Tuesday, 3 September 2013

France and the Commission

The platform I use for this blog gives my ‘pageviews by country’. One surprise is that, using this criteria, the country which comes third in the list, after the US and UK respectively, is France. (Over the last month, for example, about 12,000 pageviews compared to about 36,000 in the UK and around double that in the US, with a whole group of countries below France at around 5,000.) This is really nice, particularly as I have only once written a post specifically about France, over a year and a half ago.

So a recent post by Ronald Janssen in the Social Europe Journal allows me to make up for that. First some background if you do not live there. France is subject to the Fiscal Compact’s 3% budget deficit target like everyone else in the Eurozone.  European Commissioner Olli Rehn is the chief enforcer of these rules. In May the Commission granted France, along with a few other countries, 2 years grace before they needed to achieve that target. The Netherlands was given only one year, with consequences I talked about most recently here.

The chart below shows OECD numbers and forecasts for various fiscal measures in France. The financial balance relates to the 3% target. The underlying balance essentially cyclically adjusts this. As you can see, the key reason that France is not meeting the 3% target is depressed output. The OECD estimates the output gap in 2013 will be nearly -4%, rising in magnitude to -4.5% in 2014. The underlying primary balance is the best indicator of what government policy is doing: fiscal policy has been tightening ever since a sharp expansion following the 2008/9 recession.

  

So far, so typical of the Eurozone and elsewhere. However what makes France relatively unusual is the pattern of this tightening. As the IMF clearly showed in analysis I discussed here, it has achieved this fiscal contraction entirely through tax increases rather than spending cuts. The first best thing to do, of course, is to delay fiscal tightening until the output gap has closed. The Eurozone’s fiscal rules will not allow that, and instead in the current context encourage pro-cyclical fiscal policy. I have never met a macroeconomist who advocated pro-cyclical fiscal policy, but of course those behind the Fiscal Compact know best.

If you have to follow the Fiscal Compact, then I have always argued from the point of view of doing least damage to the economy in a recession any temporary fiscal tightening should focus more on tax increases than spending cuts. You might, for example, try to meet the Fiscal Compact rules in the short term through temporary tax hikes, and follow with more permanent spending cuts and/or tax increases once the economy recovers. To a first approximation that appears to be what the left wing government in France is trying to do (most notoriously by temporary increases in the top tax rate).

My argument has always been based on straightforward macroeconomic theory, but as Ronald Janssen points out in his post, this is fully supported by recent IMF empirical work. It is therefore entirely predictable that European Commissioner Olli Rehn should take completely the opposite point of view. He is quoted as saying that new taxes would “destroy growth and handicap the creation of jobs." “Budgetary discipline must come from a reduction in public spending and not from new taxes,” he added.

Now I'm not sure whether that counts as advice or instruction: within the Eurozone it is increasingly difficult to tell. I suppose you could argue that Rehn’s concern is more about the longer term size of the French state, and that his obvious belief that the French state is too big comes purely from worries about the implications for macroeconomic performance. But what struck me was simply this. In the election of April 2012 the French people elected a left wing government that had a clear platform of achieving fiscal consolidation partly through tax increases. Even if the Commissioner thinks that is a foolish thing to do, that is their choice.

It is one thing to have a set of fiscal rules that focus on overall budget deficits: however misguided those rules may be, the French government did agree to them. What I do not think any Eurozone government signed up to was having the Commission tell them what the size of their own state should be. With these remarks, together with its insistence that various Eurozone countries undertake certain ‘reforms’, the Commission appears to be doing its best to create a de facto fiscal union. The only problem, of course, is that the French did not elect Olli Rehn.


  

32 comments:

  1. Anonymous public servant3 September 2013 04:52

    "I have never met a macroeconomist who advocated pro-cyclical fiscal policy, but of course those behind the Fiscal Compact know best."

    I don't think any macroeconomist at the Commission argues for pro-cyclical fiscal policy. I just know that they have to deal with the political equilibrium obtained by european heads of state on fiscal consolidation, and try to make it work as smoothly as possible.

