Simon Wren-Lewis is puzzled here.
Archive for the ‘EMU’ Category
In a must-read article, Chris Pissarides states that “far from the currency bloc acting as a partnership of equals, it is a disjointed group of countries where the national interests of the big nations stand higher than the interests of the whole.”
This sums up perfectly where the European project is today. Indeed, there isn’t even solidarity among the smaller countries, as Malta and Luxembourg seek to distance themselves from Cyprus, reminding us of many similar protestations by individual PIIGS in the past, Ireland included. Not that it did any of them any good.
Was it not bizarre to see so many anti-German posters in Nicosia last week, when by all accounts it was the Cypriot President (among others) who wanted to see small depositors hit? Actually, no, it wasn’t. We have seen several statements by German politicians saying that the Cypriot business model is dead, and I’m sorry, but irrespective of the rights and wrongs of the issue this is simply unacceptable. The IMF has the right, and duty, to opine on such matters. So does the ECB, which is supposed to care about financial stability, whatever about how it behaves in practice. Perhaps one could find a rationale for the Commission, or maybe even the Eurogroup, to express an opinion on matters such as this. But an individual member state? Formally speaking, and in any club such formalities matter, it’s none of their business. Even if it is an election year.
The EU is supposed to work according to a set of well-understood principles. If we want to re-regulate the banking sector, and we should, then the recent decision to cap bankers’ bonuses is an example of how the system is supposed to work (again, irrespective of the merits of the issue). There are proposals, there is a vote, there is a decision. Fine. I’ll have more of that please.
But that is not what we are seeing here.
It might be less difficult to swallow if the German government were caped crusaders seeking to bring the entire European financial system to heel. But we all know who has been undermining the drive to have a meaningful European system of banking supervision, and it isn’t Cyprus. And is Mr Schaüble really going to try to prevent German banks from touting for business in that island, as the FT recently reported? I don’t think so. None of this means that Merkel and Schaüble are any worse than anyone else’s politicians, but if you are the arbiter of other countries’ fates, and you aren’t any better either, then there’s going to be a backlash. Which is terrible news for Germany in the long run.
My quote of the week is from another must-read article, this time by Wolfgang Münchau, who says that
I have believed for some time that it is impossible for Germany, Finland and the Netherlands to be in a monetary union with Cyprus, Greece and Portugal. Either the two sides agree to adjust more symmetrically, politically and economically, or this experiment should end.
The argument about economically asymmetric adjustment has at this stage been done to death, and almost everyone understands it, although the German government remains resolutely, proudly, and vocally, macroeconomically illiterate. Another reason why anti-German posters at mass demonstrations are something that we will have to get used to, which is tragic. But Wolfgang’s point about politically asymmetric adjustment is just as important, and gets to the heart of the matter.
When the EU club works according to its rules, people accept the outcomes, but in crises policies are made on the hoof, and it is the powerful who call the shots. This is inevitable, but it is also very dangerous, especially since the decisions that are made at times like this have a much bigger impact on peoples’ lives than anything that typically comes out of Brussels. We have been in crisis mode for much too long now, the crisis shows no signs of going away any time soon, and the political asymmetry is becoming intolerable.
A meaningful banking union, that had the power to stick its nose into the German banking system, and had a set of ex ante mutually agreed principles regarding how to resolve banks in all member states, would help reduce political asymmetries. More expansionary monetary and fiscal policies would help make economic adjustment more symmetric. I suspect we’re going to get neither, in which case we need to end the EMU experiment before it drags the broader European project down with it.
On balance I agree with Paul Krugman’s views on whether Cyprus should leave the euro or not. And most people seem to also agree with him that there will be a Cypriot public debt crisis in the not too distant future. Given what is about to happen to their GDP, how could it be otherwise?
As regards the political benefits to Cyprus of staying in the Eurozone, which Paul advances as a possible counter-argument: the Telegraph links to a piece from the Netherlands suggesting that the EU is contemplating earmarking those future Cypriot gas revenues the island has been looking forward to, to ensure that the Troika gets its money back.
Completely logical, and utterly destructive.
Colm McCarthy has a terrific piece in today’s Sunday Independent.
To his comments about money laundering hardly being something confined to Cyprus, I would add the following link.
