Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 25 August 2014

Austerity, France and Memories

Just a day after ECB President Draghi acknowledges the problems caused by European fiscal consolidation, President Hollande of France effectively sacks his economy minister for speaking out against austerity. There was a key difference of course: Draghi was careful to say that “we are operating within a set of fiscal rules – the Stability and Growth Pact – which acts as an anchor for confidence and that would be self-defeating to break.” In contrast French economy minister Montebourg apparently called for a “major change” in economic policy away from austerity, and complained about “the most extreme orthodoxy of the German right”.

Whatever the politics of what just happened in France, the economic logic is with Montebourg rather than Draghi and Hollande. Once you acknowledge that fiscal consolidation is a problem, you have also to agree that the Stability and Growth Pact (SGP) is also a problem, because that is what is driving fiscal austerity in the Eurozone. The best that Draghi could do to disguise this fact is talk about an “anchor for confidence”, to which the response has to be confidence in what? He must know full well that it was his own OMT that ended the 2010-12 crisis, not the enhanced SGP.

Writing for the Washington Post recently, Matt O’Brien asks didn’t you guys learn anything from the 1930s? That the left in particular appears to ignore these lessons seems strange. In the UK part of the folklore of the left is the fate of Ramsay MacDonald. He led the Labour government from 1929, which eventually fell apart in 1931 over the issue of whether unemployment benefits should be cut in an effort to get loans to stay on the Gold Standard. The UK abandoned the Gold Standard immediately afterwards, but Ramsay MacDonald continued as Prime Minister of a national government, and has been tagged a ‘traitor’ by many on the left ever since.

Not that France needs to look to the UK to see the disastrous and futile attempts to use austerity to stabilise the economy in a depression. By at least one account, the villain in the French case was the Banque de France, which in the 1920s used every means at its disposal to argue the case for deflation in order to return to the Gold Standard at its pre-war parity, and it was instrumental in helping to bring down the left wing Cartel government. When it did rejoin the Gold Standard in 1928, the subsequent imports of gold helped exert a powerful deflationary force on the global economy.

So why has the European left in general, and the French left in particular, not learnt the lessons of the 1920s and 1930s? Why do most mainstream left parties in Europe appear to accept the need to follow the SGP straightjacket as unemployment continues to climb? Perhaps part of the answer lies in more recent memories. After many years in the political wilderness, François Mitterrand was elected President in 1981, and his government became the first left-wing government in 23 years. In the UK and US high inflation was being met with tight monetary policy, but he and his government took a different course, using fiscal measures to support demand, and hoping that productivity improvements that followed would tame inflation. Although the demand stimulus did help France avoid the sharp recession suffered by its neighbours, inflation remained high in 1981 (not helped by increases in minimum wages and other measures that raised costs) and rose in 1982, at a time when inflation elsewhere was falling. The sharp deterioration in the trade balance that followed led to pressure on the Franc, and the government’s fiscal measures were reversed. Economic policy changed course.

To a macroeconomist, this story is very different from today, where Eurozone inflation is 0.4% and French inflation 0.5%. However, the political story of the early 1980s associates fiscal stimulus and demand expansion with ‘socialist policies’, and their failure and abandonment is associated with Mitterrand staying in power until 1995. When the markets again turned on fiscal excess in Greece in 2010, perhaps many on the left thought they would once again have to subjugate their political instincts to market pressure and undertake fiscal consolidation. Unfortunately it was not the 1980s, but events over 50 years earlier, that represented the better historical parallel.


46 comments:

  1. Krugman is partly to blame as he was quoted by an offending minister in an interview with Le Monde:

    "LeMonde: Has Europe, and France too in the past two years, focused too much on budget contraction?

