Slow train wreck

Why is anyone shocked at the political news from France this morning? Everyone is saying that the FN got a boost from the November 13 atrocities, and perhaps they did, but there are far longer run forces at play here.

One is the corruption and sleaze that characterises Parisian politics. But there are also economic factors that are having a predictable impact on attitudes (and if they are predictable, then economists don’t have the right to ignore them). Globalisation creates losers as well as winners, for example, and if no-one really cares about the losers, and we just pay lip service to the problem, then it is predictable that there will be a backlash. The Euro has not only locked in a set of distorted real exchange rates, but a macroeconomic policy mix with a pronounced deflationary bias. If times remain tough enough for long enough, and politicians hear your pain but don’t actually do anything about it, some people will eventually respond by voting for candidates who reject existing constraints on policy making. “Europe” is increasingly experienced as a set of constraints preventing governments from doing what their people want them to do, rather than as a means of empowering governments to collectively solve problems.

So why would anyone be surprised that Mme Le Pen has done so well; and is it not likely at this stage (though 2017 is a long way away) that absent major policy shifts she will come first in the first round of the Presidential election? And let there be no mistake: if she actually won the second round, either then or in 2022, this would mean the end of the EU as we currently know it.

What is so frustrating about all this is that it has been so predictable. Here are some links dating back to 2010, a year that risks being viewed by future historians as a fateful one:

Adam Posen

And me, with apologies for the self-indulgence, writing for Eurointelligence.

I am pretty sure Martin Wolf was saying similar things back then, and that many others were too.

The good news is that, as recent Irish experience shows, the populist vote stops rising when the economy recovers. (The decline in the independent vote share is quite striking, and SF have clearly stopped rising. And no, I’m not saying that anyone is like the French National Front, but support for these parties is the closest Irish equivalent to the French anti-establishment protest vote that is benefiting the FN so much.) And 2017, and even more so 2022, are a long way away. But Eurozone monetary and fiscal policy, and social policy too I would think, need to start taking into account the fact that the entire European project, the good bits as well as the harmful bits, is now facing an existential threat.

Update: Paul Krugman weighs in here.

Exchange rates

Paul Krugman suggests that exchange rates might matter for economic performance here.

On Ireland and exchange rates, one could add that, because of our large trade exposure to non-Eurozone markets, we  benefitted from an unusually large nominal depreciation in 2014-15 (which translated into a substantial real depreciation) (slides 8 and 9 here). I doubt this is unrelated to the employment boom we have enjoyed since then.

A dangerous union for small countries

Here are three papers I have read recently.

1. Reinhart and Trebesch on the way that external debts can hollow out local democracies. No need to elaborate on this I think.

2. Avdjiev, McCauley and Shin on cross-border banking: well worth a read for people not familiar with this stuff. They are talking about complicated transactions, but as we know in Ireland, much simpler transactions (banks borrowing overseas) can have dangerous consequences.

3. Athanasios Orphanides on the highly politicised nature of crisis decision-making in the Eurozone.

From 3, and from everything that we have observed during this crisis, from Ireland in 2010 to Greece in 2015, I infer that a small country is much more vulnerable inside the Eurozone than outside, if it gets into trouble. Outside, you will deal with the IMF on its own, and they have a standard policy template: debts will be written down, currencies will be devalued, and yes, there will also be austerity. Inside the Eurozone creditor countries will sit alongside the IMF at the table and you may find that neither of the first two policies will be feasible, which will make the austerity far more harmful than it would otherwise be, both economically and politically.

From 2, I infer that a small country needs to watch its banks like a hawk, especially if it is inside the Eurozone, because (from 1, and 3, and from what we have experienced since 2010) the political consequences of not doing so are just too damaging.

And from 1 and 3, I infer that government debts are something that small countries inside the Eurozone also need to be very concerned about. Especially in a monetary union without a banking union, like ours.*

So I find myself in agreement with Colm McCarthy. As was the case 15 years ago, we need to worry about the possible real exchange rate consequences of expansionary fiscal policy at this point in the cycle. And to be fair to the Irish economics profession, lots of people did worry about that then. But the main concern for me is no longer about economics, but about the risks to our Republic’s democracy. The price of freedom is eternal vigilance.