    Olli Rehn's outburst agains tax hikes must come from his own cabinet, not from his administration, which I know to be much more balanced.

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  2. Krugman blogs March 1, 2013 'Disastrous Predictions and Predictable Disasters', February 24, 2013 'Euro Delusions', and Very Sensitive People April 22, 2013 continues the criticisms of Rehn.



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  3. The issue is much more complicated also on highly relevant points.

    1. The Dutch have the idea that they have to set an example for the South. Bit moronic imho but nevertheless. Probably if they had gone for that the Commission would have given them another year. Which as things look now seem necessary anyway.

    2. The main issue at the moment in France is being uncompetitive internationally. Structural high tradedeficit. And as a consequence the 'relation' with financial markets is uncertain.
    On fundamentals a lot of people think (and not the least) that at one point the bottom will fall out. Eg GS has been going short until a few months ago.
    Whatever the French have been doing is applying the 'rob the pensionfund strategy'. And the 'prop up via the banks' strategy aka the 'Sarko-trade'. Basically banks are more and more overexposed to French debt and repo that with the ECB.
    Markets seem to accept that probably (my guess) because they assume that the EZ will never drop France. At the moment at least. However markets are highly unstable at the moment especially for dubious cases like France or EMs or high yield. It therefor can change any time. basically one 'wrong' German election and the plug is pulled out. Anyway markets are pulling the plug at the moment out of all countries with substantial tradedeficits (Turkey, India, Indonesia, Brasil). Simply a risky enviroment.

    From there the risk (not a certainty clearly) that things will go wrong on the debt front is simply much larger than filling up any outputgap. If it goes wrong and will go wrong badly. Plus it could start to play any moment.
    The housing sector is a huge bubble almost (the bubble) half of the annual GDP. If that one bursts, (by higher interest rates, basically low interest keeps it from falling apart at the moment) the economy is a goner.

    France need structural reforms (costs must go down) to be internationally competitive, more innovation longer term. They have eaten the financial room they had in that respect and are now in an area that might suddenly turn into a warzone.

    Taxation might work best from a Macro pov. However from a political platform pov it doesnot. In France like in Holland (and the UK) you have wages that are not rising in real term even are decreasing. Next to that government services are cut (mainly because of againg) or at least you have a discussion on that. It simply kills all support for a government if you rise taxes and cut services as is happening in Holland and France with little result to show. So in order to keep political support one has to operate very carefully.
    Anyway with no rising incomes hard to see where a reversal should come from when spendable income effectively is cut (and Consumers are 70% of gdp). And the business sector mainly starting from there (no consumers no new investments).
    Next to that 70% go 70% from pay check to pay check so there will not be much difference anyway with half the 'not tax increase' spend directly anyway.

    Another point is that in France the taxrises were done for the homecrowd and not in anyway with optimalisation of Macro positions in mind. The famous 75% probably cost more than it brought on revenue, but was still done for effectively populistic reasons.
    It only made France look like a new Argentina for alot of foreuign investors. Simply overall a very negative measure.
    Policies are simply mainly taken for political reasons. And the main one in France at the moment is kicking more structural reforms as far as possible ahead.
    Not that Oli takes the above in his considerations anyway.

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    1. "1. The Dutch have the idea that they have to set an example for the South. Bit moronic imho but nevertheless. Probably if they had gone for that the Commission would have given them another year. Which as things look now seem necessary anyway."

      dont you mean the dutch aristocracy has to set an example by punishing their own citizens, other than , of course, themselves

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  4. Another point.
    France is not similar to Holland imho on essentials.

    Holland looks to be able to stand on its own 2 feet. It has a basically viable economy even if the EZ would fall apart (would very likely team up with Germany anyway). Its RE bubble looks to be nearly empty (according to local specialists, I am a bit more of the see first.. category). Economy is a bit of a mess but not a real debtor risk (and without printing being necessary).