It seems that we still don’t know how this crisis is going to end. But here is one big dilemma that I see. Implicit in Colm’s article is a recognition that a meaningful banking union is a pre-requisite for a sustainable EMU. That means common supervision, a centrally-funded deposit insurance system, and a common, tax-payer-friendly, and (where necessary) jointly funded resolution system. The core reference on banking union remains this piece by Pisani-Ferry, Sapir and Véron. This past week’s events have clearly reinforced the case for such a banking union, which necessarily involves some element of fiscal union. Without it, EMU is a dangerous place to be.
And here is the dilemma (aside from the fact that it is being made increasingly clear that the Germans are never going to be convinced that such a system would be one involving mutual insurance, rather than one-way transfers, and that the idea of a meaningful banking union may therefore be dead in the water in any event). Do the rest of us want to get even more deeply involved with a Eurozone whose decision makers are as incompetent as this lot? And do those of us who live in small countries really want to get more deeply involved in a club in which big, powerful countries and small, weak countries are not treated as equal members?
Update: according to the FT, German banks (among others) are going after the Russian business that has up to now been located in Cyprus.
This interview with Athanasios Orphanides will ring a few bells in Dublin. I remember in the autumn of 2010, when the ECB in a similar fashion threatened to pull the plug on the Irish banking system, thinking that this was not a credible threat, since such action would de facto mean expelling Ireland from the Eurozone. Would an unelected bunch of central bankers really be willing to do something so political?
I can understand why Irish policymakers were not willing to test this logic at the time, even though I was very angry with them for giving in to ECB pressure not to burn the Irish banking system’s creditors, and still think they shouldn’t have done so.
One thing seems certain however. The ECB cannot have it both ways. It cannot simultaneously threaten to expel a member state from the Eurozone, and also expect us to believe that it will do “whatever it takes” to save the euro.
What investors (and, to be honest, I) have forgotten is that Draghi qualified his pledge: the ECB would do whatever it takes “within its mandate”. It isn’t clear that investors will continue to believe that “it will be enough”.
This piece by Nicolas Véron is well worth a read, even though it was posted yesterday and the situation is fast-moving.
You leave the computer switched off during the holiday weekend, and look what the Eurozone does while you’re away! I guess we don’t know yet what the final outcome is going to be in Cyprus, and I fully share Sharon Bowles’ hopes that we haven’t seen the final word yet.
But if small depositors are going to take a hit, then, as a reminder of what we will have lost, here is a handy set of links to various EU documents and regulations regarding banking deposits. This citizen’s summary which reflects the media reports of the time helps explain why people have persisted in leaving their money in peripheral European banks for so long. It seems mad to tear this guarantee up on the grounds that Cyprus is sui generis, since as Tolstoy (almost) said…
Update: Tuesday morning, and we still don’t know what is going to happen; maybe the guarantee for savings of less than €100,000 will be honoured. But I fear that Karl and the many other commentators weighing in on the issue this morning are right, and that the long run reputation of the EU’s claim to guarantee such deposits will suffer a big hit as a result of this debacle, no matter what ultimately happens.
Timothy Garton Ash may be on to something. 2010 was clearly a turning point, when the Eurozone decided to engage in generalized pro-cyclical austerity — whether they did this because of the dodgy ideas that were floating around at the time, or simply because conservative politicians were more adept at using the crisis to further their long term goals (in their case, to shrink the state) than Europe’s useless left is something historians can debate in the future.
Garton Ash suggests that 2012 may also have been a turning point, or rather a turning point that never was: with Hollande and Monti newly installed, there was a clear demand for a more symmetric adjustment policy from pro-European Southern leaders, and an opportunity for Germany to respond favourably– after all, Monti was their man. That response never came. All we got was a June summit declaration on banking union on which there has subsequently been much backtracking. There was nothing on making short run macroeconomic adjustment less asymmetric. And now the German government is busily making matters even worse on the fiscal front.
I don’t see any way that the Eurozone can avoid a major political crisis. If the current policy mix continues unabated for the foreseeable future, then the real economy in the southern periphery will continue to worsen — unless of course something miraculously turns up, which is a possibility which we can however safely discount. Since this situation will ultimately prove politically unsustainable, the ’steady as she goes’ scenario implies an eventual political crisis that could be quite nasty, at some unknowable date in the future — a year, or two years, or even — God help us — five or ten years from now.