 

*What is a banking union? If Arizona elects a bunch of communists or survivalists to run the state, and the state budget explodes as a result, local banks will still be backed up by the Fed. My money will still be safe. I will still be able to withdraw it if I choose. This is what a banking union looks like, and don’t let anyone in Brussels or Frankfurt tell you any different.

 

J.A. Hobson on the Eurozone crisis (sort of)

Philippe Legrain points out that, far from creating the sort of European-level democratic space that would allow citizens to choose between political and economic alternatives, closer European political union is likely to place more even restraints on the power of politicians to respond to voters’  demands for alternative policies. This is because ever more rules proscribing what others can do, and made up by Germany, is what Germany wants (not that she has historically felt bound by rules when fundamental national interests are at stake, as inter alia the collapse of the EMS and the scrapping of the excessive deficit procedure inform us; and quite right too in my view).

But why does Germany want this?

Harold James has one view here.

And here is J.A. Hobson:

Moreover, while the manufacturer and trader are well content to trade with foreign nations, the tendency for investors to work towards the political annexation of countries which contain their more speculative investments is very powerful.

 

Guest post by Marios Zachariadis: On the Greek Crisis and German Imbalances

Policies undertaken from a narrow national perspective that encourage systematic fiscal surpluses coupled with a national consensus on wage suppression between unions and industry facilitated by the state, impact negatively upon domestic spending while increasing national saving and may lead to mercantilist outcomes of systematic policy-induced positive trade balances with large financial flows going the other way. This mechanism in relation to export-dependent countries like Germany has been recognized for a while by leading American economists like Obstfeld (the IMF’s new chief economist succeeding Blanchard) or Bernanke, while many have also pointed out low domestic investment, consumption taxes, and rigidities in the service sector as additional policy-related reasons for this German systematic phenomenon. Continue reading “Guest post by Marios Zachariadis: On the Greek Crisis and German Imbalances”

More miscellaneous irritations

1.  “We averted the plan of a financial choking and banking system collapse.” (Tspiras)

You are the prime minister Mr Tspiras. Did you not have a plan B to deal with ECB blackmail? If not, why not? Did you really think that the others would back down because of the possibility of Grexit, when it was so clear that you would be willing to do almost anything to avoid it?

2. The new (and conveniently self-interested) German doctrine that defaults are impossible within the Eurozone. Remember the no bailout clause? Ashoka Mody is surely right: these negotiations will kill the entire European project sooner or later. Better to let countries default when that is what is required.

3. Nice to hear Merkel saying that Greece may win back her trust. If I were Greek I might not trust European promises regarding debt rescheduling. Have we not heard those before?

4. How high is Greece’s debt to GDP ratio going to be now? Over 200%? Even if there is some reprofiling, does anyone think this makes sense?

All in all a great day for Golden Dawn. As for the rest of us: I don’t suppose that any other left wing party that may come to power in the future seeking to challenge the current European economic policy mix will be as feckless as the Tspiras government. The lesson that they will draw from this debacle is: negotiating with Germany is a waste of time; be willing to act unilaterally, be willing to default unilaterally, have a plan for achieving primary surplus if you haven’t already achieved it, have a hard default and euro exit (now possible, thanks to the Germans) option in your back pocket, and be willing to use it at the first sign of hassle from the ECB. A deal could have been done today that would have strengthened the Eurozone, but instead it has just become a lot more fragile.

Update: Wolfgang Münchau is well worth reading, here.

Update: this is also well worth a read.

Update: Charles Wyplosz is well worth reading here. Good to see someone pointing out the obvious about this extraordinary programme, and also taking on the (to my mind bizarre) argument that the headline debt/GDP ratio is irrelevant.

Update: Dae Woong Kang and Ashoka Mody offer a historical perspective here.

Miscellaneous irritations

1. I see that Juncker is saying that it is a shame that the Greeks walked out of the negotiations last week; and yet the creditor negotiating stance seems to have been “give us everything we want, and maybe we will discuss what you want (debt relief) at some later date”. For an account of the negotiations, see here.