    France however is not it is within the present EZ structurally uncompetitive, looks borderline debt risk and is effectively kept alive because of ECB guarantees and the fact that Germany, in the market conception at least, is seen as backstopping France at the end of the day. Has a RE bubble that has been growing.
    EZ split would possibly see France split from Germany (and its guarantees). A break up of the EZ would not safe France in this respect. Well unlikely it would do that at least. With Germany in it, it would still be uncompetitive and without Germany it would be on its own (with debt problems likely exchanged for interestrate problems (that would make the RE bubble burst)). And ECB guarantees only work as long as Germany backs them up. If France would start printing rates will as said go up.

    You cannot prescribe the same medicine for different cases.

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  5. A last point.
    On the democracy issue.
    Fully agree that Hollande has a platform for go as it is and finance it if there is a too high deficit by tax increases.
    Like there is no platform for cuts in Holland and and certainly not for cuts in the form of tax increases.
    And effectively in the whole South there is a very similar situation as in France.

    However the populations in basically all countries donot seem to be willing to take the consequences of their choices. Businesssector moving out and going bust.
    In the South the only platform there is is that EU rules should be broken unilaterally and germany should pay the bill.
    However the latter is not for Italians and Greeks to decide (only).

    This is the problem in the EZ. Nobody wants to pay the bill. A lot of people are for cuts but with other people's entitlements or paid for by rises from other people's taxes.
    You unlikely find a solution this way and at best
    the crisis is needlessly extended.
    Next to the fact that a large black economy plus unwillingless with especially the local rich to pay high taxes at the end of the day make the present welfarestate model there unsustainable (unaffordable).

    Similar with France it will have to make decisions and it doesnot. And its politicians are not really properly informing them what is at stake. Hollande is elected on a platform that thinks can go on as is. While whatever Macro model you take it is clear that that is very unlikely. Imho is in that respect an even greater populist than LePen.

    So yes it is a democratic decision, but one thing is missing which is that the French take the responsibility of that collective decision as well. So in other words if they want to go for a suicide solution, fine but take care that the corps is taken care off and not is left rotting in front of a German door.

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    1. Goodness, Rik -- long posts! Unfortunately, also misguided. Let's separate two issues: economics and politics. On the economics, there's no justification for austerity in the EZ outside of Greece, and certainly no justification for austerity as the sole solution to what is essentially a balance-of-payments crisis in a highly suboptimal currency union. Your claim that the French "business sector" is "moving out" or "going bust" as a consequence of a bloated public sector is simply false -- the evidence is clear and widely available, and I won't review it here. On politics: the Commission and other organs are direclty accountable to no voting public. In the absence of public accountability, those organs respond to pressures of other sorts: ideological, powerful private interests, etc.. In the present case, they've imposed policies contrary to the interests of voting publics across the zone with nary an organized counterweight outside of extemist parties. I needn't remind you how very dangerous this is.

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    2. Not agree.
      Markets simply show that at least Italy, Spain, Portugal , Cyprus and probably a few others are not able to stand financially on thier own feet. Without back up by ECB and at the end Germany they would be toast.
      Thsi back up is not a given. Therefor immediate action is the low risk alternative.
      Another point probably as important is that the welfarestate or better the financing thereof in these countries is not sustainable. It has simply be finaced by deficits and oversea (largely borrowing). Plus on growth that in itself was unsustainable (also based on overborrowing). And what is worse markets know this. You put the German guarantees off and the next moment the y run against the wall.

      Clearly a reason why people not accepting austerity and the EU going for it. But that people donot accept it doesnot make it more acceptable for markets.

      It is pretty simple Italy and Co have a direct market problem (short term solved by implicit German guarantees (they make the ECB credible, the ECB is toast without Germany). And they are politically not able to sell the reforms to the voters at home. Which puts the whole thing under a lot of pressure, with a very uncertain outcome.
      You simply mess ht ewords pubblic interest and public opinion up. Clearly the people (public opinion) is anti austerity. But going the way they go now or go even for a stimulus is a very high risk move. I would not want to take, but even if it could be discussed it is in no way unquestionably in the public interest as you seem to suggest.
      Stimulus is basically what they have done the last decde or so in overall a much better economic climate and which did not work.

      France to get back to the topic is bit further away from disaster. But also there we are talking a few % of GDP while if the system collapses partially (as in Italy and Spain now) the downside is huge both politcally and economically. And if the bottom falls out the consequences are disastrous.

