The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.
You can access the entire sequence of blogs in this series through the – Euro book Category.
I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).
Part III – Options for Europe
[THIS IS THE LAST SUBSTANTIVE CHAPTER - IT INTRODUCES THE APPROACH THAT THE EURO LEADERS HAVE TAKEN AND WHY A DRAMATIC CHANGE IN POLICY IS REQUIRED - IT LEADS INTO THE FINAL SEVERAL CHAPTERS WHICH DISCUSS THE SPECIFIC OPTIONS - WHICH YOU HAVE ALREADY READ. I WILL FINISH THIS CHAPTER BY THE END OF THE WEEKEND AND THEN NEXT WEEK WRITE THE INTRODUCTION AND START CHECKING]
Chapter 18 The European Groupthink – failing to take the correct path
[PRIOR MATERIAL HERE]
[NEW MATERIAL TODAY]
The fiscal stimulus solution
When confronted with this sort of economic problem – a collapse of private spending – the solution for government is simple and well-known. The US government knew what to do – ease monetary conditions and introduce a large-scale fiscal stimulus. The Chinese government did the same as did the Australian government and several others. All the governments that followed the basic rules of macroeconomics – that spending equals income which drives employment – all were able to offset, to varying degrees, the private sector meltdown. Australia’s fiscal stimulus package was large enough and was introduced early enough to allow the nation to avoid a recession altogether. Subsequent evaluations by Government bodies including the American Congressional Budget Office (CBO), the Australian Treasury and many economists found that the fiscal interventions were highly successful. The CBO reported in 2011 that the American Recovery and Reinvestment Act (ARRA) had been responsible for the raising economic growth by at least 1.1 per cent, the unemployment rate was up to 1.9 percentage points lower and up to 3.5 million people gained jobs, compared to what would have happened without the intervention (CBO, 2011). Economists Alan Blinder and Mark Zandi found that “the effects of the fiscal stimulus alone appear very substantial, raising 2010 real GDP by about 3.4%, holding the unemployment rate about 1½ percentage points lower, and adding almost 2.7 million jobs to U.S. payrolls” (Blinder and Zandi, 2010a: 1). The Australian Treasury concluded that “absent the discretionary fiscal packages, real GDP would have contracted not only in the December quarter 2008 (which it did), but also in the March and June quarters of 2009, and therefore that the economy would have contracted significantly over the year to June 2009, rather than expanding by an estimated 0.6 per cent” (Australian Treasury, 2009). They also concluded that discretionary fiscal policy changes were estimated to be around 2.4 times more effective than monetary policy changes. The cuts in interest rates were of record historical proportions.
The fact that many of these same governments sooner or later were bullied by the conservative political lobbies in their nations into withdrawing or modifying the stimulus packages, which then undermined the emerging recoveries they had earlier created doesn’t alter the point. The global financial crisis clearly demonstrated that the claims by neo-liberal macroeconomists that the ‘business cycle was dead’ were far-fetched. In turn, the success of the fiscal interventions also demonstrated that the claims by these economists that fiscal policy was not an effective way to alter spending and would only increase inflation were also grossly amiss and reflected their ideological preference for small government rather than any evidential knowledge. University of Chicago’s John Cochrane was representative of this school of thought when he said “Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both” (Cochrane, 2009). Hand in hand with that myth was their other claim that interest rate management (monetary policy) was a sufficient policy tool to control inflation (and output variations). One of the problems in the early recovery stage was that governments all around the world, infested with this nonsense from the economists, relied on monetary policy too much and didn’t give fiscal policy enough scope. While the central banks were able to prevent a collapse of the banking system by providing billions of dollars (or equivalents) in liquidity, the near zero interest rates that have been in place since the crisis began have not been sources of significant stimulus. The rapid retreat from fiscal stimulus is exemplified by the UK policy response. They were on the road to recovery courtesy of their fiscal stimulus package until the Cameron government took office in May 2010 and set about pushing Britain down the austerity path. The British economy then laboured under continuous recession until modest growth returned in the first-quarter of 2013. Six years later, the size of the economy (measured by real GDP) is still below the peak before the crisis.
