “Can Economic Policy be Changed?” and “Can Politics be Changed?”. In the first session I took the view that European economic policy can be changed, without necessarily having to change the treaties, and presented seven specific proposals and a general proposition. The real problem is whether political forces would support such economic policy changes. 

We could (and should): 

1. Remove public investment from government deficit computation. Any constraint on the fiscal deficit, averaged over a number of years and not applied to its current level, should exclude debt-financed public investments because they do not entail an intergenerational transfer. This is widely and authoritatively recognized: ”The current fiscal stance should not be confused with the capital account… Computing the maximum deficit/GDP ratio as the sum of the current and capital accounts is misleading.” (J. H. Drèze-A. Durré, Louvain 2014). At present only the national co-financing of the so-called Juncker Investment Plan is formally excluded; the principle should be extended to all public investment.

2. Remove from the computation of government deficit any borrowing incurred to finance the payment of government arrears owed to enterprises, taxpayers, as well as the particularly scandalous arrears owed to pensioners. Such borrowing does not result in additional debt but only in a change of creditors: the loans incurred to liquidate arrears cancel out with the liquidated arrears.

Thus it should be recognized that public debt is actually higher than it looks, for it should include not just the cumulated excess of actual payments over receipts but also the accumulation of payment arrears towards enterprises, taxpayers and pensioners. But since the payment of arrears leaves unchanged the amount of total public debt, it should not be included in the government deficit which by definition should be equal to the increase in government debt.

3. Revise the calculation of a country’s structural deficit by the European Commission, which determines the maximum fiscal deficit that a government is allowed. At present this is following a particularly restrictive methodology and should be converted to standard OECD procedures, which would allow a modest but significant broadening of fiscal space.

4. Tighten the existing rule that a EU member country should not exceed a trade surplus of 6% of GDP, restricting it to 4% in line with the limit set to a country’s maximum trade deficit, and actually enforcing it, for instance imposing an equivalent minimum fiscal deficit on the trade surplus country, in place of a token fine. This would stop the surplus country (e.g. Germany at 7% of GDP) forcing its Southern partners to incur higher deficits.

5. Convert the pension system, recently reformed from a PAYE system (Pay As You Earn, i.e. re-distributive, defined benefits) to a fully funded system (capitalized, defined contributions), wholly or partly back to PAYE.

Both systems are potentially viable and capable to deal with population ageing (the capitalized system promotes financial markets but is more vulnerable to economic crises), but the transition from PAYE to a fully funded system makes a pension debt, which is conveniently hidden and buried, unnecessarily surface, equivalent to the present value of current employees’ contributions no longer available to finance current pension payments. (A country’s PAYE pension debt should only include the present value of that part of pensions – if any – which exceeds what can be financed out of pension contributions).

The reversal of such policy, as exemplified in the recent experience of Poland and Hungary, restores a country’s fiscal space to the full extent of the emerged pension debt.

6. Insure member countries against the risk of growth under-performance with respect to the average. 

 
J. H. Drèze and A. Durré (Louvain, 2014) suggest an ingenious scheme whereby a European Agency like the ECB could costlessly provide such an insurance. Eurozone governments would issue bonds indexed to the growth rate of their country’s GDP. The ECB would purchase a balanced stock of such bonds, thus earning a total rate of return equal by definition to Eurozone average growth. Thus the ECB could compensate below-average growth countries for their under-performance, out of the extra-interest earned from countries that record growth faster-than-average. No cross-subsidization among member countries (Transfer Union) would be involved. (Warning: this scheme would work on condition that no member country defaults on such bonds).

7. Mobilize the present value of the ECB Seigniorage – estimated by Willem Buiter to be of the order of €3,400 bn (sic!) – to gradually withdraw government bonds issued by ECB shareholder countries in proportion to their shares, thus avoiding a transfer Union. Again, no Transfer Union would be involved. 

See P. Paris and C. Wyplosz (2013 and 2014), on their P.A.D.R.E. (Politically Acceptable Debt Reduction for the Eurozone) scheme: the ECB would use seigniorage to pay interest on perpetual bonds issued to replace and retire outstanding Eurozone debt. 