    Arnaud Montebourg: That's not my observation, that's the diagnosis of financial institutions across the world, starting with the IMF which, whose director, Christine Lagarde, warned European leaders about an excess of budget consolidation. Paul Krugman, a Nobel laureate, also wrote on Aug. 13, "The nightmare scenario in Europe is not a hypothetical. The news that industrial production has ground to a halt raises the prospect of a new recession in Europe — its primary cause, austerity." These warnings have also been sounded by other leaders of world powers including Barack Obama."

    http://krugman.blogs.nytimes.com/2014/08/25/kingslayer-me/

    And since Wren-Lewis is part of Krugman's milieu, he is to blame as well.

    I presciently mentioned France yesterday!

    http://mainlymacro.blogspot.com/2014/08/draghi-at-jackson-hole.html?showComment=1408811510828#c5381373088109401703

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  2. Putting austerity aside, do you expect that fiscal stimulus will solve the problems of France or do they need devaluation? If you believe in the analogy of the 30s, you should plea for countries to leave the euro ''gold standard''.

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    1. which will cause the mother of all bank runs.

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  3. The EU since 2011 appears to be following the path of the US in 1937 (graph at link). One way to interpret that is that policy in 2011 (EU) and 1937 (US) were both bad (fiscal or monetary); another way to interpret it is that policy (fiscal or monetary) is irrelevant ...

    http://informationtransfereconomics.blogspot.com/2014/08/is-policy-relevant.html

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  4. Your reference to the UK coming off the gold standard in 31 might be very apposite. After it happened, Sidney Webb - a member of the previous Labour cabinet - said: "They didn't tell us we could do that.":
    http://labour-uncut.co.uk/2013/08/09/labour-history-uncut-%E2%80%9Cthey-didn%E2%80%99t-tell-us-we-could-do-that%E2%80%9D/
    The soft left then over-estimated the extent to which it was constrained by a mistaken orthodoxy. A parallel with today?

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    1. Even closer, because as the article notes there was one economist who did say you could/should do that - a certain Mr. Keynes. Back then perhaps Keynes was in a minority among his academic colleagues - I do not know - but today, tahnks to Keynes, academic economists are fairly united in saying austerity will reduce growth, but they are not what makes this 'orthodoxy':

      http://mainlymacro.blogspot.co.uk/2014/08/balanced-budget-fundamentalism.html

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  5. This post conflates two different issues: the Stability and Growth Pact, and French consolidation. France is, has been, and will militate against the Pact - behind the scenes. It is however a European initiative and France is one country among many. France cannot change the Pact by itself. Given the pact, French consolidation is a given. It's called following the law. Of course Anglo Saxons blithely call for a break-up in the euro so that the laws change; since the break-up of the euro would benefit the Anglo Saxon countries to the detriment of the euro countries, one can understand why they are so universal in their advice.

    France doesn't need more stimulus. It has a huge trade imbalance, and any stimulus would simply leak to benefit others - including the UK. So it's understandable why Brit economists think French stimulus is a good idea; it's self-serving. Let the Anglo Saxons stimulate their own economies and stop giving lectures to others. Merci.

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    1. Playing the Anglo Saxon card. This is nonsense. For the record, I have not called for a break up of the Euro, and I write in the interests of France, not the UK. France has a huge negative output gap, so lack of demand is a major problem. That implies fiscal stimulus - its basic macroeconomics. That is macroeconomics as taught in France as well as the US and UK!

      You are right that France cannot change the Pact on its own, but is there a majority of countries in favour of the Pact right now? Hollande has a unique opportunity to lead opposition to the Pact in the Eurozone, so why does he not want to take that opportunity?

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    2. I wouldn't use the conspiracy argument, but it's easy for anglo-saxons to tell eurozone surplus countries what to do without bearing any of the risks.
      You call it basic economics, you overlook the politics.
      If France would lead the rebellion to the pact, surplus countries will respond with no support for ESM, banking union or possible QE. Obviously, this could bring down the eurozone and is therefore not in anyones interest.
      If you want your basic economics implemented in the eurozone, you need to include a political solution for the lack of trust between surplus and deficit countries.

