Posts Tagged ‘Berlin View’

Draghi the Fiscal Hawk

October 23, 2015 4 comments

We are becoming accustomed to European policy makers’ schizophrenia, so when yesterday during his press conference Mario Draghi mentioned the consolidating recovery while announcing further easing in December, nobody winced. Draghi’s call for expansionary fiscal policies was instead noticed, and appreciated. I suggest some caution. Let’s look at Draghi’s words:

Fiscal policies should support the economic recovery, while remaining in compliance with the EU’s fiscal rules. Full and consistent implementation of the Stability and Growth Pact is crucial for confidence in our fiscal framework. At the same time, all countries should strive for a growth-friendly composition of fiscal policies.

During the Q&A, the first question was on precisely this point:

Question: If I could ask you to develop the last point that you made. Governor Nowotny last week said that monetary policy may be coming up to its limits and perhaps it was up to fiscal policy to loosen a little bit to provide a bit of accommodation. Could you share your thoughts on this and perhaps even touch on the Italian budget?

(Here is the link to  Austrian Central Bank Governor Nowotny making a strong statement in favour of expansionary fiscal policy). Draghi simply did not answer on fiscal policy (nor on the Italian budget, by the way). The quote is long but worth reading

Draghi: On the first issue, I’m really commenting only on monetary policy, and as we said in the last part of the introductory statement, monetary policy shouldn’t be the only game in town, but this can be viewed in a variety of ways, one of which is the way in which our colleague actually explored in examining the situation, but there are other ways. Like, for example, as we’ve said several times, the structural reforms are essential. Monetary policy is focused on maintaining price stability over the medium term, and its accommodative monetary stance supports economic activity. However, in order to reap the full benefits of our monetary policy measures, other policy areas must contribute decisively. So here we stress the high structural unemployment and the low potential output growth in the euro area as the main situations which we have to address. The ongoing cyclical recovery should be supported by effective structural policies. But there may be other points of view on this. The point is that monetary policy can support and is actually supporting a cyclical economic recovery. We have to address also the structural components of this recovery, so that we can actually move from a cyclical recovery to a structural recovery. Let’s not forget that even before the financial crisis, unemployment has been traditionally very high in the euro area and many of the structural weaknesses have been there before.

Carefully avoiding to mention fiscal policy, when answering a question on fiscal policy, speaks for itself. In fact, saying that “Fiscal policies should support the economic recovery, while remaining in compliance with the EU’s fiscal rules” and putting forward for the n-th time the confidence fairy, amounts to a substantial approval of the policies followed by EMU countries so far. We should stop fooling ourselves: Within the existing rules there is no margin for a meaningful fiscal expansion of the kind invoked by Governor Nowotny. If we look at headline deficit, forecast to be at 2% in 2015, the Maastricht limits leave room for a global fiscal expansion of 1% of GDP, decent but not a game changer (without mentioning the fiscal space of individual countries, very unevenly distributed). And if we look at the main indicator of fiscal effort put forward by the fiscal compact, the cyclical adjusted deficit, the eurozone as a whole should keep its fiscal consolidation effort going, to bring the deficit down from its current level of 0.9% of GDP to the target of 0.5%.

It is no surprise then that the new Italian budget (on which Mario Draghi carefully avoided to comment) is hailed (or decried) as expansionary simply because it slows a little (and just a little) the pace of fiscal consolidation. Within the rules forcefully defended by Draghi, this is the best countries can do. As a side note, I blame the Italian (and the French) government for deciding to play within the existing framework. Bargaining a decimal of deficit here and there will not lift our economies out of their disappointing growth; and more importantly, on a longer term perspective, it will not help advance the debate on the appropriate governance of the eurozone.

In spite of widespread recognition that aggregate demand is too low, Mario Draghi did not move an inch from his previous beliefs: the key for growth is structural reforms, and structural reforms alone. He keeps embracing the Berlin View. The only substantial difference between Draghi and ECB hawks is his belief that, in the current cyclical position, structural reforms should be eased by accommodating monetary policy. This is the only rationale for QE. Is this enough to define him a dove?

EMU Troubles: The Narrow Way Out

September 18, 2015 4 comments

I was asked to write a piece on whether we should continue to study the EMU (my answer is yes. In case you wonder, this is called vested interest). One section of it can be a stand-alone blog post: Here it is, with just a few edits:

While in the late 1980s the consensus among economists and policy makers was that the EMU was not an optimal currency area (De Grauwe, 2006), the choice was made to proceed with the single currency for two essentially opposed reasons: The first, stemming from the Berlin-Brussels Consensus, saw monetary integration, together with the establishment of institutions limiting fiscal and monetary policy activism, as an incentive for pursuing structural reforms and converging towards market efficiency: as the role of macroeconomic management was believed to be limited, giving up monetary policy would impose negligible costs to countries while forcing them, through competition, to remove growth-stifling  obstacles to markets.

