Winner of the New Statesman SPERI Prize in Political Economy 2016

Tuesday 24 November 2015

Economists and the Eurozone: wake up calls and political capture

This VoxEU post tries to build a consensus narrative about why the Eurozone crisis happened, because you can only effect a cure if you get the diagnosis right. I agree with the post. In particular it makes two crucial points that suggest where reform should be taking place but is not.

First, it points out that the crisis was generated by unsustainable flows of lending from the core to the periphery. This was a combination of irresponsible borrowing and irresponsible lending. It is a classic macroeconomic problem with a classic (partial) remedy: more effective macroprudential and countercyclical fiscal policies. The existing Eurozone fiscal rules, which focus on debt and deficit limits, failed and would fail again because they ignore this problem. Replacing them with rules that allow or mandate effective countercyclical policy should be the focus of policy makers attention, but is off the radar.

Second, the crisis was brought to an end by the ECB becoming a sovereign lender of last resort. That immediately suggests that the crisis could have been far less serious if the OMT policy had been in place much earlier. It raises important issues about how to reinterpret a no bail out policy when OMT is possible, and the nature of any conditionality. Those questions are not at present being addressed by the Eurozone leadership.

Why is it necessary to repeat once again what is a consensus position among most economists? Alas there are powerful political interests within the Eurozone that want to foster an alternative narrative, which sees every country like Greece. This erroneous narrative has already done great damage, creating a second recession from excessive fiscal tightening and insufficient monetary easing across the Eurozone.

It is natural at this point to talk about Germany, and the fact that as a result of low wage increases undercutting Eurozone neighbours before the recession, Germany is not suffering as much from this recession as other countries. But I have often tried to avoid stopping there, and instead to ask whether Germany's strange stance on these macro issues simply reflects this different conjunctural position. I think the answer is no.

I'm increasingly drawn to the view that Germany's stance reflects similar political economy pressures as you will find in other OECD economies: there is no German exceptionalism, but rather that the forces that everywhere are pushing austerity and tighter monetary policy happen for various reasons to be stronger in Germany. From this perspective, this post from Frances Coppola is particularly interesting. Perhaps the problem at the heart of the Eurozone is that economic policy advice in Germany has been effectively captured by employers' interests, and perhaps the interests of banks in particular.


  1. Re banks, the problem was certainly exacerbated by governments giving large banks the impression they’d be rescued regardless of how many silly loans they granted to the Greeces of this world.

    But that’s part of a more general problem, namely: what on Earth are governments doing riding to the rescue of money lenders (aka banks) when they don’t rescue of corporations that do anything else (e.g. make cars or computers). Reason is that private banks have captured a particular activity, namely money creation, from the state. Thus private banks are in a position to blackmail governments: “Rescue us else the country’s money supply goes West”.

    1. Ralph - banks can't threaten the 'inside' money supply; there is a third way. Struggling banks could have their equity and non-deposit liabilities crammed down through a government recapitalisation. Governments were in general fearful of being seen to 'flush' bank investors, so pulled their punches in most cases in 2008-9, but surely we can hope that governments will be less craven next time around.

  2. 1) I suppose the fixed currency exchange rate (1 € in "core" = 1 € in "Greece") was more of a reason for the unsustainable lending than fiscal policy.
    Even an excessive reliance on worthless credit ratings was probably more of a cause.

    2) Some policies of Germany can in part be explained by the fact that a country with a large trade balance surplus, a shrinking share of working population and an increasing effort to prepare for retirement through savings depends in its economic grand strategy on the reliability of foreign debtors and direct investments in foreign countries. All those savings sent abroad need to return with interest at some point or else the affordability of retirement of the middle class becomes questionable.

    3) The German domestic wage-depressing policies are the long-term effect of a decade (90's) of employer association (BDI) propaganda about national competitiveness and weakening labour unions.

  3. I am surprised that such a senior bunch of economists didn't mention actual monetary tightening in 2008 or 2011 and constant soft tightening throughout the Trichet era. They can't be taken that seriously if they miss the bloomin' obvious.

    Things are getting better these days though, and the two Germans on the board isolated and frustrated.

    If you think the German banks have captured economic policy look again. The share prices of the big three have been awful (Deutsche, Commerz and HVB inside Unicredit).

    1. "If you think the German banks have captured economic policy look again. The share prices of the big three have been awful (Deutsche, Commerz and HVB inside Unicredit)."

      Exactly so. But why should one believe one's own eyes?

    2. What monetary tightening? If you believe 1% interest rate either way makes a difference, you'll believe anything. Please explain where Trichet's raising the interest rate had any effect.