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    3. France needs stimulus, and long-term consolidation. The emphasis here is on the word "long". I don't see why infrastructure projects or a temporary tax cut prevent long-term fiscal consolidation.

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    4. Anon at 04:07. Are you so sure surplus countries would respond in this way? Germany will certainly threaten to, but if this will lead to a breakup of the Euro will they carry out this threat?

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  6. " its (sic) basic macroeconomics." You are proposing France by itself stimulate. The leakage to other countries will be enormous. France will get the deficits, and other countries the stimulus. You teach that in your first-year tutorials I hope.

    "Opposition to the pact?" How much do you follow European politics? In the horsetrading following the recent European parliamentary elections, France with Italy did what it could for European-wide stimulus, which would have been put outside the pact. The UK was one of the strongest countries in opposition - even stronger than Germany. So it went mostly nowhere. There was a chance for you to beat the drum - but you didn't.

    Just to fill you in on the details, which you seem not to know, Hollande came in on an anti-German platform. At the beginning of his term he did pretty much what you are asking him to do now. He was going to stand up to Germany and make Germany bend. He did not succeed. He did not succeed because he wanted Germany to spend more or assume more risk for other countries' debts and banks, and Germany obviously could simply say no to that, which it did. For his efforts the usual German-France axis, the driving motor of the EU since its inception, has disappeared and been replaced by something more akin to a one-country (German) show. It's not often one's hypotheticals about politics can be shown not to work, but you've succeeded because you didn't know your hypothetical has already been tried.

    Hollande overplayed his hand, because the French economy is much weaker than Germany's. Forget the GDP numbers or whatever you are looking at. There are two numbers the French care about (and rightly so): purchasing power and unemployment. The unemployment numbers are terrible. At the beginning Hollande promised to change the rise in unemployment by the end of 2013. He failed miserably. He cannot simply spend more money because of the pact. So he will try to "free up" the labour market. That's only likely to work if he exports France's unemployment to other countries, but he'll give it the good college try.

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    1. Hollande never seriously tried to influence German economic policy. May I remind you that when elected he decided to keep Ramon Fernandez as head of the Trésor (who had been nominated by Sarkozy few years before) and appointed Macron (an investment banker) as his economic adviser. These choices as well as many others show that Hollande economic policy has always been for austerity.

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    2. "Seriously" is doing a lot of work there. May I remind you that Hollande spent almost his first year trying to get European banks backstopped by Europe? That's the whole game; if Germany has to bail out Portuguese banks, then Portugal can stuff its banks with its sovereign debt and Germany has to pay should there be problems with the debt.

      Given the loss of influence that France has suffered in Europe since Hollande's election, it's simple logic to infer that Hollande lost big - that is, he pushed hard and lost.

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  7. I have some sympathy for Anonymous' comment at 05.04. (Incidentally while I respect people's right to post anonymously it can be confusing and even irritating when a number of presumably different anonymous posters contribute to a topic. Is there any way anonymous posters could be distinguished within a given forum or topic, e.g. Anon1, Anon2 etc.? Anyway, ...)

    I'm not sure the situation for France is as different from 1981 as Simon thinks. At the time, the Mitterand experiment was taken as pretty conclusive proof that a single open economy could not go it alone with fiscal stimulus. The inflation issue was secondary, as I remember, though the currency problems were dramatic. But if there's a severe balance of payments imbalance, as Martin Wolf (I think it was) has been arguing since the Euro crises began, then this does raise questions about the efficacy of demand stimulation.

    The best solution is clearly for the high-savings, surplus countries in the EZ to stimulate demand (I'm looking at you, Germany) and remember that sometimes you just have to take more consumption, foreign holidays, imports of fine wine and electronics or whatever for the wider good.