I proposed a similar scheme (on my blog Transition), envisaging Eurozone bonds retirement directly financed by the ECB by securitizing future seigniorage. 

8. A general proposition. Finally, and more generally, economic policy changes require the recovery of quantitative instruments of economic policy, in place of dubious, possibly counterproductive, so-called structural reforms (a euphemism for the destruction of the Welfare State). We need to recover

- monetary policy, which first was delegated to an independent national central banker, then transferred to the ECB in Frankfurt; 

- fiscal policy, i.e. the level and structure of taxation and public expenditure, now constrained by the recessionary straightjacket of EU fiscal austerity rules (Maastricht, the Growth and Stability Pact, the Fiscal Compact);

- the price and investment policy of state enterprises, now largely privatized or in the process of privatization; and even

- direct controls, now abandoned in favour of market forces.

The instruments are there and we know how best to use them. The problem is the lack of political will.

Greece: Enough is Enough

In Alexis Tsipras’ shoes I would apply immediately for Greece to leave the EU, as envisaged by Art. 50 of the TEU (Consolidated Version of the Treaty on European Union, Official Journal of the European Union, C 115/15, 9/5/2008).

Since Greece’s 2010 crisis the Troika (sorry, the “international institutions”) have sunk about €245bn into its rescue, i.e. more than would have been sufficient at that time to pay off the entire Greek debt. It is well known that these funds did not benefit the Greeks but went almost entirely to save French, Swiss and German banks from their exposure to Greek government bonds. And in the FT or 21 April Martin Wolf debunks Greek “mythology” including the myth that “Greece has done nothing”: 

“Greece has undergone a huge adjustment of its fiscal and external positions. Between 2009 and 2014, the primary fiscal balance (before interest) tightened by 12 per cent of gross domestic product, the structural fiscal deficit by 20 per cent of GDP and the current account balance by 12 per cent of GDP.”

“Between the first quarter of 2008 and the last of 2013, real spending in the Greek economy fell by 35 per cent and GDP by 27 per cent, while unemployment peaked at 28 per cent of the labour force. These are huge adjustments. Indeed, one of the tragedies of the impasse over the conditions for support is that the adjustment has happened. Greece does not need additional resources.”

The cost of such adjustments to the Greek people were immense. Unemployment reached 28% (48% for youth unemployment), the dismantling of collective bargaining lowered real hourly wages by 25% by 2014. The minimum wage fell to its level of the 1970s. The minimum pension fell below the poverty threshold. As many as 35.7% of the population and 44.1% of children aged 11 to 15 are now at risk of poverty or social exclusion. And Gechert and Rannenberg (of the German Hans Böckler Foundation) show that without austerity the Greek economy would only have stagnated, avoiding the deep recession, while tax increases without spending cuts would have been much more effective in lowering the Debt/GDP ratio.

Another myth debunked by Martin Wolf is that Greece will pay its debt in full. As a a result of fiscal consolidation and the bailout its debt has gone from about 120% of GDP in 2010 to over 177% today. Thus Greece needs either further debt relief or, in order to continue to service the debt, it needs the €7.2bn bail-out funds due last year that were not disbursed on the ground of alleged delays in Greek implementation of “structural reforms” agreed in the Memorandum of Understanding negotiated by the previous right-wing government with the “institutions”.

After the 25 January elections the new government, democratically elected on a specific anti-austerity campaign, and reported by post-election polls to consistently command the support of 80% of the population, an agreement with the “institutions” was reached in principle on 20 February for the release of the €7.2bn on condition of somewhat different but yet unspecified structural reforms. However there have been continuous wrangles about whether or not the Greek reform proposals were or were not sufficient to warrant the release of the residual bail-out funds.