The financial crisis was a public denouncement of the mainstream economic ideas about efficient markets and for a time Keynesian ideas were in vogue again. Mark Blyth wrote that a “major reason Keynesianism now became the policy du jour was that governing neoliberal ideas denied that such a crisis was possible in the first place” (Blyth, 2013: 101). However, such was the resistance within the academy to the idea of fiscal stimulus, that governments became “Twelve-Month Keynesians” only (p.100). To understand why one must realise that the mainstream economics paradigm is more than a set of ideas. Blyth notes that these mainstream economic theories “enshrine different distributions of wealth and power and are power resources for actors whose claims to authority and income depend upon their credibility” (p.100), which explains, in part, why there was such resistance to abandoning them, even though it was clear that they were bereft of any evidential standing.
At the extreme of this ideological resistance to fiscal stimulus, were many well-known economists (such as Robert Barro, Eugene Fama and others) who advocated the so-called laissez-faire option – letting the ‘markets’ adjust with zero government intervention. This was purely ideological dogma. There was no ‘self-correcting’ market response possible. The world was plunging very quickly into a total collapse of the magnitude not seen since 1929. There was total market failure. Blinder and Zandi (2010b: 17) say that despite obvious critical questions that can be asked about any complex stimulus package, “laissez-faire was not an option”. A failure by the US government to respond in the way they did “would have left … the economy … in a far graver condition” (p.17).
There is no doubt that the recent history debunks the majority of the macroeconomics that students learn in mainstream graduate classes in economics. Fiscal policy was very effective in militating against the private spending collapse and saved the world from a Great Depression 2.0.
The European response
The euro-zone leaders went one further than laissez-faire. They put in place a policy austerity regime that guaranteed the economic collapse would be deeper and longer than otherwise. The most responsible strategy for Europe, given the severity of the crisis and the particular exposure of some European economies and banks, would have been for the European Council to immediately suspend the SGP provisions and for the ECB to announce that they would support all necessary fiscal deficit responses to the spending collapse. The former decision could have been justified under the Article 126 of the Treaty on the Functioning of the European Union (TFEU) relating to the Excessive Deficit Procedure, whereby the Council will consider whether “the excess over the reference value is only exceptional and temporary and the ratio remains close to the reference value”. It was clear that the situation was ‘exceptional’ and with appropriate policy action would have been ‘temporary’. The Council could have stretched the meaning of ‘close’ to be anything it wanted given its propensity to continue bend the rules anyway. The ECB could have immediately announced a program such as the Securities Markets Program (SMP) whereby they promised to buy up unlimited volumes of national government debt in the secondary markets. If the SMP had have been introduced in 2008 rather than 2010, things would have been much different. No Treaty change would have been required for either of these ‘ad hoc’ arrangements to be put in place. While obviously outside the ‘spirit’ of the European mindset that created the flawed EMU design, the responses would have saved the euro-zone from the worst. Those two decisions would have stopped the crisis in its tracks. There would have been minimal output and employment losses and private sector confidence would have returned soon enough. Fiscal deficits and public debt levels would have been much higher but growth would have returned relatively quickly and the responses of the private bond markets would have been irrelevant.
History tells us that the European policy makers did exactly the opposite. By 2010, the European Council had determined that 16 of the 17 euro-zone nations had ‘excessive deficits’ under the meaning given in Articles 104.6 and 126.6 of the Treaty. Only Luxembourg escaped the net. The fact that virtually the whole euro-zone economy was in default of the fiscal rules should have told the political leaders the obvious – that the rules were poorly calibrated in relation to likely scenarios. But that was not the response and millions of Europeans lost their jobs and prosperity unnecessarily because of the policy folly that ensued.
The first mistake the European policy makers made was to quickly fall into ideological mode and claim that the crisis was the result of excessive government spending. In the early days of the collapse, the news media was full of stories of lazy Greeks and a lax government running up huge spending bills they could not afford. This was meant to be an explanation for the problems that sovereign debt markets were encountering as private bond investors realised that because the euro-zone nations do not issue their own currency they are at risk of insolvency. The real cause of the crisis – the spiralling and unsustainable private debt build-up and the exposure of the European banks to that debt – was pushed quietly to the background by the Troika and only occupied minds when the Troika sought to ensure the big French and German banks would not fail and that the Spanish, Irish and Greek taxpayers would pay the bills to make that happen. The fact that these ‘bailout loans’ were added to the outstanding sovereign debt of these nations only exacerbated the situation. Further, there was no evidence that government spending among the Member States was in any way ‘out of control’. Greek, alone was running larger deficits than most. But Spain and Ireland were exemplars of fiscal prudence as defined by the nonsensical SGP rules.