2. I see that Hugo Dixon was describing the parties that got Greece into this mess over the course of several decades as “pro-European”, implying that Syriza is anti-European. Come again? Since when does opposing a particular policy mix (in this case one that has failed disastrously over the course of several years) make you anti-European?

3. I see that Martin Schulz is now denying having said that a no vote meant that Greece would have to leave the euro.

4. I can’t count the number of times I have heard French friends tell me that the problem is that the Greeks don’t pay taxes. (All Greeks, you understand.) What about Troika officials?

5. Aside altogether from the immense catastrophe of the last several years, Greece’s GDP shrank 0.4% in the last quarter of 2014, before Syriza got to power. Just saying.

6. Like Paul Krugman, I gave a cheer when I read Wolfgang Münchau’s stating the obvious:

What I found most galling was the argument that Grexit would bring about an economic catastrophe, as though the catastrophe had not already happened.

Some of the crocodile tears being shed on Sunday night about the humanitarian catastrophe that the Greeks were now supposedly bringing down on themselves (as if the ECB’s refusal to ensure financial stability in that country is irrelevant) I found pretty hard to take. Where have these humanitarians been hiding for the last seven years?

7. No comment necessary:

SPIEGEL ONLINE: Herr Fuest, angenommen, Sie wären wahlberechtigt, wie würden Sie am Sonntag beim griechischen Referendum über die Reformpolitik abstimmen?

Fuest: Mit Ja. Nachdem Ministerpräsident Tsipras sein politisches Schicksal an den Ausgang der Wahl gebunden hat, wäre mein primäres Ziel, ihn und seine Regierung loszuwerden.

8. Faymann: “Europe is known for compromises. Renegotiation until the last minute. Greece didn’t do this when it walked out of negotation.” The Greeks have been making compromises for months; where is the German compromise on debt relief?

There, that feels better.

On the bright side, it seems that around 80% of young Greek voters voted no.

 

 

Canada Day

Yesterday, the First of July, was Canada Day.

Discussing  the crisis in the Eurozone with some visiting Canadian relatives led to the question How stable is the Canadian currency union?

At first sight it seems to be much more stable than its European counterpart. The Canadian banking system is renowned for its solidness. It is dominated by five national banks that operate coast to coast, supervised by the much-admired Bank of Canada.  There is a large national budget that includes important elements of inter-provincial fiscal equalization. Internal labour mobility is relatively high.

But on the other hand the provincial governments are not constrained in their borrowing, there are enormous differences between the economic structures of the provinces, and there is always the Quebec question.

In fact, to a surprising extent, the stability of the Canadian union appears to depend on the fact that, as the author of this article puts it,”there are no Greeces here”.  He draws attention to flaws in the design of the Canadian currency union that could come home to roost some day.

Upcoming Conference on Macroprudential Regulation

Call for Papers: Macroprudential regulation: policy dynamics and limitations

A joint academic-practitioner conference with the theme Macroprudential regulation: policy dynamics and limitations will be held in Dublin, Ireland on Friday September 4th, 2015, organized by the Financial Mathematics and Computation Cluster (FMC2), the Department of Economics, Finance & Accounting at Maynooth University and the UCD School of Business at University College Dublin.

Macroprudential regulation is fairly new, and there are many unanswered questions. Can macroprudential constraints on credit be reliably attuned with the business cycle and/or credit cycle? Are fixed constraints on credit safer and more reliable than attempts at dynamic anti-cyclical ones? Should regulators take account of market or regulatory imperfections, such as in the construction sector, in setting constraints on credit growth? Is macroprudential control by an independent central bank consistent with the democratic accountability of government economic and social policies? Potential topics include:
* Business cycles, financial cycles, and the feasibility of dynamic macroprudential control
* The desirability and effectiveness of LTI and LTV limits on mortgage lending
* Democratic accountability and central bank independence
* Modelling house price movements and household debt and their interactions
* Controlling credit growth and credit flows in the Eurozone
* International case studies of macroprudential regulation.
* Assessment of macroprudential credit-restricting policies

Please send papers or detailed proposals by June 15th, 2015 at the latest to Irene.moore@ucd.ie; all papers must be submitted electronically in adobe pdf format. There will be both main conference sessions and poster sessions. We will consider proposed contributions to the poster session until 31st July. The academic coordinators for the conference are Gregory Connor and John Cotter, who can be contacted at Gregory.connor@nuim.ie or John.cotter@ucd.ie.