Up to now Greece has paid punctually interest and debt instalments as they became due, such as $450mn owed the IMF on 9 April and a batch of Treasury Bonds that also fell due. But the IMF is still owed €203mn on 1 May and €770mn on 12 May, plus €1.6bn in June, while some of the debt with the ECB is also due for repayment. The Greek government has scraped the bottom of the barrel by requisitioning the liquid balances of state enterprises and local authorities. It has announced that it is not in a position to make these payments, unless it stops payment of pensions and public sector wages and salaries.  Without access to these €7.2bn Greece is likely to default on its payments to the IMF and the ECB.

On 15 April the FT reported that Greek officials had approached the IMF informally proposing to delay the repayment of loans due in May but were told that no rescheduling was possible; indeed they were persuaded not to make that request officially, presumably to avoid an open refusal.

At the same time Germany’s finance minister Wolfgang Schäuble was reported in an interview to have virtually ruled out that at the Eurogroup meeting in Riga on 24 April a deal might release bailout funds to Athens. "You can't pour hundreds of billions... into a bottomless pit."

However Die Zeit reported that Ms Merkel now might support emergency measures that would give Greece continued access to ECB Emergency Financial Assistance even in case of default. The possibility of a Greek default not being followed by Grexit is being discussed more and more widely (see for instance Wolfgang Munchau and Martin Wolf in the FT).  It might be possible, perhaps, but would still be very messy, and if there is sufficient goodwill to make it possible it would be much more effective to disburse the wretched €7.2bn.

The Financial Times on line of 18 April (Breaking News, 6.57 pm) reports that ECB president Mario Draghi told the IMF spring meeting the euro area was better equipped than it had been in the past (in 2010, 2011 and 2012) to deal with a new Greek crisis but warned of “uncharted waters” if the situation were to deteriorate badly.

On 21 April BloombergBusiness reported that “The European Central Bank is studying measures to rein in Emergency Liquidity Assistance to Greek banks, as resistance to further aiding the country’s stricken lenders grows in the Governing Council”. The writing is on the wall.

Grexit costs would be very serious not only for Greece but for the entire Eurozone and beyond, but unilateral withdrawal from the whole of the European Union rather than simply the Eurozone would make more sense. An application to withdraw would only take effect two years later, leaving ample time for a possible change of mind and for re-negotiations, but might be an effective and quick way of sobering up Mr Schäuble and the other Troika hawks that have been bullying Greece, pushing it towards default regardless of consequences. Greece might as well take back the initiative, not least to avoid an internal government crisis.

What is particularly deplorable is the IMF duplicity and bad faith: in Greece and everywhere else on a global scale they have been calling relentlessly for fiscal consolidation and structural reforms (a euphemism for enterprise freedom to dismiss employees and for the systematic destruction of the welfare state) but at the same time they have played a leading role in discrediting consolidation and "reforms" as policy instruments to fight a recession.

The IMF World Economic Outlook of October 2012 (Box 3.1 untypically signed by Chief Economist Olivier J. Blanchard and Senior Economist David Leigh, presumably to suggest that their views are personal and not official) raised previous estimates of fiscal multipliers for several reasons. First, the ineffectiveness of countervailing monetary expansion close to the zero floor of the interest rate'; second, lack of opportunities for exchange rate devaluation especially in the Euroarea; third, the existence of  a large gap between potential and actual income (for fiscal multipliers are higher in a downturn than in a boom) and finally, the simultaneous consolidation across many countries.  Such revision of estimated multipliers implied an upwards revision of the costs of consolidation, to the point of theorizing that tax increases and especially expenditure cuts would actually raise, instead of lowering, the ratio between Debt and GDP, thus setting up a vicious circle. This of course is what happened punctually in Greece and in other highly indebted economies – like Italy – as a result of fiscal consolidations.

Further the IMF World Economic Outlook 2015 (Ch. 3, Box 3.5 on The Effects of Structural Reforms on Total Factor Productivity, pp.104-107) issued on 14 April candidly recognizes, on the basis of available econometric evidence, that total factor productivity can be increased by using more skilled labour and ICT, by investing more in research and development and by lowering the level of regulation in product markets. In contrast, the IMF does not find any statistically significant effects on total factor productivity that result from lowering labour market regulation (See also Ronald Janssen Social Europe).