    3. Good question. Monetary economics is odd like that. It's not the magnitude of the rate rises but the signalling that matters. Trichet has got off lightly despite pressing CntrlAltDel twice.

      Doing nothing in the face of falling NGDP expectations is a form of tightening, even cutting rates but not by enough in the face of falling NGDP expectations is a form of tightening. High rates usually signal money has been, or is, loose. Low rates signal it has been, or is, tight.

    4. James,

      If it's the signalling that matters, why hasn't Draghi's QE produced even minimal Inflation?

  4. " there is no German exceptionalism."

    At last, you realise it!

  5. You say:

    "Perhaps the problem at the heart of the Eurozone is that economic policy advice in Germany has been effectively captured by employers' interests, and perhaps the interests of banks in particular"

    I'm sorry to hear such conspiracy theory. Ever heard of Ms. Nahles, the leftist socialist German minister of employment, who manages to push through almost everything she wants?

    1. The developements which led to the so called Agenda 2010 took place around 1995, e.g. unions lost much of their bargain power (long) before 2000. Therefore, Nahles is irrelevant.

      Now we have a crude mixture of aspects that did not work and some that worked like reduced early retirement. Overall, however, a clear gain for the employers.


  6. Name three reasons - beside your ideological closeness - to take Frances Coppola seriously.

    1. What on earth do you mean by ideological closeness?!

    2. Mainly Macro25 November 2015 at 02:25

      If you have to ask ...

    3. Well, if you will not tell me, I think everyone will assume you do not know what you are talking about.

  7. I understand the desire to endorse this narrative, for the two reasons you give. But there's a noticeable omission in it (the capacity for countercyclical fiscal policy), and above all, it actually *embraces* the obsession with "reforms" that has been central to the politics of the crisis. Perhaps the authors thought they had to genuflect in this way to get a hearing, but in my opinion this functions as a self-destruct bomb that defeats their whole purpose. I make my case at

    1. I recommend people read Peter's post, which says similar things to mine except in perhaps a more direct and forceful way.

    2. Mainly Macro25 November 2015 at 02:40

      Thank you for your frankness. Here, at least, the ideological closeness is clear.

    3. Anon 25 Nov: Ah, I see, you mean the ideology of following mainstream macroeconomics.

    4. Mainly Macro26 November 2015 at 02:39

      Peter criticizes the consensus authors in the VoxEU post,

      namely Richard Baldwin, Thorsten Beck, Agnès Bénassy-Quéré, Olivier Blanchard, Giancarlo Corsetti, Paul de Grauwe, Wouter den Haan, Francesco Giavazzi, Daniel Gros, Sebnem Kalemli-Ozcan, Stefano Micossi, Elias Papaioannou, Paolo Pesenti, Christopher Pissarides, Guido Tabellini and Beatrice Weder di Mauro.

      If they are not mainstream, who is?

      But if they are, Peter and you are not, and you've tied yourself into a knot.

    5. No - I wrote that I agreed with the VoxEU post. The problem Peter had was with the reference to structural reform. His point on that is well taken, but I'm more happy to let that pass than he is.

  8. The current structure of the Eurosystem is badly flawed, it is unlikely that the EU has the capacity to correct itself. Having 19 member state Treasuries, having to issue Bonds into a private market, to obtain cash Euro for their spending; is nothing short of stupid.

    The kindest thing that could be done is for the Eurozone states is to re-introduce their own currencies and peg them back to the exchange rates that they went into the Euro with originally. Set a date when they will all float, a year or so hence, and see how the FX market values them in the run up to the float. On balance of payment fundamentals, the likes of the Deutschmark will rise; the likes of the Drachma will fall.

    Forget the EU ever existed and keep only the bits of the Treaties that free trade requires. Go back to calling it EFTA if you like but; heavily restrict capital movements between currency areas because that is where the crisis started.

  9. I don't agree with the direction your view on the German stance is going. As an academic who works in Germany I can get an impression of the views on the euro crisis here and it does seem to be all about moral hazard. The idea that if Greece is let of the hook now (as they see it) then what will prevent them from being so profligate again in the future. You might argue about if that is the right way to look at things but that is how many here seem to see it.

    1. I must admit I cannot take the moral hazard argument seriously. Does anyone in their right mind think that if the Troika now wrote off Greece's debt Greek policy makers would say to themselves 'that was not too bad, lets do it all over again'.

    2. No. The Greeks will say: Thank God the Troika won't do austerity again, so we can do the rest all over again.

    3. Yes.

      After all, that's pretty much what happened a couple times already, going back to their independence.

