Europe: the Unfinished Business

The EU decisions during the last quarter of 2012 gave the Eurozone a breathing space from their friend-foes, the financial markets, not more. Now it remains to be seen whether this opportunity will be used to decisively finish the business of completing the fiscal union, the banking union, the political union. A small, but significant step was taken this third week in January when und the “enhanced cooperation” mode the European Commission was mandated by the ECOFIN to work out the details of a common financial transactions tax.

But – among others – three important areas remain to be brought forward:

  1. A more complete umbrella of economic policy objectives, maybe fashioned after the so-called “magic polygon” idea of the seventies. In these better and younger days, Austrian economic policy aimed simultaneously at growth, full employment, trade balance, budget balance and low inflation. Today, to eliminate one of the main causes of the crisis, I would add the objective of a more equitable income distribution. And today it would be extremely important to develop the concept of socio-ecological growth at the European level, as the EU project www.europe (lead by the Austrian Institute of Economic Research together with 14 European institutes) aims to do.
    EU economic policy, in its Europe 2020 agenda, does contain all or most of these objectives, but if one looks at the more recent decisions and the binding power of policy objectives, there is a strong preponderance of budget consolidation –to the exclusion of the other objectives. Only the “European Semester” and the Fiscal Pact have sanctions for non-fulfilment and are in nearly every politician’s mouth; recently – mainly as a result of the horrendous youth unemployment rates in some of the Southern EU countries – there has been attention given to unemployment, but it is lacking concreteness.
    Cyclically, this reliance of budget consolidation by all EU countries has driven the EU into a severe recession. Stronger growth elements, requiring investment (both private and public) and supply-side reforms, could shorten the recession and make it less severe. In this situation, the sequencing should be to generate growth before doint the necessary debt reduction.
  2. Severing the detrimental alliance between private (bank) debt and public debt. As a result of the crisis and the underlying problems banks are facing, many governments in the EU and EZ have taken over debt from the banks and have recapitalized them. In this way, Ireland”s public debt share in GDP has risen by 50 percentage points, other countries’ less so, but still significantly. National banks hold large shares of national debt, and in case of trouble, governments, i.e. taxpayers took over bank problems. Recognizing this vicious connection, the European Stability Mechanism was created and empowered to recapitalize banks directly. However, as the details are being worked out, there is a movement to once more request governments to guarantee the ESM payments to banks – which would obviate the purpose to sever this link.
    So far European bank resolution has been done on a national level. There is no EU-wide plan determining how the European financial landscape should look like in 10 years, which existing banks or other financial institutions need to be closed, which should merge, etc. Each country does its own business, and hardly any bank so far has been closed – with the argument that letting a bank fail might lead to a European “Lehmann moment”, destabilizing the whole financial system. Thus taxpayers will suffer severe payments for years to come, in order to rescue an overbanked European financial system.
    Missing is also a European bank insolvency law, which could help to wind down failing banks in an orderly manner. Also missing – as an essential part of a banking union- are a common European deposit insurance system and a bank-fed bank resolution fund.
  3. Turning governm,ent finance over to public institutions: The irrationality and obscene risk-taking of private banks and other financial institutions has caused this severe crisis. The interest rate spreads requested for government debt of the Southern countries (and some others) have been the flipside of the near-zero spreads in the runup to the crisis. All this has shown conclusively that to leave government finance to private markets has severe destabilizing and destructive effects. Just as it is the public sector, i.e. the ministries of finance and especially the parliaments which decide on national budgets – the “number manifestation of governments manifestos” – the financing of the national budgets must revert to the public sector, to public institutions outside the ministries, which are accountable to the parliaments. I am thinking of government financing by the ECB or the ESM or another like institution.
    Of course, we all know that irresponsible politicians could use such institutions as a self-service counter, running up inflation with vote-buying white elefant projects. In order to avoid this, financing criteria and conditions, accountability mechanisms and limits need to be worked out very carefully. However, the threat of such potential government failure is no larger than the existing market failure, as the behavior of financial markets before and during the crisis has shown.
    The recent developments by the US Fed (benchmarking monetary policy also to the unemployment rate), the ECB (unlimited provision of liquidity), the Bank of Japan (increasing its inflation target) and the designated governor of the Bank of England (using a nominal GDP benchmark instead of inflation targeting) all point already to a larger role of Central Bank Policy in economic policy-making. These may be interpreted as glimmers of hope, where the monetary authorities together with the fiscal authorities work closely together to achieve the wider economic policy objectives outlined above.


A number of other open gaps will need to be closed in the very near future, in order to make the Eurozone and the EU operative again. There are large differences in policy requirements country-by-country, there is the new EU budget framework, and many other tasks. It is important, however, not to become relaxed about the lull in the crisis, but rather to use this temporal window to briskly attack the tasks at hand.vvv



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2 responses to “Europe: the Unfinished Business

  1. Excellent post Kurt, I will gladly share it!
    I would be more cautious than you about the ECB. It played the firefighter (and to Draghi’s credit, I am unsure Trichet would have done it), but it remains strongly anchored in orthodoxy…

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