Such schizophrenic duplicity on the part of the IMF has not even incompetence as a conceivable justification. A Greek unilateral withdrawal from the European Union would sober up lots of people in Washington as well as in Brussels, Frankfurt and Berlin. Go for it Alexis and Yanis on behalf of all of us, not just on behalf of Greece. 

UPDATE (13 May)

Last Monday (11 May) Greece paid the $750mn owed to the IMF, one day before the deadline, ending days of uncertainty over funds availability and whether payment might be withheld in order to put pressure on creditors. 

Where did the money come from? The FT reminds us that “The Greek government ordered hundreds of state entities — among them hospitals, universities and local authorities — to deposit their cash reserves with the central bank. But many such entities, including an overwhelming majority of municipalities, have declined to comply”.

An unmissable piece of news, which appears to have gone largely unreported in the financial press: TSIPRAS TO FIRE [FIRED] BANK OF GREECE BOSS FOR UNDERMINING SYRIZA POSITION: “Bank of Greece Governor Yannis Stournaras will be quitting his post today (last Sunday). Alexis Tsipras will ask for his resignation in the light of documentary proof that the former New Democracy Finance Minister personally gave specific briefs to a top journalist about “putting the most negative spin possible on the news” about Greek finances.

Yannis Stournaras was Greek Minister of Finance from 5 July 2012 until he moved to the BoG last year. As a senior consultant to the Bank he was personally involved in the entry of Greece into the euro. As a senior Governor he sits on the Board of the IMF, a position that places him in a serious conflict of interest with the Greek government.  “Meanwhile, the forensic investigation into debt overstatement in 2010 and how much Greek debt can be objectively defined as ‘odious’ continues”. 

Moderate optimism

The month of January 2015 gave us several, interlocked reasons for moderate optimism about the prospects for economic recovery in the Eurozone and in Italy.

First, the further fall in oil prices, strengthening the trend already present from last summer. From mid-June 2014 to the end of January 2015 the price of crude oil fell by as much as 60 percent, reducing the energy costs of Eurozone producers in spite of the parallel but much lower depreciation of the euro against the dollar (on which more below). Quantitative estimates of the effect of this cost reduction on the rate of GDP growth are uncertain and vary around 0.5% -0.8%, but undoubtedly the positive effect is present and is not negligible.

The second reason for moderate optimism is the ECB decision on 22 January to implement Quantitative Easing, albeit with the disapproval of the Bundesbank president Jens Weidmann and a minority of other representatives of the Nordic  member states of the Eurorozone: € 60 billion per month for 19 months, from March 2015 to September 2016, and if necessary even further, until the Eurozone inflation target "below but close to 2 percent" is reached.  This amount however includes other interventions already decided previously, so that the additional amount really is not €1,140bn but only about €900bn, and the surprise effect (important for example in the Swiss frank large appreciation of 15 January) had been diluted by months, indeed years, of announcements, discussions and debates. However the size of the intervention was still greater than earlier expectations, of the order of €500bn, and therefore there still was some element of surprise. The provision that National Central Banks should take on 80% of the risk of default on 80% of their country’s bonds purchased by the ECB is an important limitation of the Monetary Union but an acceptable price for this massive intervention.

Third, the depreciation of the euro down to a rate of $ 1.11, then stabilized at $1.13 (below the rate of $ 1.17 at which the euro was first introduced and a far cry from its peak of $1.47), for several reasons: ECB Quantitative Easing; the expectation of the Fed raising interest rates, repeatedly announced and now postponed probably to next June; expectations - rightly or wrongly - of the worsening of the Greek crisis and even a possible exit of Greece from the Eurozone (Grexit).  Such devaluation should have a significant impact on the competitiveness of all member countries and therefore their exports and growth, improving the relative position of those who like Italy have seen labour productivity stagnate or even decline over the last decade. Predicting the quantitative impact of euro devaluation on the rate of GDP growth is difficult and risky, but this effect could have an order of magnitude of 0.8-1%.