    If the countries in question are unwilling to do this, because the inhabitants price work lower and consumption higher than others, (that is, they like working more than spending) a second best solution for the high unemployment countries could be to engineer an internal devaluation by raising VAT (this is, I think, allowed within the EU and as it is charged on imports and rebated on exports it acts as a kind of devaluation) and recycling the increased government income into the economy through public spending, preferably on sectors with low import propensities.

    I haven't seen much discussion of this approach - VAT is generally seen as a relatively neutral tax source - but it could be a way of getting some of the benefits of devaluation without the negative impacts on (for example) external spending power.

    Is this way off beam?

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    1. on the idea of surplus countries to stimulate demand to bail out deficit countries: assuming that would work, how are politicians going to sell that to voters in surplus countries?

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    2. There are two issues here. The first is for the Eurozone as a whole. The ECB either cannot or will not do anything about a chronic lack of demand, so the only alternative is fiscal stimulus. That is why the SGP has to be suspended. Yet when the French economy minister says that, he gets sacked. Crazy!

      The second is about the relative competitive positions of Germany and the rest. If the Eurozone as a whole eliminates its output gap, then there must be for a while a negative output gap outside Germany and a positive output gap in Germany. A few years with 3% inflation in Germany, and 1% outside, plus some internal devaluation using taxes, should do the trick. Inflation in Germany is currently 1%.

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    3. There is a better way to manage the second issue. Introducing Tax Credit Certificates in each country other than Germany and using them to support demand and to reduce labor cost (so to avoid recreating competitivity and trade unbalances). http://bastaconleurocrisi.blogspot.it/2013/09/tax-credit-certificates-certificati-di.html

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  8. "but it could be a way of getting some of the benefits of devaluation without the negative impacts on (for example) external spending power."

    Yes, this is what Spain has done.

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  9. ''Italy's new prime minister, Matteo Renzi, wants to stimulate growth. But what he really intends to do is accumulate even more debt. True, debt spurs demand; but this type of demand is artificial and short-lived. Sustainable growth can be achieved only if Italy's economy regains its competitiveness, and within the eurozone there is only one way to accomplish this: by reducing the prices of its goods relative to those of its eurozone competitors. What Italy managed in the past by devaluing the lira must now be emulated through so-called real depreciation.''


    http://www.theguardian.com/business/2014/aug/26/italy-triple-dip-recession-loss-of-competitiveness-europe

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    1. Italy has magneto problems; the government needs to stimulate the economy until they get rid of the output gap and then increase taxes and decrease spending ala bill clinton.

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  10. Hans-Werner Sinn can take his 42% salary cut to Italian workers and shove it.

    Italy should leave the euro. It's time for the Mediterranean to stop bailing out self-entitled whiny Northern Europeans. We have believed in, and made sacrifices for, the European project for 20 years. They have given nothing, and they have now brought the European Union to the brink of dissolution, all in pursuit of their economic voodoo (which somehow always works out in their interest).

    Let's see how they keep their cherished export surplus with an appropriately valued Deutsche Mark.

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    1. why did they join the EU in the first place if they had to make sacrifices? Doesn't make sense to me.

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  11. Note that I only include policy and economic elites in the "Northern European" generalization above. The German people are just uninformed and ignorant about the underlying causes of the crisis, just as the Italian people.

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    1. You seem to be pretty misinformed yourself. *Every* German elite wanted Italy out of the euro. Were Northern European elites responsible for Italy fudging the books so it could qualify for the euro?

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    2. German industrialists wanted Italy IN. And Italy didn't fudge more than anybody else.

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    3. Yeah, you seem to have no idea what you are talking about. German industrialists knew full well that an Italy outside the euro would wipe the floor with their Mittelstand. Italy had been perfectly able to compete with Germany until it fixed its exchange rate to the DM in 1987 (EMS).

      And of course Italy didn't fudge any books. It was the only country together with Ireland to always meet the 3% deficit target in the euro years (unlike Germany). It also had the highest primary surplus in the Eurozone for all those years, again together with Ireland.