Another group of academics and policy makers, while not necessarily subscribing to the Consensus, highlighted the political economy of the single currency: Adopting the euro in a non-optimal currency area would have created the incentives for completing it with a political union: a federation, endowed with a common fiscal policy and capable of implementing the fiscal transfers that are required to avoid divergence. In other words a non-optimal euro was seen as just an intermediate step towards a real United States of Europe. A key argument of the proponents of a federal Europe was, and still is, that fiscal transfers seem unavoidable to ensure economic convergence. A seminal paper by Sala-i-Martin and Sachs (1991) shows that even in the United States, where market flexibility is substantially larger than in the EMU, transfers from booming states to states in crisis account for almost 50% of the reaction to asymmetric shocks.

It is interesting to notice how the hopes of both views were dashed by subsequent events. As the theory of optimal currency areas correctly predicted, the inception of the euro without sufficiently strong correction mechanisms, triggered a divergence between a core, characterized by excess savings and export-led growth, and a periphery that sustained the Eurozone growth through debt-driven (public and private) consumption and investment.

Even before the crisis the federal project failed to make it into the political agenda. The euro came to be seen by the political elites not, as the federalists hoped, as an intermediate step towards closer integration, but rather as the endpoint of the process initiated by Jean Monnet and Robert Schuman in 1950. The crisis further deepened economic divergence and recrimination, highlighting national self-interest as the driving force of policy makers, and making solidarity an empty word. As we write, the Greek crisis management, the refugee emergency, the centrifugal forces shaking Europe, are seen as a potential threat to the Union, rather than a push for further integration as it happened in the past (Rachman, 2015).

The Consensus partisans won the policy debate. The EMU institutions, banning discretionary policy, reflect their intellectual framework; and the policies followed (more or less willingly) by EMU countries, especially since the crisis, are the logical consequences of the consensus: austerity and structural reforms aimed at increasing competitiveness and reducing the weight of the State in the economy. But while they can rejoice of their victory, Consensus proponents have to deal with the failure of their policies: five years of Berlin View therapy has nearly killed the patient. Peripheral countries’ debt is still unsustainable, growth is nowhere to be seen (including in successful Germany), and social hardship is reaching unbearable levels (Kentikelenis et al., 2014). Coupling austerity with reforms proved to be self-defeating, as the short term recessionary impact on the economy was much larger than expected (Blanchard and Leigh, 2013), and as a consequence the long run benefits failed to materialize (Eggertsson et al., 2014). It is then no surprise that in spite of austerity and reforms, divergence between the core and the periphery of the Eurozone is even larger today than it was in 2007.

The dire state of the Eurozone economy is in some sense the revenge of optimal currency areas theory, with a twist. It appears evident today, but it was clear two decades ago, that market flexibility alone would never suffice to ensure convergence (rather the opposite), so that the Consensus faces a potentially fatal challenge. On the other hand, the federalist project, that was already faltering, seems to have received a fatal blow from the crisis.

The conclusion I draw from these somewhat trivial considerations is that the EMU is walking a fine line. If the federalist project is dead, and if Consensus policies are killing the EMU, what have we left, besides a dissolution of the euro?

I conclude the paper by arguing that two pillars of a new EMU governance/policy are necessary (neither of them in isolation would suffice):

  1. Putting in place any possible surrogate of fiscal transfers, like for example a EU wide unemployment benefit, making sure that it is designed to be politically feasible (i.e. no country is net contributor on average), eurobonds, etc.
  2. Scrapping  the Consensus together with its foundation, the efficient market hypothesis, and head towards real, flexible coordination of (imperfect) macroeconomic policies in order to deal with (imperfect) markets. Government by the rules only works in the ideal neoclassical world.

I know, more easily said than done. But I see no other possibility.

And the Winner is (should be)…. Fiscal Policy!

September 4, 2015 2 comments

So, Mario Draghi is disappointed by eurozone growth, and is ready to step up the ECB quantitative easing program. The monetary expansion apparently is not working out as planned.