Fourth, the resounding victory of Alexis Tsipras and his party Syriza in the Greek elections of 25 January, which has called into question the austerity policy adopted by European institutions under the hegemonic influence of Germany as the only strategy response to the Great Recession of 2007, along with so-called "structural reforms".  These last are a euphemism for the dismantling of the welfare state, privatization of under-valued public assets and the cancellation of decades of achievements of the labour movement.

The first moves of the new Greek government were reassuring: Greece has no intention to leave the euro (a choice supported by 60% of the Greek population), nor to press for further cancellation of public debt, nor to request additional aid.  At the end of February Greece expected to receive €2 bn aid from the European Union and €5 bn from the IMF, conditionally on reform implementation.  Now the Greek government requests only €1.9bn from the ECB as reimbursement of the additional interest earned by the Bank on the Greek bonds in its portfolio. As Finance Minister Yannis Varoufakis rightly said, "A Monetary Union responding to a serious financial crisis by granting more loans to deficit countries on condition that they shrink their national income is not sustainable”.  Varoufakis proposes a " menu of swaps " of Greek bonds with new bonds of two types: one indexed to nominal economic growth, whose service therefore would be conditional on the resumption of growth, and the other a "perpetual bond" that would replace the Greek government bonds in the hands of the European Central Bank. The Greek budget would remain in primary surplus, but only on a more modest scale of 1-1.5%, thanks to the decision to pursue big tax evaders.  In this way Greece could effectively honour existing commitments, while creating a fiscal space sufficient to finance the reconstruction of the welfare state, to increase the minimum wage and pensions, as well as to grant the benefits in kind or subsidies (for example in electricity and transport) promised and partly already introduced by the new government.  Otherwise, Varoufakis says, "Greece will become deformed rather than reformed." Varoufakis' plan was received favorably at its presentation to the City of London, and provides an excellent and credible basis for discussions and negotiations with the European institutions.

Why, then, the "moderate" nature of optimism rooted in so many positive developments?

First, the fall in the oil price is the result of lower demand in the recession, the Saudi decision not to cut production to match lower demand, and the significant growth of the US production obtained from bituminous shale.  But the price reduction undermines its causes: not only does it stop investment in the development of alternative energy sources, but at the current price of around $ 50 per barrel it makes most of the production to be sold at a loss and therefore not sustainable. On 30 January the announcement of the closure of one hundred high-cost wells in the United States raised the price of oil by more than $ 8 in a single day although production had continued to rise. And if the low oil price were maintained there would be - and are already experiencing them - negative effects on the demand for imports by oil-producers and therefore on income and employment in the non-oil-exporting countries.

Second, in the opinion of many observers and businessmen, monetary easing by the ECB was "too little too late", in comparison with the $ 4.5 trillion mobilized by the Fed already commenced in 2008, and further, in view of the greater use by US companies of credit and securities to finance investments, compared to the larger component of profit reinvestment by companies in Europe and especially in Italy.  But there is no doubt that monetary easing - in addition to its impact already mentioned on euro devaluation - will facilitate the recapitalization of banks that have an excess of government bonds in their portfolios.

Third, the devaluation of the euro could unleash a war between currency areas with rounds of competitive devaluations, and the associated de-stabilization of financial markets.

Finally, European and German economic authorities have immediately taken rigid and hostile positions adverse to any form of restructuring of Greek debt.

Matteo Renzi has been likened to Alexis Tsipras but unfortunately we are not so lucky, all they have in common is their young age; Italy also has €40bn credits towards Greece, and our excellent Pier Carlo Padoan has neither the imagination nor the tenacity of Yanis Varoufakis.  If anything Alexis Tsipras has something more in common with our new President Sergio Mattarella: immediately after their election both went to visit a monument to the victims of Nazi atrocities, a gesture that cannot have been greeted with enthusiasm by Angela Merkel.  The French are watching from the sidelines; in order to widen the breach in European austerity opened by Syriza we will have to wait for a parallel Podemos victory in the next elections in Spain.