      They even screwed up a currency union before.

    4. Anon 25 Nov. That makes no sense. If your view was correct, who would lend them the money to do it all over again?

    5. Mainly Macro26 November 2015 at 02:43

      " who would lend them the money to do it all over again?"

      Excellent answer. Unfortunately, it contradicts what you have been saying for years in the past when you recommended an early Greek default. Who would have lent them then? How would Greece have survived without foreign credit?

    6. "That makes no sense. If your view was correct, who would lend them the money to do it all over again?"

      That depends on the lenders conviction that other european partners and/or institutions would guarantee - in whatever way - for those credits (again).

      Greece on it's own, w/o euro partners, would be a interesting scenario - there are always sharks.

    7. No, what it means is that you have not been reading what I wrote in the past. I have argued that the IMF alone should have provided credit to Greece after a complete default in 2010.

    8. Mainly Macro26 November 2015 at 07:01

      "the IMF alone should have provided credit to Greece after a complete default in 2010"

      Where would be the difference from the Troika (the IMF was a member)? As its chief economist Olivier Blanchard pointed out, the IMF was willing to save banks that had lent to Greece to avoid a Lehman Brothers moment.

      Furthermore, under its statutes the IMF may only lend if it has a reasonable chance of getting its money back. What were those chances?

      Or is this just wishful thinking that the IMF should have done what Simon Wren-Lewis wants?

    9. Inter-eurozone lending is toxic.

      1) As I have argued before, the amount of lending done by the IMF as part of the Troika is the same order of magnitude as the amount of Troika money that has actually gone to help the Greek transition to primary balance, as opposed to lending to bail out Greece's previous creditors.

      2) I doubt very much if the IMF would have bailed out Eurozone banks on their own.

      3) So with IMF lending alone, and complete default, Greece would have got a similar amount of money but without a huge burden of debt.

      4) Greece was forced to take on inter-eurozone debt to bail out eurozone banks. For Eurozone countries to then, in 2015, refuse to write down that debt is unforgivable.

  10. "was a combination of irresponsible borrowing and irresponsible lending. It is a classic macroeconomic problem with a classic (partial) remedy:"
    The Eurozone needs to BREAK UP. All these utopian schemes will never work. get the hell out of there!
    No it wasn't. The problem is the eurozone countries do not issue their own currency. The scaremongering about issuing their own currency is BS. The focus should be on getting as much real output as possible from the country.
    There is a big difference between a fixed exchange rate system like the Eurozone and the UK that I think the mainstream STILL ignore. It is the difference between ‘conversion’ and exchange. In 'conversion' the supply of the liability shrinks. So the Bristol pound is deleted when the UK pound is issued. The UK pound is deleted when the pound of sterling silver is issued in a metallic system. The Barclays bank deposit is deleted when the £20 note is drawn from the ATM. That is what conversion is.

    Exchange is different. There is no deletion. When you exchange USD for GBP at the desk, the USD stays in circulation. It becomes the assets of the desk.

    That’s why the price floats, because the quantity is fixed. If the price stays the same the quantity has to adjust.

    If a currency moves down so that imports become 'more expensive', then the 'inflation' that goes off is a distributional response that tries to eliminate some of those imports so that the exchange demands equalise. That also eliminates somebody else's exports.

    The important thing to remember is that when a currency goes down, all the others in the world go up in relation to it and nations that rely upon exports (export led nations) start to lose trade - which depresses their own economy.

    Any one of those other economies can intervene in the foreign exchange markets, purchase the 'spare' currency and that will halt the slide for everybody. And all exporters to an import nation have a central bank with infinite capacity to do that.

    Export-led nations have to constantly provide liquidity into the rest of the world to allow others to buy their goods. Otherwise the rest of the world runs out of the particular money that is needed for the export transaction to complete and the export never happens (UK buyers buy Chinese goods with GBP, but Chinese workers and taxes are paid in Yuan. The relative shortage of Yuan due to the export differential has to be provided by the Chinese or Chinese goods become, in absurdum, infinitely expensive).

    So the important insight, IMV, is that exporters need to export and the central banks that support that policy with 'liquidity operations' will ultimately halt any slide for any important export destination - either explicitly or implicitly through their own banking system.

    Every analysis I've seen analyses the situation from the point of view of the currency that is being depressed. Almost none look at it from the exporter's point of view. So where are the goods they no longer can sell to the importer going to go in a world where overall export growth is fundamentally limited by the increase in world income? In a world where 'export led growth' is the insane mantra, that is a mistake and leads to a mistaken view and mistaken policy recommendations.