Yet it was in the ideological interests of the neo-liberals to deny and blur the reality so that they could reconstruct the private debt crisis in Europe (and elsewhere) as a public debt crisis, which had its roots in out of control government spending. The solution then was obvious – the need for fiscal austerity. The SGP rules then gave these zealots the cover needed to impose the austerity. All the aggregates that really matter like GDP and employment growth and unemployment were considered expendable. There was a mindless zeroing in on the SGP rules and financial numbers, with the understanding of what was driving the rising deficits and debt ratios ignored. As Mark Blyth noted “treating it as a crisis brought about by debt-fueled consumption and profligate state spending is to confuse correlation (they happened at the same time) with causation (out-of-control spending caused the crisis)” (Blyth, 2013: 97).
[THIS CHAPTER WILL CONSIDER THE FISCAL COMPACT AND OTHER POLICY RESPONSES - IT DOES NOT INTEND TO BE A FULL HISTORY OF THE CRISIS IN EUROPE - JUST SET THE POLICY FAILURE IN THE CURRENT CONTEXT]
Additional references
This list will be progressively compiled.
Australian Treasury (2009) ‘The Return of Fiscal Policy’, Presentation to the Australian Business Economists Annual Forecasting Conference, Sydney, December 8, 2009. http://www.treasury.gov.au/documents/1686/HTML/docshell.asp?URL=Australian_Business_Economists_Annual_Forecasting_Conf_2009.htm
Barber, L. and Barber, T. (2008) ‘Barroso warns on protectionist pressures’, Financial Times, March 2, 2008. http://www.ft.com/intl/cms/s/0/3ab2bf90-e8a1-11dc-913a-0000779fd2ac.html
Blinder, A. and Zandi, M. (2010a) ‘How the Great Recession Was Brought to an End’, July 27, 2010. https://www.economy.com/mark-zandi/documents/End-of-Great-Recession.pdf
Blinder, A. and Zandi, M. (2010b) ‘Stimulus Worked’, Finance and Development, December, 14-17. http://www.imf.org/external/pubs/ft/fandd/2010/12/pdf/Blinder.pdf
Blyth, M. (2013) Austerity: The History of a Dangerous Idea, New York, Oxford University Press.
Cassidy, J. (2013) ‘Why is Europe so messed up? An illuminating history’, The New Yorker, May 20, 2013. http://www.newyorker.com/online/blogs/johncassidy/2013/05/austerity-an-irreverent-and-timely-history.html
Cochrane, J. (2009) ‘Fiscal Stimulus, Fiscal Inflation, or Fiscal Fallacies?’, mimeo, February 27, 2009. http://faculty.chicagobooth.edu/john.cochrane/research/papers/fiscal2.htm
Congressional Budget Office (2011) ‘Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic Output from October 2010 Through December 2010′, Washington, D.C., February. http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/120xx/doc12074/02-23-arra.pdf
European Commission (2008) ‘Autumn economic forecast 2008-2010′, IP/08/1617, Brussels, November 3, 2008. http://europa.eu/rapid/press-release_IP-08-1617_en.pdf
Federal Reserve Bank (2007a) ‘Press Release’, August 7, 2007. http://www.federalreserve.gov/newsevents/press/monetary/20070807a.htm
Federal Reserve Bank (2007b) ‘Press Release’, August 10, 2007. http://www.federalreserve.gov/newsevents/press/monetary/20070810a.htm
Federal Reserve Bank (2007c) ‘Press Release’, August 17, 2007.
http://www.federalreserve.gov/newsevents/press/monetary/20070817b.htm
Feyrer, J. and Sacerdote, B. (2011) ‘Did the Stimulus Stimulate? Real Time Estimates of the Effects of the American Recovery and Reinvestment Act’, Working Paper 16759, National Bureau of Economic Research.
UNCTAD (2010) ‘Trade and Development Report, 2010, United Nations Conference on Trade and Development, New York. http://unctad.org/en/Docs/tdr2010_en.pdf
(c) Copyright 2014 Bill Mitchell. All Rights Reserved.