Today the Irish people will vote on the Treaty “on the Stability, Coordination and Governance in the EMU”, also known as the “fiscal compact”. This referendum is of paramount importance for the whole European Union. I recently wrote an editorial on the French daily Le Monde, together with Imola Streho, explaining why we believe it to be poorly designed and economically ill conceived. Here is an English version.
Martin Wolf has a very interesting piece on China’s attempt to rebalance its growth model from exports to domestic demand. Wolf remarkably shows how this attempt has been going on for at least a decade, with unequal pace, and several stop-and-go. I’d add that the crisis itself played a contradictory role. China on one side was one of the first countries in 2009 to implement a robust stimulus plan amounting to more than 10% of GDP; on the other, it did not resist (as most countries) more or less hidden protectionist measures and currency manipulation. Wolf concludes that, while successful, the rebalancing from external to domestic demand led to excessive (and not necessarily productive) investment. The new rebalancing challenge of China lies in increasing income and consumption of its population.
What I take from this is that China fully grasps its new role in the world economy. Its leadership understood long ago that the transition from developing/emerging economy to fully developed economy needed to pass among other things through less dependence on exports. A large dynamic economy cannot rely on growth in the rest of the world for its prosperity. Even the debate on reforming the welfare state and on health care had as one of his reasons the necessity to reduce precautionary savings. The rebalancing act is long and unsteady, but definitively under way.
It is also worth noticing that a better balance between domestic and external demand in the large economies is crucial element in reducing the macroeconomic fragility of the world economy through decreasing trade imbalances.
It is striking, in contrast, how Europe remains trapped in a sort of small country syndrome. The “Berlin View” permeating the Fiscal Compact advocates fiscal discipline and domestic demand compression, in order to improve competitiveness and to foster export-led growth. Besides the fact that it is not working, this is equivalent to tying Europe’s fate to the performance of the rest of the world, giving up the ambition of being a major player in the world economic arena. What a difference with the ambition and the forward looking attitude of China…
Paul Krugman has an interesting piece on federal and local expenditure in the United States, where he shows that the consolidated fiscal stance has been considerably more restrictive with Obama than during the Reagan era. This is not what retained my attention, nevertheless. Krugman does not mention that most of the US states (the exception being Vermont) have some form of balanced budget amendment. Krugman himself had warned a while ago that this made the task of the federal government in fighting the recession particularly hard. But once again, this is not the point I want to make.
I recently wrote a paper with Jerome Creel and Paul Hubert, in which we try to assess the impact of the different fiscal rules that are being discussed for reforming the Eurozone governance. For our simulations we took into account the standard Keynesian positive effects of deficit spending: Government expenditure substitutes missing private demand, and hence supports economic activity. But we also embedded a negative effect of deficit and debt, that goes through increased interest rates (the famous spreads). High interest rates make it harder for the private sector to finance spending, and hence depress aggregate demand and growth. We assessed the performance of the rules in terms of average growth over the next 20 years.
OFCE le blog has posted the English translation of an article I wrote with André Grjebine a few weeks ago, for the French daily Le Monde. We commented the Standard & Poor’s downgrades, developing the points I had made here.
I maintain that the motivation of S&P marks a turning point in the debate on EMU governance. It was the first time that a major market participant explicitly challenged the priorities that the German leadership is imposing to Europe.
The current discussion on the Greek austerity plan shows that markets are joining those who preach to the desert.
The European Council meeting, next Monday, should finally lift the veil of mystery that has surrounded the new “fiscal compact”, the set of rules supposed to govern fiscal policy in EU member countries. As of now, the only official document in our hands is the Statement approved by the Heads of State and Government at the December 9 meeting.
I have argued at length that I am not in the camp of those who believe fiscal profligacy is the source of EMU problems (recently, here and here). Rather the contrary, I always thought (see for example here and here) that even the current rules de facto prevented EMU countries from effectively using the standard tools of macroeconomic policy.
Standard and Poor’s decision to downgrade a large number of EU countries, on Friday, was widely expected; and, as I write, markets barely reacted. This is not surprising, as the downgrade had already been embedded in market behaviours.
There are of course notable political consequences, for example in what concerns the French presidential race. But from an economist perspective, this is really not a turning point.
There is nevertheless a remarkable news, that went almost unnoticed. Read more…
The Brussels EU Summit is extremely negative for the decisions that have been taken:
- We are going to converge towards a “German Europe”, based on fiscal austerity and on compression of domestic demand. The stubbornness in rejecting any role for active macroeconomic policies is scary, especially as we are still engulfed into a crisis that could have been substantially worse, were it not for the stimulus packages of 2009. Just ask a question: where would the EU be, if the rules Germany wants, were already in place in 2008?
- The eurozone emerges from the Summit, once again, as the only major economy of the world that does not have a properly functioning central bank. With the support of ECB President Mario Draghi, it was once again made clear that the ECB should and would not act as a lender of last resort.
There will be time to discuss these issues, and to ask where does the EMU go (or does not go) from here.
Here I want to underline the only positive aspect of the meeting: The (self) exclusion of the UK from the process of further integration. This is seen as dangerous by most commentators. I’d argue that it is the only good news that we got from the sleepless night in Bruxelles.
The European leaders could not afford to emerge from negotiations empty-handed, and this forced them to refuse the British vetoes. For the past 38 years the UK has been constantly pushing on the brakes of European integration, obtaining (should I use the term ‘blackmailing’?) compensations and opt-out clauses for every advance that it reluctantly allowed.
The looming Armageddon gave European leaders the strength to finally break free from this grip.
Europe is finally advancing towards increased cooperation. In the wrong direction, for the reasons recalled above, but it is advancing. It is to be hoped that last night we set a precedent, and that in the future the method of enhanced cooperation will become the norm each time that a country blocks the process for selfish reasons.
I made this point in an interview this morning.
There was a lot of noise, yesterday, about the main central banks’ decision to coordinate in maximizing liquidity provision (in dollars) to households and firms. An excellent and clear explanation of what they exactly did can be found here.
Are we effectively at a turning point? I am afraid not, for essentially two reasons:
- The first is that, after an initial moment of euphoria, markets may realize what really happened, i.e. that central banks are preparing for a major Lehman-like event: If the euro breaks down, and if investors flee from it, central banks are ready to act to avoid contagion. This is reassuring, but it also informs us that the main monetary authorities of the planet are seriously considering the possibility of such an event occurring.
- Second, this move, per se, does nothing to address the main source of the problem: the lack of proper Eurozone governance, and the unwillingness of the ECB to act as a lender/buyer of last resort. Major changes on these issues would be a turning point, reducing the risk of a euro crisis, and hence making liquidity in dollars unnecessary.
A safe bet: Financial market euphoria will be short-lived.