      Italy joined the euro with debt at 120% of GDP (this was subsequently reduced to 100% by 2007). If Germany hadn't wanted Italy in, Italy wouldn't have been allowed to join. Simple as that.

      Don't mistake what the German people wanted with what German businesses wanted.

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    4. Italy under Berlosconi should have brought down debt much more. The fact that countries like Greece increased public debt and Italy didn't do enough to bring down public debt during the boom years up to the crisis resulted in the stability and growth pact. There is no confidence in the surplus countries that these countries will otherwise bring down public debt.

      We will never know if Italy could have competed with Germany without the euro. The Deutschmark has been a hard currency for decades, and Germany still was a surplus country. And Italy lost out to cheap manufacturing to Asia, that has nothing to do with Germany.

      Italy was desperate to join the eurozone, that's why as you point out they did run up debt up to 120% of GDP, so they could stay in the EMS. They should have left EMS and devaluated the lira instead. At that time already a clear sign they couldn't compete without devaluation.
      It's Italy's and only Italy's fault they joined the eurozone.

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  12. Germany had an export surplus in 70s, 80s and 90s - with an overvalued Deutsch Mark. But that's not the problem. Italy sucks. They have a productivity slowdown since the 90s and almost nothing happens in economic policy. Italy doesn't compete with Germany, Italy competes in many branches with China, Spain and some eastern European countries.

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    1. Germany had a small surplus until it stopped the DM appreciating against its competitors in Europe through EMS first and the euro second. From 1950 until 1985 it hovered around 2% of GDP. Then suddenly it shoots to almost 5% in 1990, then goes negative until 2002, and then shoots up again reaching the currently absurd 7%. The only two periods of above 2% surpluses coincide with exchange rate fixes. Italy also had a trade surplus with Germany until the euro.

      The Italian productivity slowdown is also due to the exchange rate. Italy is and has always been a direct competitor of Germany and the second largest manufacturing country in Europe, fifth largest in the world (that's gone now), which is why German industrialists wanted the country in.

      Fixing the exchange rate delivered negative demand shocks to Italian exports which reduced productivity growth through reverse Kaldor-Verdoon law effects (growth in demand causes productivity growth, no demand no productivity growth).

      This is a chart of Italian and German productivity. Note how Italy shoots back up to trend after the 1992 exchange rate readjustment, only to fall into stagnation again with the revaluation of 1996 to reach parity with the ECU (soon to be euro).

      http://www.oltrelacoltre.com/public/uploads/2012/10/productivity.jpg

      There is no economic future for Italy within the euro. Simple as that.

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    2. Not exactly. German current account balance was between -2% and +2% of GDP between 1960 and 1980. It then increases substantially up to 5% ofg GDP in the 80s but then was negative during all the 90s. It's only after the euro and the Hartz reforms that Germany started to generate those huge surplus (up to 8% of the GDP). May I remind you that Germany was thought to be the sick man of Europe in the 90s. It's only because they rebuilt on the back of the other eurozone countries that they have been able to get this huge competitivness advantage. But what for? Their growth is very slow and their jobless rate is low mostly because of their demographic decline. Their banks (as well as French banks) were saved from bankruptcy because Greece was prevented to organize on a referendum in 2011.

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    3. @Hypnos: Germany had a period of trade deficit because of the costs of the German re-unification.

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    4. @Bertrand Groslambert: "... their jobless rate is low mostly because of their demographic decline." No! Read: Dustmann, C., Fitzenberger, B. Schönberg, U. and Spitz-Oener, A. (2014): From Sick Man of Europe to Economic Superstar: Germany's Resurgent Economy, published in Journal of Economic Perspectives, 28(1),167–188.

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    5. Dear anonymous,

      1)the paper you refer does not mention the fact that German working age population is decreasing since 1998 and lost 600,000 people since 2008, whereas French is continuously increasing and gained 700,000 people since 2008. That makes a big difference.