Big surprise. I am afraid some people do not have access to Wikipedia. If they had, they would read, under “liquidity trap“, the following:

A liquidity trap is a situation, described in Keynesian economics, in which injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

In a liquidity trap the propensity to hoard of the private sector becomes virtually unlimited, so that monetary policy (be it conventional or unconventional) loses traction. It is true that the age of great moderation, and three decades of almighty central bankers had made the concept fade into oblivion. But, since 2008 we were forced to reconsider the effectiveness of monetary policy at the so-called zero lower bound.Or at least we should have…

So, had policy makers taken the time to look at the history of the great depression, or at least to open the Wikipedia entry, they should have learnt that when monetary policy loses traction, the witness in lifting the economy out of the recession, needs to be taken by fiscal policy. In a liquidity trap the winner is fiscal policy.  Or at least it should be. Here is a measure of the fiscal stance, computed as the change in government balance once we exclude cyclical components and interest payments.

2015_09_LiquidityThe vast majority of EMU countries undertook a strong fiscal tightening, regardless of the actual health of their public finances. This generalized austerity, an offspring of the Berlin View, led to our double dip recession, and to further divergence in the eurozone, that would have needed coordinated, not synchronized fiscal policies. Well done guys…

And yet, Mario Draghi is surprised by the impact of QE.

Of Democracy and of a Different Europe

July 6, 2015 3 comments

I have mixed feeling about the Oki victory in Greece. The choice was between two evils: slow death by more of the same (the troika plan), or a roller-coaster ride that has a high chance of ending catastrophically for Greece and for the EMU. I would have voted no, were I Greek, but not joyfully. This said, two things I have been reading in the past days are disturbing:

  1. First, the claim that Tsipras’ rhetoric on democracy is misplaced: After all, people say, we all are democracies. Why should Greek democracy count more than the Portuguese, or the Spanish one? There is no reason, of course. Point is that Tsipras did something that is now really revolutionary in Europe, he tried – hold your breath –  to implement the platform on which he was elected. How many governments in Europe went to power promising an end to austerity, promising a “new deal for Europe”, just to retract a few months/weeks/days later and align themselves with the Berlin View that austerity is the only way? Greek democracy today should count more than democracy in the rest of Europe, because it is the only case in which voters are actually listened to by their government. This is why Syriza’s anomaly needed to be crushed, well beyond the actual content of its proposed policies. If European policy makers feel that their democracy should be as important as Greece’s, they could start by trying to do what their voters elected them for. That would certainly not hurt.
  2. The second thing that bothers me, is the convergence of the establishment and of euro-skeptical movements across Europe. Don’t be fooled by the enthusiastic adherence of many no-euro movements to the Oki campaign Their siding with Tsipras was instrumental to Grexit, turmoil, and weakening the euro itself. Something orthogonal to what Tsipras has been doing and saying in the past two years. The referendum made it clear that the establishment and the no-euro converge in trying to prove that there is no alternative to austerity in Europe. The former, because if Greece is not normalized, we would enter into a new phase in which statements and policies would have to be assessed on the basis of facts (not so favorable to austerity) rather than taken as a matter of faith. Euro skeptics need Tsipras to be crushed because this would definitely prove that the only way to get rid of austerity is to get rid of the euro altogether.

Therefore the referendum, while certainly hazardous and ill-conceived (what did the Greek people vote on, in the end?), had the great merit of exposing the hypocrisy of some commentators, and to show that the only hope for a different Europe has to be found in the struggle that an inexperienced prime minister is leading from Athens. Since yesterday, with the renewed support of his people. Dangerous times ahead, but with a small hope for change.

Reform or Perish

June 19, 2015 2 comments

Very busy period. Plus, it is kind of tiresome to comment daily ups and downs of the negotiation between Greece and the Troika Institutions.

But as yesterday we made another step towards Grexit, it struck me how close the two sides are on the most controversial issue, primary surplus. Greece conceded to the creditors’ demand of a 1% surplus in 2015, and there still is a difference on the target for 2016, of about 0.5% (around 900 millions). Just look at how often most countries, not just Greece, respected their targets in the past, and you’ll understand how this does not look like a difference impossible to bridge.

The remaining issue is reforms. Creditors argue that Greece cannot be trusted in its commitment to reform. After all, they cheated so often in the past… In particular, creditors point at one of Syriza’s red lines, the refusal to touch pension reforms, as proof that the country is structurally incapable of reform. And here is the proof, the percentage of GDP that crisis countries spent in welfare::


I took total social expenditure that bundles together pensions, expenditure for supporting families, labour market policies, and so on and so forth. All these expenditure that, according to the Berlin View, choke the animal spirits of the economy, and kill productivity.