The danger is that the game of chicken played by Germans and Greeks might lead to a lethal crash, perhaps in the form of an "accidental Grexit" (an expression coined by Wolfgang Munchau): the expiry of any deadline before a new agreement is reached, the loss of Greek access not only to Quantitative Easing but also to emergency liquidity provided by the ECB, capital flight and a panic run on the banks by the public seeking to withdraw cash from their accounts.  At that point, a severe liquidity crisis could force Greece to issue some form of national currency, perhaps initially notes issued by the Treasury circulating in parallel with euro cash now in short supply: from there to a formal exit is only a small step. Cyprus came within a breath of this predicament.

Marcello De Cecco noted that while a Greek exit from the Eurozone could very well happen in the way I described, it would be the result of a deliberate policy of not wanting to help Greece, instead of a series of casual fatalities, when there is will there is always a way, and if deadlines are not met this means that Greek exit is not so much feared but wanted.

In any case, a possible Greek exit from the Eurozone – whether accidental or deliberate - cannot be ruled out completely, and would be catastrophic for the entire Eurozone, with contagion spreading first to Portugal, then to the other southern countries including Spain and Italy, eventually turning against Germany itself and the other Nordic countries. That is enough to temper anybody’s optimism.

POSTCRIPT

On 4 February the ECB Governing Board decided that Greek government debt will no longer be accepted as collateral starting next week.  This appears to be like undue ECB interference in Greek negotiations with the EU, but 1) it is well within the Bank’s discretionary powers; 2) it is likely to be part of the price paid by Mario Draghi for the large size of his Quantitative Easing and 3) it is also a way of raising the stakes which might, in the end, favour Greece by raising the cost of a Greek exit for Germany and the hawks as well as for Greece.  After all, Yanis Varoufakis is an accomplished game theorist and should know what he is doing (see Varoufakis Y., Rational Conflict. Oxford, Blackwell, 1991; Varoufakis Y. and S. Hargreaves-Heap, Game Theory: A critical text. London and New York, Routledge, 2004).  At least, this is what we might still hope.

For assessments supporting this last point see the excellent post by Frances Coppola, What on Earth is the ECB up to? and the other posts listed at the end of it.

Europe is a Cow

The Greek etymology of Europa (εὐρυ- "wide" or "broad" and ὤψ"eye(s)" or "face"), suggests that as a goddess she represented a cow (with a wide face). See also Antonio Carracci (b. ca. 1583, Venice, d. 1618, Rome),The Rape of Europe, currently being shown at the exhibition "From Guercino to Caravaggio", Palazzo Barberini, Rome. 

1. Costs and benefits of the Euro

The introduction of the Euro involved for all the EMU member states significant benefits and costs.  Benefits include: a greater economic and financial integration of trade and investment; a rate of inflation lower than the Bundesbank best performance with the DM; and ten years of an interest rate on public debt rapidly converging to a common, decreasing level.

At the same time national governments lost the use of several instruments of economic policy: monetary policy, delegated to the ECB; the nominal exchange rate of the national currency (the alternative “internal” devaluation through lower price and wage inflation than competitors being conflictual and impopular), and fiscal policy now subjected to a much stricter discipline (Maastricht, Growth and Stability Pact, followed by the Fiscal Compact).

Italy had the additional cost of a fiscal squeeze undertaken in order to approach the required pre-requisites – an excellent investment in view of the benefits obtained as a result.  In the transition to the Euro, Italy and Greece recorded an initial burst of inflation caused by the lack of price monitoring and control on the part of the government; this immediately eroded the international competitiveness of both countries, which could no longer be restored through devaluation.  Monetary sovereignty had already been surrendered by the government to the Italian Central Bank in 1980.  A greater financial integration turned into a channel of contagion in the subsequent crisis.  And, above all, on 19 October 2010 in Deauville, Angela Merkel and Nicolas Sarkozy decided that ESM bailouts would inflict losses on government creditors – a position ethically unimpeachable but infelicitous, because it caused a further widening of the spreads of long term interest rates on the public debt of member states with respect to German Bunds.  Thus began the Eurozone tribulations, characterized by stagnation, record unemployment, deflation, still today in the grips of the deepest crisis ever experienced by modern capitalism.