There are no submission fees or attendance fees for the conference. We are grateful to the Science Foundation of Ireland and the Irish Institute of Bankers for their generous support of this conference. The Financial Mathematics Computation Cluster (FMC2) is a collaboration between University College Dublin, Maynooth University, Dublin City University and industry partners, with support from the Science Foundation of Ireland.

Ultra posse nemo obligatur, anyone?

Paul Mason has a blog post and interview here, worth reading and watching. I am going to stick my neck out and assert that Manolis Glezos does in fact speak with a certain moral authority. But it is the German deputy finance minister’s constant insistence on obeying the law that prompts this post, along with its title. For German government use of the principle in the economic domain, see here (p. 188).

Irish virtue, Irish (or should that be FG?) interests

There has been some talk recently about how Greece should take its medicine the way Ireland has. So here is a chart, taken from the IMF’s WEO database, showing the two countries’ structural budget balances as a percentage of GDP:

 

Even if you start the clock in 2008, there is a sizeable difference. And if you start in 2010, when the programmes started, there is no comparison in terms of the “fiscal effort” made. (And yes, I know, it would be much better to look at ex ante measures of austerity, but this is what was to hand.) On top of that, the multiplier in Greece is presumably larger than in very small and very open Ireland. The EC estimates that it is almost twice as large in this paper, not that I take their Greek multiplier estimate particularly seriously. And finally, there is this chart which a friend sends me.

So, to summarise: the Greeks have done more “reform” than we have, have endured a lot more austerity, and live in a country where the costs of austerity are likely to be higher than here. Perhaps the Irish government might want to tone down its assertions of relative virtue, and display a bit of solidarity with Greece. Is a less deflationary and less creditor-friendly Eurozone  not in Ireland’s long term interests, assuming that we remain a member of the single currency?

Except of course that it won’t, for party political reasons. And you can see why. Expect to see more ad hominem attacks on dangerous ex-IMF radicals and other fellow travellers in the months ahead (despite the fact that the government is expecting the electorate’s gratitude for…implementing the programme that the self-same IMF and its fellow-Troika members designed! You couldn’t make it up.).

Yanis Varoufakis

Yanis Varoufakis will be confirmed as the new Greek finance minister later today.  He “is no extremist.” [EDIT: The Guardian think “radical”.]

Here is a recent interview with him and ‘A modest proposal for resolving the eurozone crisis’ is here.  Back in September a document on ‘What the Syriza government will do’ was published.

A moment of truth for the European project

I thought that an appropriate way to celebrate Syriza’s victory was to do what I should have done a long time ago, and finally read Peter Mair’s Ruling the Void on the journey from Dublin to Oxford this morning. It’s a terrifically insightful (and readable, and short) book that had me nodding in agreement throughout, and you could base a whole series of blog posts on it. So let me just pick up, on the day that is in it, on one of the very last points made in the book:

…we are afforded a right to participate at the European level…and we are afforded the right to be represented in Europe, even if it is sometimes difficult to work out when and how this representative link functions; but we are not afforded the right to organise opposition within the European polity. There is no government-opposition nexus at this level.  We know that a failure to allow for opposition within the polity is likely to lead either (a) to the elimination of meaningful opposition, and to more or less total submission, or (b) to the mobilisation of an opposition of principle against the polity — to anti-European opposition and to Euroscepticism

Democratic political systems need oppositions which can force policy reversals if voters decide that that is what they want. Kicking the bums out is not enough, we have to be able to kick out their policies as well.