Well, Greece does not do much worse than its fellow crisis economies, but it is true that it is hard to detect a downward trend. The reform effort was not very strong, and certaiinly not adapted to an economy undergoing such a terrible crisis. The very fact that after four years of adjustment program the country spends 24% of its GDP in social protection, is a proof that it cannot be trusted.This is just proof that, once more, the Greek made fun of their fellow Europeans, and that they want us to pay for their pensions.

Hold on. Did I just say “terrible crisis”? What was that story of ratios, denominators and numerators? The ratio is today at the same level as 2009. But what about actual expenditure? There is a vary simple way to check for this. Multiply each of the lines above for the value of GDP. Here is what you get (normalized at 2009=100, as country sizes are too different):


The picture looks quite different, does it? Greece, whose crisis was significantly worse than for the other countries, slashed social expenditure by 25% in 5 years (I know, I know, it is current expenditure. I am too busy to deflate the figure. But I challenge you to prove that things would be substantially different). Now, just in case you had not noticed, social expenditure has an important role as an automatic stabilizer: It supports incomes, thus making hardship more bearable, and lying the foundations for the recovery. In a crisis the line should go up, not down. This picture is yet another illustration of the Greek tragedy, and of the stupidity of the policies that the Troika insists on imposing. By the way, notice how expenditure increased from 2005 to 2009, in response to the global financial crisis. A further proof that sensible policies were implemented in the early phase of the crisis, and that we went berserk only in the second phase.

Ah, and of course virtuous Germany, the model we should all follow, is the black line. Do what I say…

One may object that focusing on expenditure is misleading. There is more than expenditure in assessing the burden of the welfare state on the economy. While Greece slashed spending, its welfare state did not become any better; its capacity to collect taxes did not improve, that its inefficient public administration and its crony capitalism are stronger than ever. Yes, somebody may object all that. That someone is Yanis Varoufakis, who is demanding precisely this: stop asking that Greece slashes spending, and lift the financial constraint that prevents any meaningful medium term reform effort. Reform is not just cutting expenditure. Reform is reorganization of the administrative machine, elimination of wasteful programs, redesigning of incentives. All that is a billion times harder to do for a government that spends all its energies finding money to pay its debt.

Real reform is a medium term objective that needs time, and sometimes resources. In a sentence, reform should stop being associated with austerity.

But hey, I am no finance minister. Just sayin’…


Mr Sinn on EMU Core Countries’ Inflation

December 17, 2014 16 comments

Two weeks ago I received a request from Prof Sinn to make it known to my readers that he feels misrepresented by my post of September 29. Here is his very civilized mail, that I publish with his permission:

Dear Mr. Saraceno,
I have just become acquainted with your blog: You misrepresent me here. In my book The Euro Trap. On Bursting Bubbles, Budgets and Beliefs, Oxford University Press 2014, and in many other writings, I advise against extreme deflation scenarios for southern Europe because of the grievous effects upon debtors. I explicitly draw the comparison with Germany in the 1929 – 1933 period. I advocate instead a mixed solution with moderate deflation in southern Europe and  more inflation in northern Europe,  Germany in particular. In addition, I advocate a debt conference for southern Europe and a “breathing currency union” which allows for temporary exits of those southern European countries for which the stress of an internal adjustment would be unbearable. You may also wish to consult my paper “Austerity, Growth and Inflation: Remarks on the Eurozone’s Unresolved Competitiveness Problem”, The World Economy 37, 2014, p. 1-1,, in which I also argue for more inflation in Germany to solve the Eurozone’s problem of distorted relative prices.  I would be glad if you could make this response known to your readers.

Sincerely yours
Hans-Werner Sinn
Professor of Economics and Public Finance
President of CESifo Group

I was swamped with end of semester duties, and I only managed to read the paper (not the book) this morning. But in spite of Mr Sinn’s polite remarks, I stand by my statement (spoiler alert: the readers will find very little new content here). True, in the paper Mr Sinn advocates some inflation in the core (look at sections 9 an 10). In particular, he argues that

What the Eurozone needs for its internal realignment is a demand-driven boom in the core countries. Such a boom would also increase wages and prices, but it would do so because of demand rather that supply effects. Such demand-driven wage and price increases would come through real and nominal income increases in the core and increasing imports from other countries, and at the same time, they would undermine the competitiveness of exports. Both effects would undoubtedly work to reduce the current account surpluses in the core and the deficits in the south.