    1. I couldn't agree more.
      "Irresponsible borrowing and irresponsible lending" have been induced by an irresponsible monetary system.

  11. "Why is it necessary to repeat once again what is a consensus position among most economists? "

    To stop this endless cycle happening in the future I think you need to ask "were mainstream economists asking the right questions during the Great Moderation?". Was globalisation delivering for society? Or was it marginalising many (globally and within countries?). Was it fuelling a credit boom that historically evidence has shown are often dealt with (usually foolishly) austerity policy? Was rational expectations theory and intertemporal obsessed theory helpful, or was part of the problem of economists eye's being off the ball? Do you think Sargent and Prescott have done the profession and the world a favour?

    Have we learned our lessons now? I think not. The cycle will go on.

    People paid a lot of attention to economists during the Great Moderation. Like financial wizards they were the masters. The crash saw economist's reputation crash and economics with it. They are not going to listen to you now.

    1. Was it fuelling a credit boom that historically evidence has shown are often dealt with (usually foolishly) austerity policy?

      That is of course:

      Was it fuelling a credit boom in which historical evidence has shown that the subsequent crashes are often dealt with (usually foolishly) by austerity policy?

  12. I have a feeling that you yourself have learned a lot from this experience Prof Wren Lewis. Instead of teaching a lot of abstraction it is time your students do some history and start asking real questions. What is a "constraint". What is "potential output". What do they really mean and do they really exist? No a budget constraint is not a straight line. In macro it should not mean the same thing as micro (as much as people would like it to). Sure you like to tell people that an economy is not a household, but there are nobel prize economists out there who say that aggregate utility is the sum of individual utilities. They have worked hard to see macro as an aggregation of micro - which from a social view is also nonsense. I will bring it up for you if you like, but Sargent was asked "are debt levels sustainable". His answer was "the budget constraint will make it so". This is not helpful, and anyway, what the hec does he really mean? It is not just politicians and the media who contributing to the confusion of households and their budgets with that of a national economy.

    Ultimately it is about issues of power. This is not something neo-classical theory can handle. Some countries are able to go infinitely into deficits and not have their currencies and social systems collapse. Which ones do you think they are? Do the history, not the neo-classical theory.


  13. To get the whole picture, you have to know that their is someone who has a "differing opinion"(see chapter 1, pp. 29-33) in the Council of Economic Experts (Peter Bofinger). He writes (page 31):
    In the past years, the convincing and pragmatic actions of the European Central Bank
    have ensured that the euro area was stabilised. If the ECB cannot assume this – even for itself –
    problematic role, policies that can lead to higher instability of the euro area should not be promoted.
    Instead, solutions should be pursued that combine necessary fiscal discipline with an unrestricted fiscal policy
    to act in times of crisis. This necessitates a transfer of fiscal sovereignty from the national to the European level
    as well as mechanisms for a common liability for government bonds. Without the willingness to engage in further
    political integration, a stable architecture of the euro area is not in sight. Once the capability to act is ensured at the European level,
    an insolvency mechanism for individual member states could be discussed again."

    Other members of the council:
    Volker Wieland is a pupil of John Taylor. Politically, I think, he wants to establish american style capitalism in Germany. Deregulation and all that. That means to underemphasize the social elements of the "social market economy" in Germany and to promote a starve the beast policy.
    He is now professor for monetary economics (he did some fine work there) at the Institute for Monetary and Financial Stability (IMFS), which is financed by the "Stiftung für Geld und Währung", a public trust, wich was founded by the Bundesbank with the emission of a gold coin. Until 2007 he was a director of the Center of Financial Studies, which was founded by the german banking industry.
    Lars Feld holds now the chair for "Ordnungspolitik" in Freiburg and is the chief of the Walter Eucken institute, a right wing think tank, which wants to spread the ideas of Eucken and Friedrich Hayek (he was a prof in Freiburg in the 1960's and is still very influential their).
    How influential these circles are you can see here at the Hayek prize ceremony in Freiburg last sunday: Two former german "Bundespräsidenten" and the present one attended.(One got a prize and one is now president of the Hayek-Stiftung).
    At the board of trustees of the Hayek-Stiftung are two former central bankers: Issing (now President of the Center for Financial Studies) and Tietmeyer. And Jens Weidmann got the Hayek prize this year for his "tireless commitment to a stability oriented monetary policy".

    1. I have talked to Peter Bofinger, and it is that discussion that has helped inform my views (although no blame should be attached to him!) Thanks for the info on the other members.