But can we envisage a shift in the short run macroeconomic policy mix — looser monetary policy, more debt restructuring, a countervailing core fiscal stimulus channelled either through Germany or some EU body like the EIB — and moves towards an appropriate Eurozone architecture — a real banking union, which will require at least some element of fiscal union, and ideally some other elements of fiscal union as well — which is brought about in the absence of crisis? We have all seen how OMT has bred complacency and allowed German politicians to wriggle off the hooks on which they had been impaled last June. 2012 was a pretty good year to force change from that point of view as well; another way in which the year was a turning point that never was.
The problem of course is that a political crisis serious enough to force major reform may also lead to the collapse of the Eurozone: otherwise it won’t succeed in forcing major reform. Germany’s leaders can prove me wrong, by heeding Garton Ash’s advice and seizing their second chance. But I am afraid that they will not do so.
It isn’t Paul Krugman’s fault that the European Commission has been busily defending a macroeconomic policy mix that is doing tremendous damage to the European periphery: the EC only has itself to blame on this one. And so the latest outraged tweets emerging from the Brussels bubble are a little hard to take.
One of the tragedies of the interwar period is that the good guys — liberal internationalists — tended to support a macroeconomic policy mix that was destructive, as a result of their support for the gold standard. In so doing they helped undermine the case for liberal internationalism. It would be helpful if the cocooned elites in Brussels remembered that they are, de facto, the public face of the European project, and that when they defend the indefensible they are in their turn undermining that project.
Paul de Grauwe and Yuemei Ji have an interesting commentary on the causes and effects of austerity here.
Terrific article by Mark Mazower here.
Mario Monti has done Europe’s voters a huge service. It would have been easy for him to remain aloof during this election; by standing for election he allowed Italians to directly express their opinion on the EU’s current macroeconomic policy mix. The results are pretty conclusive: current policies have no democratic legitimacy, at least in Italy.
We all remember Jean-Claude Juncker’s statement that “We all know what to do, but we don’t know how to get re-elected once we have done it”. He got it half right: they certainly don’t know how to get re-elected. But it is also clear that they really don’t know what to do about the economy either. And this represents a huge problem for the European project, since by pinning their colours so firmly to the mast of an incoherent and destructive macroeconomic policy mix, Europe’s leaders risk doing huge damage to that project. Indeed, the damage is already occurring.
It would be nice to think that these leaders would take seriously pleas by people like Karl for a saner approach to macroeconomic policy. The evidence since September, however, is that they will sit on their hands unless forced to do otherwise by the markets: the risk of financial crisis, not the reality of peripheral unemployment crises, is what grabs their attention. Another reason to welcome the Italian vote, perhaps.
Update: Paul Krugman has a very similar reaction here.
You might have thought that the disastrous but wholly unsurprising eurozone GDP numbers indicate that the bloc is in a bad way, and will continue to be so until the current macroeconomic policy mix is jettisoned.
The current situation can be summarised like this: we have disappointing hard data from the end of last year, some more encouraging soft data in the recent past and growing investor confidence in the future.
Thank goodness for that.
By Philip LaneMonday, February 11th, 2013
(If Ashok is right then, contra Manasse, the Eurozone crisis will become a bit more symmetric, but he is right to query whether this will be good news for the project.)
And here is an account of a Slovenian constitutional court decision. If the account of the legal reasoning is accurate then this is quite appalling.
The FT has a sobering report here.
Just like a year ago, we are hearing a lot of guff about how the euro crisis is over, and just like a year ago the people I talk to in Brussels are becoming increasingly alarmed by the complacency of the European establishment. It does seem as though the only thing that makes Europe’s useless political class worry is the risk of imminent cardiac arrest, as proxied by bond yields and the like; but the cancer of unemployment will do just as much damage if allowed to progress unchecked.
Here are the latest Eurozone unemployment statistics. Just because we are becoming used to this sort of news does not mean that they are even remotely acceptable. They are grim.
There are certain costs that are obviously not worth paying to keep the EMU experiment going. One is a dilution of the continent’s democratic traditions. Another is unemployment rates of the sort we are seeing in Spain and Greece. No doubt crocodile tears will be shed by supporters of status quo macroeconomic policies, but such responses are no longer acceptable. EMU supporters, and €-sceptics who are worried about the costs of an EMU break-up, now have to start being very concrete in terms of proposing Eurozone economic policies, including short run monetary and fiscal policies, that can start reversing these trends in 2013. (A group of us tried to do so here, for example.) And then we need to see such policies being implemented, quickly.