Syriza is opposed to European macroeconomic policy, and won the elections on that basis. They speak for lots of Eurozone voters, not just Greek ones. If the EU have any sense they will not play hardball with the new Greek government, especially since just about everyone agrees that Greece’s debt is unsustainable. Nor should anyone be hoping that the new Greek government will be “pragmatic”, and forget its opposition pledges once in government. The Greeks want fundamental change, and have voted for a democratic pro-European party to express that desire — which, you might think, is a lot more than the Troika deserves. If Syriza doesn’t deliver, for fear of upsetting its Eurozone partners, voters may turn to parties that really are anti-European. In the Greek context, that could be very ugly indeed.

How the EU responds to last night’s election will tell us a lot about the actually existing European project.

Quote of the day

 “One must prevent the dealings of the ECB from easing the pressure for improvements in competitiveness.” 

(Angela Merkel, according to the FT.)

It is very good to see this sentiment being openly expressed by the German leader, since it is what we believe the German government thinks, and confirmation is useful. But, really, it is intolerable. Where in the treaties does it say that Eurozone monetary policy should be run in a sub-optimal and deflationary manner, thus increasing unemployment, putting the public finances under pressure and worsening economic distress more generally, so as to force other peoples’ governments to do things that the Germans think are good for them, but that have nothing to do with monetary policy?

No democrat should accept a Eurozone run along those lines.

Macroprudential regulation: policy dynamics and constraints

The Irish Central Bank is planning to impose macroprudential risk regulation on the domestic banking sector (see here). The general approach of the Irish Central Bank has been widely welcomed by economists, although the specifics of the proposals are controversial.

John Cotter (UCD) and I are planning a conference in September 2015 on macroprudential regulation, the fifth in our series of FMCC conferences on financial risk and regulation. Macroprudential regulation is fairly new, and there are many unanswered questions. Can macroprudential constraints on credit be reliably attuned with the business cycle and/or credit cycle? Are a-cyclical constraints on credit safer and more reliable than attempts at anti-cyclical ones? Should regulators take account of market imperfections, such as the poor performance of the Irish property development industry and the high costs of new housing construction in Ireland, in setting constraints on credit growth?

Macroprudential regulation has particular importance in Ireland, a small open economy buffeted by credit flows from bigger neighbours. The failure to impose macroprudential regulatory control on the Irish banking sector was a central cause of the Irish financial crisis of 2008-2011. During 2000-2007, within a flawed eurozone currency system, a politically-neutered Irish Central Bank ignored a runaway inflow of foreign credit into the Irish banking system. This massive credit inflow undermined the stability of the Irish financial system and led to the disastrous failure of the Irish domestic banking sector.

There is a varied range of views among economists on macroprudential regulation. This is clear in the responses to the Irish Central Bank’s policy discussion document. Three thoughtful responses come from David Duffy and Kieran McQuinn (both at ESRI) here, Ronan Lyons (TCD) here, and Karl Whelan (UCD) here. (For full disclosure, my own response to the Irish Central Bank discussion document is here.) Lyons recommends fixed, a-cyclical credit controls whereas Duffy and McQuinn argue for dynamic, anti-cyclical controls. Duffy and McQuinn stress the need for more new housing in light of fast Irish demographic growth, and the positive role of high housing prices (aided by bank credit growth) in eliciting an adequate supply response. Lyons argues that excessive bank credit growth should not be used as a hidden subsidy for a cost-inefficient building industry.

Lyons makes a case for no loan-to-income (LTI) constraint, instead relying only upon a loan-to-value (LTV) constraint for macroprudential credit control. This contrasts sharply with the view of Karl Whelan who argues for LTI-only macroprudential controls in the current Irish case. Duffy and McQuinn advocate for both controls. I share the view of Duffy and McQuinn. Lyons does not consider the importance of dual-trigger mortgage default in Ireland (that is, mortgage default which is triggered jointly by income stress and negative equity). The amount of Irish mortgage arrears is likely to remain large and volatile, and this is a key potential source of market instability. Both initial LTI and initial LTV ratios are linked to subsequent mortgage default probabilities, so both should be controlled.

