Home > Economics - General > One size fits nobody? — Crooked Timber

One size fits nobody? — Crooked Timber

January 23rd, 2011

Much recent discussion of the future of the euro, most notably that of Paul Krugman, has started from the idea that Europe is not an optimal currency area, and that a ‘one-size fits all’ monetary policy is therefore bound to lead to the kinds of problems we are now observing. At any given time, some countries would benefit from a more expansionary policy and others from a more contractionary policy, so the effect of monetary union is an unsatisfactory splitting of the difference.

Without resolving that issue in general terms, I want to argue that this is not an accurate description of the current state of the eurozone. It’s true that Germany is doing a lot better than the eurozone as a whole, and the peripheral countries a lot worse. So, the optimal policy for Germany alone would be tighter than for the rest of the eurozone. The peripheral countries might benefit from an even more expansionary policy (though that’s not as clear to me as it seems to be to others. A heavily indebted country that undertakes monetary expansion is likely to find it hard to sell bonds denominated in its own currency).

But when you look at the actual policies of the ECB, including Trichet’s recent threat to raise interest rates, it’s hard to see that this policy is optimal for any EU country, even Germany.

Particularly in GDP terms, Germany’s recovery has not been that strong, and an expansion based on exports could easily be derailed by the kind of currency appreciation that would follow an interest rate rise, or even a really credible commitment to hold inflation down. And given the difficulties of handing out explicit haircuts, a modest amount of inflation seems likely to be a low-risk way of easing debt burdens without endangering the (largely German and French, and also UK) banks that hold a lot of the debt.

To say that the problem is the ECB rather than the euro is, for some purposes, a distinction without a difference. But in other respects it is critical. If the optimal currency area analysis is correct then a breakup of the euro is probably inevitable and the big question is how to manage it. On the other hand, on the analysis offered here, the ECB must, in the end, be bluffing. Faced with the end of the currency it has been set up to manage, the ECB must eventually back down on everything else, including its inflation targets. The problem on this analysis is how to broker the politics of pushing the ECB towards large-scale quantitative easing and a higher inflation target.

This is, of course, complicated by the fact that, as discussed in a number of the contributions to a recent Crooked Timber seminar , the actual policies being pursued and advocated by Germany don’t necessarily correspond to any reasonable conception of Germany’s national interest. In particular (and by no means uniquely to Germany) policies that are primarily driven by the interests of banks have become the basis of a popular backlash against other scapegoats – in this case the citizens of the peripheral economies who are on the hook for failures of the financial sector. Until that’s understood, the disastrous policies of the ECB will continue to go unchallenged.

Posted via email from John’s posterous

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  1. melanie
    January 23rd, 2011 at 18:46 | #1

    Independent central banks in general? Why should we accept their allegedly expert entitlement to decide what the inflation rate should be? This kind of macroeconomic ‘stabilisation’ has not succeeded in stabilising the world economy. I wouldn’t say that Obama’s recent jab at China’s insufficient attention to the neo-liberal dogma was very convincing either.

  2. glmmph
    January 23rd, 2011 at 19:45 | #2

    A classic case of the tail wagging the dog. While the political elite continue to believe in neo-classical economics, and the universities of this world continue to preach it, there is a very likely little hope of change. Not that neo-classical economics is all wrong, but like all fundamentalist religions, the point where it is most wrong it the point where its most fervently defended.

    Take two classic examples. The first is that central banks, or governments, control credit creation, or, in simple terms, the creation of new money. The evidence points to reserves following credit creation, not preceding.

    The second is that quantitative easing is a mortal sin, and governments so doing will suffer in purgatory until overthrown. This has led to the Bernanke madness, where for every $100bn the US government raises in bonds, it buys back a month later from the 18 primary dealers at about 50 basis points difference, giving the primary dealers somewhere close to $5bn commission a month.

    A lurk, or an ideology run amok. As for the ECU, they need to get on with governing for their people and stop governing for their banks. And this primarily would be through managing targeting aggregate demand and the drivers of aggregate demand, including employment support. But of course, no one can convince a true believer.

  3. Chris Warren
    January 23rd, 2011 at 21:17 | #3

    a modest amount of inflation seems likely to be a low-risk way of easing debt burdens without endangering the (largely German and French, and also UK) banks that hold a lot of the debt.

    Grrrrr!

    This just destroys economic justice for workers and pensioners.

    If banks made decisions in the past, then let them live with the consequences now. They took the profits – when super-profits were the consequences.

  4. January 24th, 2011 at 06:25 | #4

    I wonder wat exactly is the difference between expansionary policy and contractionary policy ?

  5. Chris Warren
    January 24th, 2011 at 08:33 | #5

    @timber sales

    Injecting 13 trillion dollars to bail out capitalism, is expansionary.

    See Bailout Trillions .

