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Apr 28 2010

Something must change, said Fred

Published by at 6:57 am under Europe,Opinion,Top Stories

I wrote this article in 2005 (for the original click here, then scroll five stories down). Today, it’s as relevant as all hell. So, I thought I’d “re-publish” it. Back then I mentioned the Italians by name and not the Greeks, or Portuguese, but in the context they were included. Here we go:

Something has to change

My gut tells me the European Union (EU) can’t survive (in the long term) with the monetary and fiscal arrangements as they stand now. They are too “country-insensitive”. Among others. Somehow, sometime, something has to change.

But, let’s start at the start.

Outside the EU, governments have two, major instruments for smoothing out the swings of the short-term business cycle, i.e monetary and fiscal policy.

In theory (sometimes also in practice, although it’s not always so easy, or possible, to change tack with fiscal policy on short notice) these 2 instruments are used in combination to optimise the impact on the business cycle.

So, the ideal situation is the one where the 2 instruments compliment each other, i.e. pull together, not against each other. And where the 2 instruments are put to work counter-cyclically, i.e. they are expansive in a downswing and restrictive in an upswing.

That’s the ideal. Mostly only found in handbooks.

More common is the situation where the “fixed expenses” of the public sector (interest on debt, social services etc.) comprises such a big part of the total expenses, that it leaves the minister of finance little room to play.

But, even here the finance minister (responsible for fiscal policy) and the president of the central bank (hopefully, responsible for monetary policy!) would try to co-ordinate policies as far as possible.

And in the EU?

Here member countries have lost effective control over both, ie. monetary and fiscal policy. Monetary policy is determined by the European Central Bank (ECB), while EU politicians effectively run EU fiscal policy from Brussels.

This is a double whammy. Firstly, because the members now have nothing left to steer with and, secondly, because “co-ordination between the 2 instruments” is not possible any longer (if not in theory, definitely not in practice).

This may lead to situations (like we have it now), where the ECB considers raising interest rates (because of inflationary pressures building up), while the big member countries in the EU are told to make their fiscal policies more restrictive, or risk being fined by Brussels. And all of this in an economic environment which (at least for Germany) borders on a recession.

That, the “macro discrepancy”.

There is also a “micro discrepancy”: The EU politicians control EU fiscal policy with a single, simple rule (deficit may not be larger than….) which is totally insensitive to economic conditions in individual member countries.

And the ECB is similarly insensitive to the monetary situations in individual member states. (Forget about this thing that member countries are represented in the ECB and so co-determine. Like in politics, power is also not divisible in the world of monetary policy determination. You either have it, or you don’t. Ask FW de Klerk about that.)

So, the monetary and fiscal policy arrangements of the EU are not realistic and will have to change, sooner or later.

On a more basic level (if it’s possible): How can monetary policy be the same for Germany and Italy? It’s a dream. The peoples are too different.

The one fought tooth and nail for the integrity of its currency over the last 50 years. The other just didn’t care and simply added another nought at the back every few years for decades on end.

These mentalities didn’t change with the signing of a Maastricht document. Proof that it didn’t, lies in the different routes taken by real wages in the years after the signing of Maastricht – the Germans displayed huge discipline, while the Italians thought life was one long party (as they always have).

No. You can put a horse and a cow in the same paddock, but you won’t make a “corse” out of them.

2 responses so far

2 Responses to “Something must change, said Fred”

  1. adminon 28 Apr 2010 at 10:21 am

    Maybe I should clarify: this was an observation that the EU (as it was organised back then and still is today) cannot work (ie. the financial side of the arrangement). Either there needs to be more centralisation of power, or less. But, this “in-between animal”, which is the EU of today, can’t work in the long term.

    My guess is, the current crisis will end up in a more centralised financial/economic Maastricht treaty, so to say.

    And, will it work? I would be very sceptical about the chances of a single EU government. For the same reason as mentioned above: You can put a horse and a cow in the same paddock, but you won’t make a “corse” out of them. The peoples of southern and northern EU are too different.

    Christo

  2. adminon 07 May 2010 at 12:45 pm

    In today’s FTD, US economist Joseph Stiglitz wrote a very interesting piece on the EU and its problems. The central message: the EU can’t survive as it (ie. the fiscal and monetary policy arrangement) stands now. Only with a major revamp can the EU still be kept intact.

    Here is the German version. I suspect the article will appear on http://www.project-syndicate.org in English soon.

    Keep your eyes peeled – it’s worth a read.

    Christo

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