In fact the Great Crisis of 1929 had seen a rapid recovery already from 1933 thanks to the public investment of F.D. Roosevelt’s New Deal, while the crisis that began in 2007 and is still rampaging has been aggravated and prolonged by the perverse austerity policies imposed by International Financial Organisations and the European Union.

2. Euro’s diseases

The Euro suffered from policy errors by various national governments, including the fiscal profligacy of Southern members, but above all from two congenital diseases and a subsequent degenerative disease.

First, the Euro’s premature birth, before political and fiscal integration (and before defence and foreign policy integration): the Euro should have been the very final stage of European integration, its crowning, instead of which it was used to accelerate integration processes, pushing la finalité politique through the tensions generated by monetary dysfunction.

Second, the ECB was born incomplete, not to say mutilated, not so much because of its independence, which is common to the major central banks in the world, but because it was modelled on the Bundesbank, and even more than the latter was totally separated from fiscal policy, without the virtually unlimited power to buy government bonds enjoyed by other central banks otherwise equally independent (as the Fed or the Bank of England or the Central Bank of Japan). Moreover the ECB was born without the usual powers of supervision, recapitalization/consolidation/liquidation of commercial banks, and without the safety net of a common European insurance of bank deposits (the amount nominally insured today is the same throughout the Eurozone, but is the responsibility of national Treasuries, and is therefore worthless in case of a country’s default).

The degenerative disease of EMU has been the progressive economic divergence of member states, not only in terms of monetary and fiscal parameters for which a statutory convergence was envisaged but not observed, but also in terms of other real and financial parameters whose convergence should have been a condition of entrance and continued membership of the Eurozone but was not, such as the unemployment rate, the share of non-performing loans, international competitiveness.  Such progressive divergence created strong and increasing centrifugal tensions.

3. Possible solutions

Monetary policy on its own is not sufficient to re-launch the European economy, in spite of the original and courageous initiatives of the ECB President Mario Draghi (LTROs, OMTs and other unconventional initiatives), also because of the policy constraints imposed by Treaties and/or by the pressures of Northern member states.  It is enough to consider the failure of Japanese policies of Abenomics, i.e. monetary expansion accompanied by modest fiscal stimuli and structural reforms.

International trade, which since the 1970s had been a dominant factor of global economic growth, in the last years has slowed down more than global GDP; the IMF confirms that it has reduced considerably its earlier role in growth promotion.

Many quarters invoke “structural reforms”.  A reform by definition ought to be a change for the better, and a structural reform a significant change for the better, which therefore should be politically uncontroversial and unanimously acceptable. But such reforms raise three serious problems.  There is no agreement on the desirability of this or that reform, in view of their re-distributive effects; any positive effect, if any, can only accrue in the long run (5-10 years); and there are structural reforms that, although clearly beneficial in the long run, in the short run can have strong negative effects. For instance, a competition increase reducing prices today would promote undesirable further deflation; this kind of structural reform is like an investment that although beneficial is not always sufficiently profitable to be recommended.

A reduction of public expenditure in order to reduce taxation (as anticipated but not yet implemented by the Italian spending review) has a positive effect only if it reduces the waste of resources, but otherwise a balanced reduction of both public expenditure and taxation can only have a recessionary impact on income and employment, as demonstrated by Haavelmo.  What might be desirable is an increase of public investment funded by the reduction of current public expenditure.

A superior solution would be a collective large-scale public investment undertaken at the European level. The trouble is that Europe’s so-called virtuous countries, which would be in the best position to undertake a growth-promoting role – thanks to the low interest rates at which they can borrow and their greater margin for fiscal manoeuvre – are stubbornly reluctant to do it.  And the Union budget, at a miserable 1% of European GDP (compared to 20% in the USA), does not allow any large scale initiative.