    I would argue that any monotonous increase in per-capita debt constitutes an expansionary policy, irrespective of what is happening to M1, M2, M3.

  6. Ernestine Gross
    January 24th, 2011 at 09:22 | #6

    “I would argue that any monotonous increase in per-capita debt constitutes an expansionary policy, irrespective of what is happening to M1, M2, M3.”

    So would I (not sure though that monotonicity is necessary).

  7. Ikonoclast
    January 25th, 2011 at 07:11 | #8

    Any large continental nation has some of the same problems as the Eurozone re currency. Monetary policy at any given time will not suit all regions. However, a single nation state has other across-the-board policy levers that the Eurozone does not; namely fiscal policy, welfare policy, etc. Perhaps ultimately, fiat currency can only be properly by a sovereign nation. Then, the democratic vote might have some chance of managing matters in the interests of the people and not just the bankers.

    Has the eurozone been subverted to being merely a ploy to place economic management beyond the reach of the democratic interests of the majority in each nation and in the hands of the plutocrats? I tend to think this is what is happening.

  8. Alice
    January 25th, 2011 at 07:39 | #9

    @Ikonoclast
    on your comment
    “Has the eurozone been subverted to being merely a ploy to place economic management beyond the reach of the democratic interests of the majority in each nation and in the hands of the plutocrats? I tend to think this is what is happening.”

    Perhaps the brief freedoms attained as a result of the industrial revolution are coming to an end and perhaps the plutocrats will regain control as the new aristocratic powers for the next five hundred years so its back to the dark ages for the majority. Bit of a shame really but it gives us something to talk about.

  9. Donald Oats
    January 25th, 2011 at 08:13 | #10

    Exactly, Ikonoclast.
    Western Australia vs rest of us is a case in point, regarding your comment:

    Any large continental nation has some of the same problems as the Eurozone re currency. Monetary policy at any given time will not suit all regions.

  10. Jim Birch
    January 25th, 2011 at 14:49 | #11

    @Ikonoclast
    It’s not obvious to me that “democratic interests” would do much better than plutocrats if you mean voters by the phrase “democratic interests of the majority”. The average voter is pretty well mystified by economics – especially macro – so they are easily swayed by anyone with a bit of charisma and a viscerally attractive narrative. What’s needed is an elite that are willing to run evidence-based rather that ideology-based policy, and can hold out against the would be plutocrats and the voters.

    Krugman’s argument that the eurozone is economically wired to go pop, see eg, the Spanish tragedy, is a different issue to the ongoing plutocrat menace. And while it may have some parallels with the problems of local economies meshing with national policies it’s really a quite different degree of disassociation of cause and effect that also disables countries’ conventional responses to economic crises. It’s like one part of national economic policy is being driven by a game of Go played on another planet or something.

  11. melanie
    January 25th, 2011 at 19:24 | #12

    @ Ikonoklast. I agree. I read something within the last six months about a county (presumably rural) somewhere in the south of the USA that has an average per capita income of $8,000 p.a. Unbelievable! Sorry I cannot find the source again, but if it’s true it’s far worse than Greece.

  12. Ikonoclast
    January 26th, 2011 at 06:53 | #13

    @Jim Birch

    Unfortunately, the only area where empirical evidence is (relatively) unequivocal in detail is that of the hard sciences.

    It’s not obvious to me that some kind of technocratic, “non-ideological” elite would do better than the democratic majority at managing the economy. Indeed, what we have in power now in the West are technocratic, “non-ideological” managerial elites who run our economies. I place “non-ideological” in quotes because, in political economy, every decision ideologically conditioned.

    The current elites are running evidence based policy, of sorts. The evidence is that corporate power can be used to trump democratic power. The evidence is that limits to growth can be ignored (for a while). The evidence is that long term damage to the environment can be ignored for immediate profits. The evidence is that finance sector, ponzi style economics can be run to strip wealth from the workers and concentrate it in the hands of the non-productive. The evidence is that the day of reckoning can be ignored until it actually arrives.

    It seems to me that if our democracy was healthy and truly democratic decisions were being made then our decisions on average would be wiser, albeit never perfect. I seem to recall that the majority in Australia and the UK did not want to enter the Iraq and Afghanistan wars. I seem to recall that the majority in Australia did want timely action against gobal warming. I seem to recall that the majority in Queensland do not want to sell off more government assets.

    In each of the above cases, technocratic and undemocratic managerial elites have thwarted the will of the majority and led us down disastrous paths. People become dispirited, cynical and disengaged when they see democracy subverted in this fashion.

  13. Alice
    January 26th, 2011 at 08:08 | #14

    @Jim Birch
    Jim says “What’s needed is an elite that are willing to run evidence-based rather that ideology-based policy, and can hold out against the would be plutocrats and the voters.”

    You mean an elite that is benevolent and kind and peaceful and just?
    Not while Murdoch media is alive and well and reigns as their voice I fear….

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