  14. Simon, is it possible to provide a bit more detail on "more effective macroprudential and countercyclical fiscal policies" that you mention as the remedy for the irresponsible lending and borrowing? what types of policies did you have in mind? Thanks

    1. Have a look at this post

  15. "Ultimately it is about issues of power. This is not something neo-classical theory can handle. Some countries are able to go infinitely into deficits and not have their currencies and social systems collapse. Which ones do you think they are?"
    The ones that can't enforce taxation properly. Taxes (and fees and fines) are one of the reasons why currency has value. Money is basically a tax credit.
    It is instructive to compare the MMT and current philosophies:
    The incumbent philosophy should be familiar to everybody.

    * A central bank ensures there is sufficient borrowing in the economy to maintain 'aggregate demand' at 'full employment' where 'full employment' is defined as a few million people out of work give or take a few million more.
    * The central bank is supposedly independent, but is really politically homogenous.
    * Activity is based entirely upon the private sector, under roughly 'free market' rules, operating exclusively and having access to all the resources of society.
    * In this model the government is just another actor in proceedings that has to carve out its space 'competitively' with everybody else by taxing, spending and borrowing.
    * push is for ever smaller government with the state constantly deferring to private interests and binding its own hands ever tighter (except the central bank and military spending.)
    * If anybody is left behind it is their fault, not the fault of a system incapable of maintaining real full employment - where everybody has a job and an income.

    The result of this philosophy is all around us - vast inequality, massive private debt burdens, wage shares on the floor, insufficient investment, productivity trashed, and millions of people without a living income to sustain them. And of course eight years after a collapse we're still not back on our feet. It simply doesn't work for the majority.

    The new philosophy is very different.

    1. The state, as representative of us all, takes the resources necessary to create the critical public infrastructure and basic functions - all those that are a natural monopoly or are best treated as a natural monopoly, plus whatever is required to fulfil the critical public purpose of the people who elect them (a health service, education, etc).
    2. The private sector is then allowed to play with the rest of the resources as it sees fit.
    3. The state then takes what the private sector decides it doesn't want to use and deploys them sensibly for the 'nice to have' public purpose (for example with labour the Job Guarantee):
    Within this philosophy the free market private sector is bookended by the public sector and sensibly contained - like any good nuclear reactor should be. Here the public sector gets first dibs at the resources of society and maintains the structures necessary for the private sector to operate at optimal efficiency and maximum output (for example, removing the need for 'jobs' in the private sector allows it to press on with automation).

    Correctly configured this philosophy actually creates a private sector that is larger than the original structure because, of course, it can maintain more of the population at a higher level of economic activity. However what it does do is remove political power from bankers and corporate leaders and we've known for decades they don't like that idea.

  16. O.K. Layman here, as will become immediately apparent. But from the outset the idea that lenders and borrowers are equally responsible when loans go bad is absurd. Lenders have all the power: they have what borrowers want or need. But even when the positions are perversely reversed, and lenders compete to lend to unworthy borrowers, it is nonsense to expect borrowers to say no. Interest rates are today's price for the risk assumed by the lender, but the future is utterly unknowable when it comes to sovereign debt. The truth has to be that the low interest rates on the original sovereign debt of the periphery countries was based on an unspoken promise that someone, somehow, would make good on losses. It's politics masquerading as economics.

    1. I'm not sure about unspoken promises (by whom?), and I'm more inclined to think this was a simple market mistake (it happens). But I'd be very interested in evidence that suggested otherwise.

  17. The correct narrative was already provided more than 3 years ago in Italy, though not strongly advertized (in fact more than 50Y ago by Meade).

    This happended because there are, in fact, powerful political interests within the Eurozone that want to foster an alternative narrative.
    This is why the narrative rather then erroneous is functional (to whom?) and thus strongly sustained notwithstanding the great damage it created.

    1. Here a scientific paper in english

  18. I'm quite happy to see this post on VoxEu, but I have concerns about at least one of its authors. My understanding is that Professor Giavazzi has been for years in Italy one of the most vocal supporters of the opposite narrative (that the EU crisis was all about governments' profligacy and austerity was the right cure). Now, it is legitimate to change one's opinion in the face of ever-growing evidence, as Professor Giavazzi did. Unfortunately it is also my understanding that he's now denying that he ever held a different position - and it's way too easy to see how this can be used to discredit this consensus, at least by the parties in Italy that have all the interest in maintaining the current fiscal policies.

  19. True @LowBotomysed
    besides being ludicrous this show only that the political necessity to sustain the euro (which never had any economic meaning) is coming to an end, and that all the conditions that it brought about (free circulation of capital and people, etc.) must coherently also stop, “whatever it takes”.


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