Winner of the New Statesman SPERI Prize in Political Economy 2016

Friday 1 June 2012

The Euro: an alternative moral tale

                Part of the austerity mindset that I talked about in the context of the Irish referendum is the belief that transfers from creditors to debtors are unfair (HT MT) because they result from the feckless behaviour of the debtor. There is a clear parallel with the attitude to benefit recipients within a society, which Chris Dillow talks about here. I do not want to get into the economics or politics of attitudes of this kind, but just claim that they are important in influencing policy, a position I think David Glasner supports here. Instead I want to confront this mindset with an alternative moral tale. Let’s talk about the Core countries and the Periphery, because I want to look at why they became creditors and debtors.
                When the Euro was formed, its fiscal architecture was embodied in the Stability and Growth Pact (SGP). This architecture was the construction of the Core, not the Periphery. In political terms, it was the price that the low inflation countries of the Core laid down for their participation in the Euro. That fiscal architecture was all about containing deficits, and said nothing about using fiscal policy to control domestic demand. To many economists, this was something of a surprise. Much of the academic work leading up to the formation of the Euro had stressed the crucial role that countercyclical policy could play in reducing the consequences of asymmetric shocks in a monetary union. The SGP effectively ignored that work.
                Why? Perhaps because in the debate on the wisdom of setting up the Euro, the problem of asymmetric shocks (or asymmetric adjustment to common shocks) was the key argument used by the anti-Euro camp. So it was easier to deny that the problem would arise, rather than talk about how it might be reduced. However I suspect countercyclical fiscal policy was also ignored because many in the Core just did not believe in the kind of Keynesian world in which the policy worked. In that sense, we were seeing the forerunner to a belief in expansionary austerity. To put this in simple terms, the view was that any demand and competitiveness imbalances would be quickly self-correcting, as uncompetitive countries would lose exports, output would fall and inflation would decline. The Keynesian view that this self-correction might be slow, costly and painful, and that fiscal policy could reduce those costs and pain, was discounted.
                Much the same can be said about monetary policy and the ECB. This was designed by the Core. The ECB was independent of government, but also explicitly prevented from acting as a lender of last resort to governments.
                After the Euro was formed, interest rates came down substantially in the Periphery. There was a substantial amount of lending by the Core private sector to the Periphery private sector. This led to inevitable overheating in these periphery countries relative to the core. At this point the Core, and the bureaucratic apparatus that was essentially under the Core’s control, should have been sounding alarm bells. But instead they continued to follow the flawed fiscal architecture. In the case of Spain, as is well known, the budget deficit looked OK according to these fiscal rules, so the overheating there was allowed to continue. As a result, we got a housing and construction bubble. The aftermath of this is what countries like Ireland and Spain are dealing with now.
                So, the basic problem was one of excessive private sector borrowing in the Periphery, partly financed by excessive lending by the Core. The Core countries had set up a fiscal architecture that effectively ignored this kind of problem, and they did nothing to address their mistake in subsequent years.
                So who is to blame? Consider a parallel with the sub-prime crisis. Do we hold the low income households who took out mortgages they could not afford responsible for the financial crisis that ensued? Do we blame them for the Great Recession? Do we pity the poor financial institutions that lost money lending to these irresponsible people? I hope not. Instead we ask, how can the financial system have allowed this to happen? What was wrong with the architecture of regulation, and who was responsible for this?
                I think we should have the same response to the Euro crisis. What was wrong with the fiscal and banking architecture that allowed housing bubbles and the like in the Periphery, and who was responsible for this architecture?
                But in the case of the Euro, it gets worse. Even after the crisis, the Core countries continued with their anti-Keynesian mindset. As the immediate manifestation of the crisis was unwillingness by markets to lend to Periphery governments, then it was assumed the problem must be excessive borrowing by Periphery governments. Never mind that the problem in Ireland was in large part because the government bailed out its banking sector (and therefore lenders to that sector, some of whom were of course from the Core), and the problem in Spain was that it might be forced to do the same. (On Spain, read this from Yanis Varoufakis.) So the Core countries imposed sharp fiscal austerity on the Periphery, as the price for ‘rescuing’ these countries. It was conveniently forgotten that the reason these countries governments found it difficult or impossible to fund their deficits was because the common currency denied them their own central bank, and that the ECB had been designed by the Core such that it could not explicitly play that role. The terms of the rescue were hardly generous, because it was argued these governments needed to learn their lesson.
                It then got even worse. The austerity inflicted on Greece led the electorate there to believe that there was no hope down this path, and so the terms of their particular rescue needed to be renegotiated. Impossible, responded the Core. If you try to do that, you will have to leave the Euro. The damage that response has done to the operation of the Euro is immense, and entirely predictable. The gains from the ‘permanent’ abolition of exchange rate risk – gains that were central to the economic rationale for the Euro – are being unraveled.
                From this perspective, the actions of the Core from before the Euro was formed until the present day have been misguided and irresponsible. They risk destroying the Euro. It would not be the first time that the actions of a creditor had caused needless destruction. Bear this in mind when you next read about how the terms of Greece’s rescue cannot possibly be changed because of the message this would send to other Periphery countries. If the Euro is to survive, the Core has to stop thinking like the aggrieved party, and instead must recognise that it designed the system that, quite simply, created this crisis.