This is a diagnosis that we share But the agreement stops around here. Where we disagree is on how to trigger the demand-driven boom. Mr Sinn expects this to happen thanks to market mechanisms, just because of the reversal of capital flows that the crisis triggered. He argues that the capital which foolishly left Germany to be invested in peripheral countries, being repatriated would trigger an investment and property boom in Germany, that would reduce German’s current account surplus. This and this alone would be needed. Not a policy of wage increases, useless, nor a fiscal expansion even more useless.

Problem is, the data speak against Mr Sinn’s belief. Since the crisis hit, capital massively left peripheral countries, and yet this did not fuel domestic demand in Germany. Last August I showed the following figure:


It shows that after a drop (in the acute phase of the financial crisis) due to a sharp decline of GDP, since 2009 domestic demand as a percentage of GDP kept decreasing, in Germany as well as in the rest of the Eurozone. The reversal of capital flows depressed demand in the periphery, but did not boost it in Germany. Mr Sinn is too skilled an economist to fail to see this. The reason is, of course, that the magic investment boom did not happen:

2014_12_17_Sinn_1Mr Sinn, being a fine economist, could object that this is because GDP, the denominator, grew more fell less in Germany than in the rest of the EMU. Well, think again.

2014_12_17_Sinn_2Yes, France comes out as investing (privately) less than Germany. But we are far from an investment boom in Germany as well. Mr Sinn, will agree, I ma sure.

What basically happened, I said it before, is that adjustment was not symmetric. Peripheral countries reduced their excess demand, while Germany and the core did not reduce their excess savings. The result is that, if we compare 2007 to 2014, external imbalances of the periphery were greatly reduced or reversed, while with the exception of Finland the core did not do its homework:

2014_12_17_Sinn_0The EMU as a whole became a large Germany, running a current account surplus (it was more or less in balance in 2007), and relying on its exports for growth. A very dubious strategy in the long run.

The conclusion in my opinion is one and only one: We cannot count on markets alone, in the current macroeconomic situation, if we want rebalancing to take place. In the article he suggested I read, Mr Sinn states that a 4 or 5 per cent inflation rate would be politically impossible to sell to the German public:

Moreover, it is unclear whether the German population would accept being deprived of their savings. Given the devastating experiences Germany made with hyperinflation from 1914 to 1923, which in the end undermined the stability of its society, the resistance against an extended period of inflation in Germany could be as strong or even stronger than the resistance against deflation in southern Europe. After all, a rate of 4.1 per cent for German inflation for 10 years, which would be necessary to allow the necessary realignment between France and Germany without France sliding into a deflation, would mean that the German price level would increase by 50 per cent and that, in terms of domestic goods, German savers would be deprived of 33 per cent of their wealth. If the German inflation rate were even 5.5 per cent, which would be necessary to accommodate the Spanish realignment without price cuts, its price level would increase by 71 per cent over a decade and German savers would be deprived of 42 per cent of their wealth.

This shows all the logic of Ordoliberalism: It is impossible to sell inflation to the the German public, because this would deprive them of their savings. This argument only makes sense if one subscribes to the Berlin View that the bad guys in the south partied with hard earned money of northern (hard) workers. Otherwise the argument makes no sense at all, as high inflation in the core for next few years simply  compensates low inflation in the past. Should I remind Mr Sinn that the outlier in terms of labour costs  is not the EMU periphery, but Germany?

Also, I find it disturbing that, while acknowledging that inflation in Germany would be needed, Mr Sinn rejects it on the ground that it would be a hard sell. The role of intellectuals and academics is mostly to discuss, find solutions (or at least try), and then argue for them. All the more so if this is unpopular, because it is then that their pedagogical role is most needed. All too often public intellectuals abdicate to their role, and simply follow the trend. Should we all argue in favour of a euro breakup only because public opinion is less and less favorable to the single currency?

Finally, a short comment on another bit of Mr Sinn’s article:

And although the core countries would suffer [from high inflation], the solution would not be comfortable for the devaluating countries either. They will unavoidably face a long-lasting stagnation with rising mass unemployment and increasing hardship for the population at large. People will turn away from the European idea, and voices opting for exiting the euro will gain strength. Thus, it might be politically impossible to induce the necessary differential inflation in the Eurozone.

I don’t really see his point here. But let’s take it for good, just for the sake of argument. I think it is too late to worry about support for the euro in the periphery. It is hard to see how “excessive” inflation in the core would impose more hardness than seven years of adjustment, ill-conceived structural reforms, and self-defeating austerity.

So Mr Sinn, thank you for your mail and for the reference to your paper that I have read with interest. But no, I don’t think I misrepresented you.  The core of your argument remains that the burden of adjustment should rest on the periphery’s shoulders. And you failed to convince me that this is right.