You have to live through times like this to really appreciate the wisdom of Keynes’ famous line about the long run.
The markets are going into a minor tizzy this morning thanks to the news that Mario Monti is stepping down earlier than expected. And I can certainly understand why people like Beppe Grillo and Silvio Berlusconi might seem like a cause for alarm.
But what if Wolfgang Münchau is right, and the real problem in Italy right now is the austerity policies that Monti is pursuing, and that are being praised to the skies by the entire European establishment as we speak? Bang on cue, we learned this morning that Italian industrial output fell by 1.1% in October, much faster than expected. If Wolfgang is right, then what Europhiles (and the markets) should be devoutly hoping for is centrist, Europhile politicians willing to reject the status quo policies that are doing such damage. Why should Eurosceptics have all the best tunes?
One of the things that makes it possible for Europe’s politicians to persist with this nonsense is their conviction, like Mr Micawber, that something will turn up. There is no sign in Ireland that anything at all is turning up. The most important indicator of all, employment, is still falling, and you can see signs of strain all around if you care to look. At the panto last night, I was struck by the lack of sparkly fairy wands, light sabres, and all the rest compared with previous years: it really was very noticeable. And these were the people who could still afford to take their kids to the panto. Also noticeable was the almost complete absence of recession jokes, which were such a feature in 2008 and 2009. It just isn’t funny any more.
Colm McCarthy was in good form yesterday regarding this over-optimism in the Irish context. Of course, it is always possible that predictions of rapid growth just around the corner aren’t fuelled by optimism at all. It is at least theoretically possible that these growth predictions are whatever is required to make Ireland — the Eurozone’s supposed success story — seem solvent.
Mind you, you’d have to be a complete cynic to believe that such a thing was possible.
Update: Good Heavens Above. The corner appears to be receding from view in the Netherlands.
It would be a good thing if the leaders meeting in Brussels today were to take reports like this one seriously.
In an earlier post I drew attention to the extent to which Ireland’s recent apparent competitive gains reflected the weakness of the euro relative to the dollar and sterling.
Another component of competitiveness is, of course, our rate of inflation relative to that of the Euro area as a whole.
It is therefore of interest to put on record the inflation rates in Ireland and in the Euro area since 1999.
This is facilitated by the European Central Bank’s website, from which monthly data on the rate of inflation as measured by the Harmonised Index of Consumer Prices (HICP) may be readily downloaded.
The following Chart tells the story.
It may be seen that for the first five years of the new monetary union Ireland’s inflation rate was - contrary to expectations - significantly higher than the Euro area average. This resulted in a significant loss of competitiveness relative to the rest of the Euro area.
For the years between 2004 and 2007 our inflation rate behaved as expected in a monetary union and differed little from that of the Euro area average.
During 2009 and 2010 we experienced more deflation than the rest of the Euro area. This helped restore some of the competitiveness we had lost in the early years of membership and the ‘internal devaluation’ was hailed at the time in the belief that it would play a big role in getting the economy moving again.
Since 2010, however, our inflation rate has been climbing back up towards the Euro area average.
It would seem that any further ‘restoration of competitiveness’ will require further weakness of the euro on the foreign exchange markets.
Simon Wren-Lewis has a nice post here. The whole situation makes you wonder whether, despite all the ECB’s talk of independence, there is a major Western central bank more subject to political constraints anywhere in the world.
I would add a couple of points.
First, the ECB and the rest of us are fixated on what will fly politically in Germany; but there are 16 other member states in the Eurozone, and not all of them are as pliable as little, eager-to-please Ireland. In particular, I have always thought that there were two reasons to avoid having Italy enter a bailout programme: not just the fact that EFSF/ESM won’t have enough money, but the fact that if this happens, Italy may decide to leave EMU. The reason why economists like Paul de Grauwe have been asking for ECB intervention is so that an Italian bailout becomes unnecessary; now it seems that Italy will only get ECB intervention if it enters a bailout programme. The whole thing seems upside down, and people are playing with fire here. Despite its large debts, Italy wouldn’t be having these difficulties on the market if it wasn’t in EMU: to ask a big, important country with a sense of its own dignity to give up sovereignty — and potentially enter the same death spiral as Greece, and now apparently Spain — simply so that it can remain in a single currency that isn’t working seems like a bit of a stretch to me.
