Yesterday I published a note on OFCE le blog (in French), analyzing one possible outcome of the recent Italian elections: A center-left minority government, with external support of the Cinque Stelle movement led by comedian Beppe Grillo. The last part of the post argues that if a convergence between the Democratic Party and Beppe Grillo were to be found (at the moment the scenario is rather unlikely), it would happen on a number of progressive issues, like for example minimum citizenship income. But then, I conclude, this has implications for Europe as a whole. Here is a translation of the last paragraphs: It is clear that the convergence could hardly happen within the bounds of the current fiscal consolidation. An agreement would therefore need a prior reversal of austerity that, it is worth repeating, was disavowed by the voters. This would not be easy for the Democratic Party that, like the Socialist Party in France, made the choice of fiscal discipline, and has kept a very ambiguous position along all the electoral campaign. But in turn, this has implications for Europe as a whole. European leaders in the next weeks may face a choice between demanding that Italy stays the course of fiscal consolidation, condemning the third economy of the eurozone to political paralysis and probably social chaos; or, accept that a new government is formed, that will most likely abandon austerity. In both cases it will be impossible to act as if nothing had happened. Europe could be forced to rethink its own economic strategies, that are failing not only in Italy. An some countries reluctantly embracing fiscal consolidation (France to name one) could take the opportunity to challenge austerity as the only policy for growth.
Let’s be clear, here. I am totally aware that at the moment this is nothing more than wishful thinking. But hey, you never know…
Il Sole 24 Ore just published an editorial I wrote with Jean-Luc Gaffard, on the structural problems facing the EU. Here is an English (slightly longer and different) version of the piece:
It is hard not to rejoice at the ECB announcement that it would buy, if necessary, an unlimited amount of government bonds. The Outright Monetary Transactions (OMT) program is meant to protect from speculation countries that would otherwise have no choice but to abandon the euro zone, causing the implosion of the single currency. As had to be expected, the mere announcement that the ECB was willing to act (at least partially) as a lender of last resort calmed speculation and spreads came down to more reasonable levels.
So, we had another crucial summit, on June 28-29, followed by another also crucial Eurogroup, on July 9. Like all the ones that preceded, and the ones that will follow, they were trumpeted as the final solution to eurozone woes. And as usual, these “final solutions” lasted days, if not hours.
I was tempted to comment immediately after, but I wanted to see the dust settle for once, so as to have more perspective. Did not work that way, though, as news kept piling up. But let’s look at what was agreed.
Countries like the United States, Japan or the United Kingdom can finance their debt at zero or negative real interest rates. This in spite of debt levels higher than those of the euro area, and growth forecasts that are not necessarily better. Meanwhile, the eurozone peripheral countries have to deal on a daily basis with the mood of markets, and to pay interests on debt at the limit of sustainability.
The reasons for this state of affairs are clear, and have been repeatedly mentioned. Eurozone countries are forced to borrow in a currency that they do not issue: the euro is in effect a foreign currency. To quote Paul de Grauwe,
In a nutshell the difference in the nature of sovereign debt between members and non-members of a monetary union boils down to the following. Members of a monetary union issue debt in a currency over which they have no control. It follows that financial markets acquire the power to force default on these countries. This is not the case in countries that are no part of a monetary union, and have kept control over the currency in which they issue debt. These countries cannot easily be forced into default by financial markets.
In other words, peripheral eurozone countries are in the same situation of Latin America in the eighties: they are forced to pay high risk premia to markets fearing the risk of default, induced by the vicious circle austerity-recession-debt burden.
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.
The latest IMF World Economic Outlook came out last week. It has lots of interesting remarks on the European austerity. Remarkably enough, it poses the problem of timing: fiscal consolidation, if too hasty, may end up being counterproductive. I played a little with the data accompanying the report, including the forecasts.
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.
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.