There are certainly many points for discussion, which should make for an interesting conference! A formal Call for Papers will follow shortly – if there are particular themes or panels that we should include, feel free to mention them in the comments thread below.

Austerity Talk at Battle of Ideas in London

The ‘Battle of Ideas’ festival held at the Barbican in London last weekend included a panel session entitled ‘Piigs can’t fly: Democracy/Technocracy/Austerity’. I was invited to make a 7-minute presentation of my views as expressed at various crisis conferences over the years:

Back in 1986, long before most people imagined that the single currency would really come into being, Paul Krugman wrote of the potential fiscal co-ordination problem: a bias towards excessive restriction because each country ignores the impact of its actions on the exports of others. “Achieving co-ordination of fiscal policies is probably even harder politically than co-ordination of monetary policies. There is not even temporarily a natural central player whose actions can solve the co-ordination problem. None the less, in surveying the problems of European integration, it is hard to avoid the conclusion that this is the systemic change most needed in the near future”.

Without this problem ever having been addressed, the potential for exchange-rate realignment was locked down. As many US economists warned, the euro was a federalist project lacking in federalist foundations, whether minimalist (banking union or federalist insurance schemes) or maximalist (a Washington-style federal budget).

In the face of this existing (anti-Keynesian?; pre-Keynesian?; antediluvian?) institutional structure, Ireland had no choice but to impose austerity (which would have been required even in the absence of the disastrous bank guarantee of 2008). The large primary budget deficits – which meant that government spending would still far exceed tax revenues even if interest payments ceased – precluded debt default.

The actions of the ECB in 2010 in forcing us to pay off remaining unsecured bank bonds (by threatening to cut off liquidity) appear to have been beyond its mandate and it is difficult to think of any reason not to support economist Colm McCarthy’s call for this to be brought to the ECJ. But, as he notes, the need for  retrenchment would have remained.

The Irish experience under austerity has been distinguished by remarkable industrial peace. Paddy Teahon, the chief civil servant behind social partnership, argued that the process had promoted a shared understanding among unions, employers and the government of the key mechanisms and relationships that drive the economy. I wrote back in 2009 that “the Teahon view will be seen to be of validity if some agreement can be reached to reduce public-sector pay until the current crisis is overcome”.

As to whether austerity has worked, it has achieved what it was supposed to achieve, which was to close the deficit and slow the accelerating debt ratio. It was never supposed on its own to get the economy back to work, but rather to position the economy well for when markets rebounded. The flexibility of the labour market makes it easier for Ireland to bounce back from austerity than is the case for Greece for example. So does the openness of the economy, as long as export markets recover.

[All of the other panellists having been hostile to ‘the displacement of democracy by technocracy’, I suggested that:] Many or most economists of my acquaintance in Ireland were content enough with the policies espoused by, and implemented at the behest of, the troika. Technocracy can be viewed as an advantageous buffer between government and – on the other hand – purveyors of snake oil and the representatives of powerful entrenched interests (though technocrats too are not immune, of course, from regulatory capture).

Sinking, fast and slow

For well over a year now some of us have been pointing out that the Eurozone crisis was entering a very dangerous phase, in which slowly increasing unemployment would eat away at the foundations of Europe’s societies, while short-sighted politicians and excitable journalists proclaimed that the Euro was saved. The invaluable Eurointelligence has been doing a great job recently tracking the apparently inexorable deterioration in the economic fundamentals of the Eurozone, with Germany itself now apparently affected. But for both political and personal reasons I find myself worrying most about France.

Twiddling their thumbs and hoping that something (the economy) will turn up, flawed macroeconomic policy notwithstanding, seems to have been the French government’s master plan up till now. As a result it is hard to see Francois “Say” Hollande, or any other Socialist for that matter, getting through to the second round in 2017.

You may think that Paul Krugman is being too alarmist when he raises the possibility of President Le Pen, and I hope you are right. But Sarokozy’s apparent return to the political fray does worry me. Of course, you may think that if he wins the UMP nomination, the Left will rally round and vote for him when it comes to the second round.

How confident are you about that?