      2) the paper you refer rightly argues that Germany rebuilt thanks to "a dramatic decline in unit labour costs and ultimately to an increase in competitiveness of the German economy." That´s exactly the point: they shrank their domestic demand (increasing VAT, limiting investment, and restraining wages). And then they rebuilt by exporting mostly in Europe between 2000 and 2007 while peripheral eurozone countries experienced a booming demand (note that France was not).

      3)All European countries are now following the same plan and try to gain competitiveness at the expense of their neighbors. Obviously when all countries do that, everybody lose and the result is deflation and shrinking demand across Europe.

      4) The paper your refer to, claim that German economy is superstar. Its gdp growth rate was 0.7% in 2012, 0,4% in 2013 and will certainly be less than 2% in 2014. German cumulative growth since end of 2008 is 3% versus 0,7% for France and 5,8% for the US. Is that really a superstar?

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  13. It is Proust's inflation madeleine.

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  14. Nice article, it is a good point of view

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  15. I am afraid that I must take issue with your recollection of historical data: the French inflation rate was 13.4% in 1981, 11.8% in 1982 as measured by the CPI (INSEE source). The GDP deflator data are, respectively, 11.2% and 11.3%, ie basically identical in spite of the mid-1981 massive devaluation.

    On the basic historical story that you tell, you are however essentially correct, with the nuance that the BoP crisis actually occurred during the summer of 1981 and was really severe. I should know, I was there with one of the coalition parties and we were seriously scared...

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    1. My mistake. My source was the Sachs and Wyplosz article I linked to, and I turned their "and began to rise in 1982" into "rose in 1982", which was very sloppy of me.

      Do you have any sense if I am right in suggesting that this episode plays more strongly in current French policymakers minds than anything from the 1920s/30s?

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    2. Always beware of Sachs's historical sense...Russia early nineties anyone?

      I am not the best person to say, having lived outside France for most of the past ten years. All I can say is this: one hears a lot of comparisons from France to the 1920s/30s in terms of the severity of the crisis, hardly ever in terms of policy responses. Further, almost all senior socialist politicians were young and apprenticed under Mitterrand. Who doesn't reminisce about his/her youth, loves or otherwise?

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  16. It is true that this episode plays more strongly in French policymakers minds than the 1920's. I remember being taugh in high school about it, and never about the 1920's deflation.

    But I still don't get why the situation now is much different than the one in 1981-1983. If France were to stimulate its economy on its own while others continue to pursue austerity policies, much of the stimulus effect would be "captured" by neighboring economies. France is after all a fairly open economy sitting in the middle of a free trade zone.
    Only a european-wide stimulus effort could do the trick. In my understanding, that is precisely what Hollande and Macron are pushing for (behind closed door). Montebourg direct and public attacks on the German government was compromising this strategy. This is why he had to go.

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    1. I agree a euro-area wide stimulus would be best. What I do not understand is the idea that this has to be done 'behind closed doors', and why you have to get rid of ministers who are honest. Germany is quite happy to make its views public? A more convincing explanation of 'behind closed doors' is that you think you will fail and do not want the political consequences of that. But that tells the other side that you are prepared to fail!

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    2. I guess that is a fair point to make.
      The problem is that Montebourg just comes across as a very unreasonable man in general (once he told Mittal he is "not welcomed" in France, and often publicly accuses certain CEOs of being "liars" and "rogue").
      He is just not the ideal person to conduct any negociation, because he never looks like he will uphold his side of the bargain (in the present case, that would be deregulating the labor market in France). I very much agree that austerity policies are doing a lot of harm at the moment in France and Europe, but I am still happy to see him go.

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    3. "I agree a euro-area wide stimulus would be best."

      What exactly should be stimulated, Mr. Wren-Lewis?

      I really confused how little economic professors know about the real economy and real businesses!

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