  1. How would you weight the odds of a sensible and responsible action from the Core, against letting the Periphery collapse?
    Depending on those odds, do you believe there is anything the Periphery could do unilaterally?

    1. I am also interested into Simon's answers, but let me add what I would think (looking form The Netherlands, but unfortunately not the Dutch position.)

      I would think the odds are slightly against sensible actions. Perhaps the best chance of it would be Germany's economy getting much worse (it's already starting). China's slowdown could trigger that, because Germany's economy now thrives mostly on exports outside the Eurozone. In other words, I think the best chance for resolution of Europe's problems is a global recession. Ouch.

      As for the periphery, I am afraid that the only thing they can do is step out of the Euro. I really hope that won't happen, because it would also be devastating for us in the Core. (And of course that would also be a strong trigger for Germany and the ECB to take action, but it would be too late: the ECB would have successfully fought inflation of a non-existing currency.)

  2. Bearded bloggers are the best.

  3. "Do we hold the low income households who took out mortgages they could not afford responsible for the financial crisis that ensued? Do we blame them for the Great Recession? Do we pity the poor financial institutions that lost money lending to these irresponsible people? I hope not."

    This is a prime tactic by Republicans in the United States; with low income households sharing blame with government policies to increase home ownership. This reasoning gave Michelle Bachmann the chutzpah to claim the financial crisis was caused by over-regulation during a republican primary debate. Joe Nocera's column in the New York Times today describes an individual being prosecuted for the false information on the 'liar loan' mortgage application filled out by his mortgage broker. Meanwhile, the industry that generated and profited enormously from these types of loans goes unpunished.

    The forces allied to deny Keynes were built up over multiple decades and have deeply vested intellectual and material interests in maintaining their positions. In the long run persistent battering by inconvenient reality may break up their club, but of course in the long run we are all dead.

  4. The ECB, the Core, thinks it is acting in the interests of its wealthy. It is the wealthy, through their corporations and banks, that are running things. Look at Europe. Look at the US. The world economic problem has a simple solution. Money has been taken from the consumer, the people, as a result of cartel and oligarchy and manipulated government, and is all concentrated at the top. Tax it at the top, and distribute it at the bottom. See:

    It's not as bad in Europe, but it is still bad. You have to tax the money, you can't just borrow it. And just printing it would be inflationary. But you have to get it into the hands of the people. (I like that term better than consumer, because consumer leaves off the part where people work, and is a put down.) In Europe, that means getting it to the periphery. But it also means getting it to labor in the Core, whose wages have not been held below their gains in productivity, part of the problem.

    But it won't happen, because the wealthy are in control, and all they want is all the money. They have made a category error. They mistake money with power, but power is people and industry and agriculture and the flow of resources through the economy. Things that they already control, but because they just want the money, they are controlling it wrong. They are squeezing off the flow, which is to say they are sucking all of the money out of the economy, and hoarding it.

    The wealthy want civilization without taxes. It's their civilization. They should want to pay the taxes.

  5. It seems clear to me that the ones who are responsible are those who financed the projects that are now at risk, be they homes, derivative securities, Irish banks looking for capital, etc. Who can blame people for wanting to borrow money? Who can blame children for wanting a bigger allowance?

    And when people ask to borrow money, the lenders say "no." If not, shame on them.

  6. Maybe they ignored asymetric shocks because the growth and stability pact was made in a time when people like Greenspan and Brown claimed governments now controlled the business cycle.
    Also, the idea was that markets would keep government debt in check by demanding higher interest rates for certain countries, but that didn't happen.
    Countercyclical fiscal policy played a role in causing the crisis, to the extend that while during recession the government should spend, during the good times the government should use surpluses to bring down the debt. Unfortunately this didn't happen either in Italy and Greece, countries with the largest debts above 100% of GDP kept on borrowing.
    What I find surprising is that the original stability pact did not say anything about private debts. The crisis in Ireland and Spain as said was not caused by government debt, but housing bubbles. I think this issue has been addressed in the socalled new 6 pack agreement but it's now too late.

  7. I think you're right to stress the overall architecture. From a thought experiment standpoint you can try this: If all the 'moral agents' all the story took the same actions within the US federal system as they did within the euro system, they would be fine.

    Indeed, many US states do run similar deficits in federal funding, but we don't talk about immoral Virginia living it up at the expense of Delaware, because the architecture is fundamentally different. But people still made the same choices, and morals are about choices.

    I also wrote something a while ago about why Germany isn't innocent. I shied away from saying they were explicitly "to blame" for the above reasons, really, but they certainly benefited at the expense of the victims crisis (they ate everybody else's lunch):

  8. Anonymous3 June 2012 08:41

    Countercyclical fiscal policy played a role in causing the crisis, [...]»

    I think that you meant LACK of Countercyclical fiscal policy.


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