Second, I agree with Simon that the ECB’s worrying about the moral hazard facing states like Italy in a situation like this is pretty stupid. (I would add that it is also wrong because it mixes up fiscal and monetary policy. Let the ECB stick to monetary policy, and let governments, individually and collectively, stick to fiscal policy.) But in our dysfunctional, destructive monetary union it may indeed be politically necessary for the ECB to insist on fiscal policy conditionality before doing the job of a central bank. Forcing Italy into a bailout programme seems like a particularly dangerous way of doing this, however.
There is a better way I think. The IMF is signaling that Spain and Italy are doing all that could be reasonably asked of them right now. Surely if the IMF is willing to certify that a country is running a sensible fiscal policy, this should be enough to allow the ECB to do what needs to be done?
UPDATE: Francesco Giavazzi is quoted here as making an obvious and very important point: for an unelected technocrat like Monti to steer Italy into a bailout programme, with the consequent loss of sovereignty that would be involved, prior to elections, would be unacceptable.
By Philip LaneWednesday, August 1st, 2012
Landon Thomas outlines some of the reform ideas doing the rounds in policy circles and profiles some of the key participants in this NYT article. He includes the ESBies idea proposed by our euro-nomics group and a member of our group Markus Brunnermeier, as well as Daniel Gros and Graham Bishop.
I am not entirely sure if it belongs in a post with this title heading but Hans-Werner Sinn makes his own proposal in this FT op-ed.
I spent a few hours today revising and updating this paper, and was both astonished, and not surprised at all, to see the extent to which trust in the EU and its institutions collapsed in 2011. The figures below show the percentage of respondents in Eurobarometer surveys saying they trusted the institution in question, minus the percentage who said they didn’t trust it. The decline in 2011 is really quite dramatic. I am sure that the usual suspects will tell us that what Europe obviously needs is a better communications strategy. Personally, I think that less destructive economic policies would have a bigger impact.
Since Brendan and Philip have both posted on competitiveness in the past couple of days, I thought I’d follow up with a link to the following piece by Gaulier, Taglioni and Vicard.
Eurointelligence points us to a piece by Alan Beattie on the political difficulties which the IMF faces in dealing with the Eurozone crisis. As we know in Ireland all too well, while the IMF has generally been on the side of the angels, it is the ECB and EC that have called the shots, with the result that the IMF’s reputation suffers by association with Troika policies that are a complete and utter disaster. The dilemma for the IMF is that a complete withdrawal from the Eurozone crisis, while the single currency collapses, won’t do its reputation much good either.
Charles Goodhart and Sony Kapoor have it right, I think: it is the Eurozone that is dysfunctional, and in the future IMF conditionality has to be directed at the ECB and other Eurozone-level bodies as much as (if not more than) it is directed at individual member states. It’s time for the IMF to decide whether it wants to prove Peter Doyle right, or prove him wrong.
The orthodox view is that enhanced competitiveness should play a significant part in Ireland’s (and other euro area countries’) recovery from recession.
In the March 2012 “Review Under the Extended Arrangement” the IMF team states that:
“Ireland’s economy has shown a capacity for export-led growth, aided by significant progress in unwinding past competitiveness losses.” (my italics)
The evidence does indeed point to a significant improvement in Ireland’s competitiveness between 2008 and the present. The following two graphs show the ECB’s ‘Harmonized Competitiveness Indicator’ (HCI) based on (a) Consumer Prices and (b) Unit Labour Costs. (A rising index implies a loss of competitiveness.) Both graphs show a competitive gain since 2008, with second showing the more dramatic improvement. However, this measure is affected by the changing composition of the labour force, which became smaller but more high-tech as a result of the collapse of many low-productivity sectors during the recession.
Concentrating on the HCI based on the CPI, the Irish competitive gain has still been impressive – our HCI fell 17% between mid-2008 and mid-2012, giving us the largest competitive gain recorded in any of the 17 euro-area countries over these years. Greece, at the other extreme, recorded no change in its HCI, Portugal fell only 4.5%, Spain 6.6%, Italy 6.8%. So by this measure Ireland is some PIIG(S)!