The Irish Case for LTV and LTI Caps on New Mortgage Lending

The Irish Central Bank discussion paper on macro-prudential policy tools published yesterday seems to be a trial balloon for possible caps on Loan-to-Income (LTI) and Loan-to-Value (LTV) ratios for new residential property mortgages in Ireland. The general theory behind imposing these limits is laid out clearly in that document; there is no reason to repeat it here. I want to discuss some notable features of the Irish environment which strengthen the case for these caps (but do not make the decision easy).

Continue reading “The Irish Case for LTV and LTI Caps on New Mortgage Lending”

Balanced budget tax cuts

In his press conference yesterday, Mario Draghi said the following:

Within the Stability and Growth Pact, one could do things that are growth-friendly and also would contribute to budget consolidation, and I gave an example of a balanced budget tax cut. Reducing taxes that are especially distortionary, where the short-term multipliers could be higher, and cutting expenditure in the most unproductive parts, so mostly, actually not mostly, entirely, current government expenditure.

There are at least three possible interpretations of this statement.

1. Draghi genuinely thinks that balanced budget multipliers are negative, which I find hard to believe. A balanced budget tax cut under current circumstances would be contractionary, not expansionary; at least, that is what we teach our students.

2. Draghi genuinely thinks that the Eurozone’s problems right now are on the supply side, and that tax cuts will help address these problems. I also find that hard to believe. The major problems facing the Eurozone right now are pretty clearly on the demand side.

3. Despite its nominal independence, the ECB is in fact the most politically constrained of the major central banks. If Draghi is going to push the ECB towards QE, and question the overall fiscal stance of the Eurozone, he has to come out with this sort of stuff from time to time, to appease the Germans.

I find the last of these three explanations entirely plausible, and it helps explain the ECB’s poor performance in the crisis to date. But why should a nominally independent central bank feel that its hand are tied in this way? Ultimately, perhaps, because the Eurozone is not a political union, and because democratic legitimacy resides at the level of the member states. This means that exit from the Eurozone is always an option, even if it is not openly acknowledged.

Another reason to think that monetary union without political union is a bad idea.

France

Paul Krugman asks whether anyone thinks that Hollande has the faintest idea about how austerity is going to fix the French economy, in a context where France is clearly facing a huge demand-side problem.

I guess this is the latest statement of what the French are thinking. They recognise that there is a demand side problem in Europe, and hope that someone else (the ECB, and European institutions who might promote European investment) will address this. And they hope that if they do things that the Europeans like, then this will lead not only to saner European macroeconomic policy, but to investment by French companies as well:

“Je souhaite… que chacun prenne ses responsabilités”, poursuit Michel Sapin. “Le gouvernement a pris les siennes, je souhaite que l’Europe le fasse aussi. Mais il faut que les entreprises prennent les leurs.”

I sort of understand what is going on politically. One thing that strikes you about France is how partisan the politics there are. There are some — typically on the left — who think that demand is all that ever matters, and others — by no means all on the right, since VSP’s are to be found right across the spectrum — who think that supply is all that matters. So the government is trying to say that both demand and supply matter, and is describing this in terms of a bargain: if we are tough on spending and all the rest, then the French private sector and “Europe” should do their part, and invest.

But what if, as appears to be the case, the big reason that French companies are not investing is a lack of demand? And what if the Germans simply refuse to budge on macroeconomic policy, as seems likely? Is French policy simply going to consist of saying “pretty please”, or do they have a credible threat to move things along?

Threatening to leave the euro if things keep going the way they are might just do it (what would be the political point of the euro without France?), but does anyone see Hollande credibly threatening that? Does anyone see him credibly threatening anything? And what is his Plan B if Eurozone macroeconomic policy remains essentially unchanged? Does he even have one?

In the mean time, austerity in France will continue to hurt the French economy. How high in the polls does the FN have to rise before Hollande realises that what he is doing is neither prudent nor responsible, but incredibly dangerous?

And how long before the French political system is willing to acknowledge, publicly, that Montebourg’s warnings do not reflect a particularly “left wing” view of economics, but would be regarded as plain common sense by most macroeconomists?