The Daily Update - Europe - Stiglitz

We have argued before that putting creditor and debtor nations into a euro style currency union without fiscal union makes little sense.  Interestingly, this view was echoed by the Nobel laureate economist Joseph E. Stiglitz in his new book ‘The Euro: How a Common Currency Threatens the Future of Europe.’  In his opinion the euro is the key factor behind the poor performance of the Eurozone economies since 2008.  Stiglitz’s views attract interest given that he had held an advisory role to President Bill Clinton in the 1990s and then was the chief economist at the World Bank at the time its sister institution, the IMF, imposed policies that often inflicted recessions and depressions: an arguable failure, but with uncanny similarities to policies used on Greece and other afflicted nations in Europe.

For Stiglitz the current euro structure is ill-conceived, lacking the appropriate institutions to allow it to function effectively.  The current structure tying all 19 members to one exchange rate, the ECB targeting inflation, set against strict ‘convergence criteria’ and trigger levels for budget adjustment (3% budget deficit and debt to GDP of 60%) left austerity and structural reform as the main adjustment levers in a downturn.  The global financial crisis of 2008 provided such an asymmetric shock exposing this weakness. Fiscal policy, an important economic stabiliser, is underutilised under the current structure. Instead of bringing Europe closer together by promoting growth, employment and stability the current structure has allowed imbalances and inequality to build and set creditors against debtors given austerity policies led to economic contraction and the need for debt restructuring.

Stiglitz is critical of policy responses being overly focused on austerity and at times ill-considered structural reforms which compounded the downturn.  In his view for the euro to be more workable it requires a more effective fiscal redistribution mechanism and a banking union with deposit insurance. He favours the removal of limits on government deficits to enable a ‘smoothing’ over the economic cycle.  It must do more to encourage growth, employment and stability to deliver prosperity to more of its members if it is to thrive.  He also discusses other less palatable options too: the amicable divorce and a two speed euro. These issues are becoming increasingly pressing as growth continues to languish amidst growing support for populist politics, even in core euro countries such as Italy and France.

To be fair Europe has already recognised the need for change to deliver a ‘deeper and fairer’ monetary union in the 2015 Five Presidents’ Report: This calls for a European Deposit Insurance Scheme and a Single Resolution Mechanism and Fund, building on Single Bank Supervision.  For monetary union to be effective there needs to be greater fiscal union: the report advocates a future euro area treasury and the use of a common macroeconomic stabilisation fund so shocks can be better managed.  To achieve greater fiscal unity will require greater aggregation of budgets on a European wide basis: we note the MacDougall Report of 1977 suggested 2-2.5% of GDP on a pre-Federal Europe basis and 5-7% in a later stage moving to 25% if the EU were to become a full federal union like the US. Currently, the EU budget equates to ~1% of GDP so much has still to be done on this front.  By way of comparison, Krugman’s blog of 2012 noted how in response to the 2008 recession the particularly afflicted state ‘Florida received what amounted to an annual transfer from Washington of $31bn plus, or more than 4% of state GDP.  That’s a transfer not a loan.  Aid on this scale is inconceivable in Europe as currently constituted.’ The Greek crisis highlighted Germany’s view that Europe is not a ‘transfer union’ and a ‘weaker’ union than the US is inevitable. Other institutions, already in place, to approve national budgets and police a level of responsibility will become increasingly important for fiscal integration to deepen.

The euro has complicated the post-GFC adjustment process in Europe over and above the challenges facing much of the world: elevated debt levels, rising inequality, ageing populations, secular stagnation and an over-reliance on increasingly questioned neoliberal policies.  These structural challenges and ‘more of the same’ policies bode poorly for global growth remaining anything other than anaemic and suggest the hunt for yield trend has further to run. Credits from creditor nations with positive yields will continue to be highly sought-after.