It might seem that the recent Juncker Plan, with investments of the order of €315bn over three years beginning in the autumn of 2015, represents an important progress in this direction.  But in truth these investments include a presumed and unrealistic multiplier effect on private investments, of the order of almost 15 times.  European Union funds would be only €21bn, of which 8bn diverted from other important uses, 8bn consisting only of guarantees, and 5bn provided by the EIB and unlikely to be fully available without its re-capitalisation.  It is believed that at the moment the funds really available for the Plan are of the order of €2bn – a sick joke (“Europe’s alchemist”, “Laughingly inadequate” The Economist 29 November. See also Mazzucato and Penna, The Guardian, 27 November). 

Jacques Drèze and Alain Durré (CORE 2013) have proposed the issue of bonds indexed to average growth rate of the Eurozone on the part of the ECB or other EU agency, which would then swap them with government bonds issued by member states indexed to national growth rates, in proportion to their share in European GDP.  In such a way the EU agency would be able to insure member states against macroeconomic shocks, paying a subsidy to under-performing states out of the profit made on the bonds of over-performing states, at zero cost.  This is a brilliant scheme, which however in case of default by countries participating in the scheme would inflict serious capital losses on the emitting European Agency.

Pierre Pâris and Charles Wyplosz (2013, 2014) have proposed a scheme called PADRE – Politically Acceptable Debt Reduction in the Eurozone, similar to a proposal of mine of 2013 – consisting in the mobilization of ECB seigniorage for the purchase and retirement of government debt of all countries holding shares in the ECB (including 10 countries that are members of the EU but not of EMU), in the same proportions of the shares they hold.  Therefore even a possible default by a large country would not damage other members and would not involve a Transfer Union.  In his Caffè Lectures of 2011 Willem Buiter estimated the present value of ECB seigniorage at about €3300 billions, but seigniorage mobilization for Eurozone debt reduction is unlikely to be acceptable to the Northern members of EMU.

4. Disintegration of the Eurozone?

Over the last years there has been frequent discussion of the possible disintegration of the Eurozone, with the return to national currencies by the weaker or the stronger members.

The recovery of national monetary sovereignty would allow weaker members the use of all the instruments of monetary policy, and the ability to recover international competitiveness through exchange rate devaluation.  However European fiscal discipline would continue to apply to all EU members even after ceasing to be members of EMU, by virtue of the Growth and Stability Pact.

The initial exchange rate between the Euro and the new national currency would be irrelevant, because the same rate would apply to prices.  But its use as an instrument of economic policy would involve for the weaker members the cost of successive devaluations, higher inflation and higher interest rates, as well as the revaluation of debt; exiting stronger members would face the cost of revaluations making them lose international competitiveness.  All exiting countries would also face the large scale cost of exit from the entire European Union, that requires the single currency as a part of the obligations of membership – the acquis communautaire (except for Denmark and the UK that negotiated a derogation from the Maastricht Treaty before signing it).

Even under unchanged current policies, sooner or later the economic crisis might well come to an end thanks to the automatic mechanisms that always operate in the course of any economic cycle in a capitalist system.  Once the floor of zero gross investment is reached, further falls of investment come to an end, stabilizing national income; at that point net investment is negative and gradually eliminates excess capacity; gross investment resumes first to replace excessive capacity losses, then to exploit the superior technical opportunities accumulated during the crisis; and the ensuing multiplier/accelerator interaction boosts growth further.  Growth revival, however, might happen too late to prevent the disintegration of the Euro (just as it happened with the ruinous disintegration of the USSR and the rouble in 1992).

If this happens this Europe of ours will have betrayed the vision and the values of its Founding Fathers.  And we would not even be able to cry over the inglorious end of the European project because the Europe we have today is no use to us, and it most certainly does not deserve our tears.

[Note: An Italian version of this paper was presented at a Round Table on “Perspective of European Economic Policy”, at the Conference for the Centenary of Federico Caffè’s Birth, Sapienza University of Rome, 4-5 December 2014].