However, we need to dig deeper and understand why Ireland’s HCI has fallen so steeply.
Part of the story - the part on which some commentators dwell - is that early in the recession the Irish price level and Irish nominal wages fell. From a peak of 108 in 2008 the Irish Consumer Price Index fell to 100 in January 2010. But it has started to rise again – by mid-2012 it was back up to 105. The fall in the Harmonized Index of Consumer Prices has been even less impressive – from a peak of 110 to a low of 105 and now rising back to its previous peak.
Wages are more important than prices as an index of competitiveness because price indices are influenced by indirect taxes and include many non-traded services and administered prices. But Irish nominal wages tell much the same story as the price indices. The index of hourly earnings in manufacturing peaked around 106 at the end of 2009 (2008 = 100) and then fell to a low of 102 in 2011, where it appears to have stabilized. Even in the construction sector, where employment collapsed in the wake of the building bust, wage rates declined only 6 per cent between 2008 and 2011.
Falling wages and prices are in line with what many commentators thought would happen after the surge in unemployment in 2008. Widely-publicized wage cuts in the private and public sectors were seen as part of the ‘internal devaluation’ needed to rescue the Irish economy from the recession. It was argued that this was the only way we could engineer a reduction in our real exchange rate given our commitment to the euro. (Paul Krugman likes to refer pejoratively to an ‘internal devaluation’ as simply ‘wage cuts’.)
However, the Irish wage and price deflation has not been very dramatic and seems to have stalled in 2011, even though the unemployment rate continues to climb.
So why has Ireland’s competitiveness improved so sharply since 2008 if the ‘internal devaluation’ has been so modest? The answer, of course, lies in the behaviour of the euro on world currency markets and the fact that non-euro area trade is much more important for Ireland than for any other member of the EMU.
This can be seen by looking at the HCI for the euro area as a whole. The euro area HCI fell from 100 in mid-2008 to 84.7 in mid-2012 – almost as big a fall as was recorded for Ireland and far higher than that recorded in any other euro area country.
The paradox that the euro area HCI has fallen much further than the average (however weighted) of the constituent EMU countries is explained by the fact that for each individual country the HCI is compiled using weights that reflect the structure of that country’s total international trade, but for the euro area as a whole the weights reflect the only the area’s trade with the non-euro world.
In its notes on the series the ECB draws attention to this:
“The purpose of harmonized competitiveness indicators (HCIs) is to provide consistent and comparable measures of euro area countries’ price and cost competitiveness that are also consistent with the real effective exchange rates (EERs) of the euro. The HCIs are constructed using the same methodology and data sources that are used for the euro EERs. While the HCI of a specific country takes into account both intra and extra-euro area trade, however, the euro EERs are based on extra-euro area trade only.” (my italics)
It is understandable that Ireland should show a large competitive gain by euro area standards as the euro declined on world markets after 2008 because non-euro area trade is far more important to Ireland than to any of the other 16 members of the EMU. A fall in the dollar value of the euro does nothing to make France more competitive relative to Germany, or Greece relative to either of them, but it does a lot for Ireland relative to its two most important trading partners - the UK and the US.
As a consequence, the decline in the value of the euro on world currency markets, and especially relative to sterling and the dollar, has had a much larger effect on our competitiveness than on that of any other euro area country.
The following graph shows the USD / EUR exchange rate and Ireland’s HCI since 2008. It does not take any econometrics to convince me that the main driving force behind Ireland’s competitive gain has been the weakness of the euro. Undoubtedly a more sophisticated treatment, including the euro-sterling and other exchange rates of importance to Ireland – duly weighted – would show an even closer co-movement.
This should alert us to the point that Ireland’s much-praised recent competitive gain has been due more to the weakening of the euro on the world currency markets than to domestic wage and price discipline.
No doubt it could also be shown that a significant amount of the loss of competitiveness in the years before 2008 was due to the strength of the euro.
The fault - and the blame - lay not with us but with the far-from-optimal currency arrangement under which we labour.
Continuing gains in competitiveness would therefore seem to depend more on further euro weakness than on the process of ‘internal devaluation’. Should this have been a condition of our Agreement with the Troika?