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 spreadsof 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 significantchange 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).

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 disinvestment 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.
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 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].

Labels:Deauville,Drèze &Durré,ECB,Euro, F.D. Roosevelt,G&S,Juncker Plan,Maastricht,Mario Draghi,Merkel,Pâris and Wyplosz,Sarkozy,Structural Reforms,Willem Buiter