      Carindustry (holding the industry alive with Bns of indirect subsidies is hardly better); steelmakers; shipyards; 300K immigrants (usually high income) to the UK. I donot know what you call evidence.

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    3. Rik,

      I read your arguments, and it reminds me of Bizarro-world from Superman comics where everything was backwards.

      "This is the problem in the EZ. Nobody wants to pay the bill."

      You take a discussion of how the French are BALANCING THEIR BUDGET and describe it as them not being willing to pay the bill. Don't you think that's a bit odd?

      "Markets simply show that at least Italy, Spain, Portugal , Cyprus and probably a few others are not able to stand financially on thier own feet. Without backup by ECB"

      But the ECB control of their control is why they can't stand on their own feet! Moderate inflation to whittle away a bit of their debt is historically how govts get out of this mess - surely that's the main lesson we get from reading R&R's "This time is different"? And so where the ECB is causing them this pain, you then describe that as "not able to stand on their own feet without backup by the ECB". Isn't that bit odd?

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    4. An egregious typo on my part. Sorry. I meant:

      "But the ECB control of their currency..."

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  6. The reason we have a pro cyclical policy in the eurozone is precisely because the policymakers are not democratically accountable (and yes that does include the Council of Ministers).

    We have a pre modern economic policy because we have a pre modern oligarchy. Lacking the ability to flush failed policymakers away at election time means that groupthink trumps rational macroeconomics every time. Twas ever thus in oligarchies.

    Across the eurozone national constitutions have even been changed in order to enshrine pro cyclical economics. Budgets are no longer susceptible to public opinion (or to the opinions of informed economists)because they are instead subject to the repressive prescriptions of treaty deficit and inflation targets. Fundamental economic policy has been removed from the democratic political arena entirely. If they want to restore some semblance of sanity to their domestic economic management 17 nations now have to break solemn treaties and repeal their constitutions!

    The further from accountability our leadership has travelled the more insane they have become. Twas ever thus with oligarchies......



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  7. One should add that Hollande was not only elected as someone who had an idea where the other candidate had none. Sarkozy was firmly on pro-Merkel - to the point that the term "Merkozy" was coined - and "pro-business" course, whatever that means. So it's not as if Rehn's perspectuve had not been up to election.

    And this was 3-4 years into the crisis, and nothing major happened since them in one way or the other. I.e. Hollande would have a difficult time to say "Well, for no obvious reason I'll do a 180° turn on our policies and do what hasn't worked before, but what you voted against, because THAT'S WHY." What is Rehn thinking?

    Seriously, when this whole thing is over somewhere after the first term of Marine le Pen, and the EU has not gone broke until then, we have to find a way to elect those clowns. The whole EU show being held alive by the garbage national political theater has dumped is going on for way too long now.

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  8. Rik, "competitiveness" matters very little to the French economy, if you look at the data you'll see that all indicators of competitiveness point to France being firmly in the EU average (unlike say Spain), you'll see that the trade deficits are small (as a percentage of GDP, about minus 2 percent, same as the UK), etc. Why not focus on what really matters? Unemployment, long-term unemployment, youth unemployment...

    (and no, they have nothing to do with competitiveness)

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    1. I am not sure which data you use. But I look at data that are normally used. In those indicate that eg your labourcosts are considerably higher than those of Germany.
      Which is probably the reason for some of the other problems unemployment in general terms for instance.

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    2. Rik, I am not sure which data you use. I looked at the OECD data and double checked in the ECB stats.

      For instance, here:

      http://www.oecd-ilibrary.org/economics/data/main-economic-indicators_mei-data-en

      http://www.oecd-ilibrary.org/docserver/download/3012021ec017.pdf

      you can see that France is roughly where other EU countries are.

      Now you write "considerably higher than Germany." There are two problems with this statement: 1. what do you mean by "considerably" and 2. why do you compare France to Germany.

      Germany is very special, it is in fact the main reason why Europe is in such a mess: no bubbles and a 20% fall in unit labour costs over the last 15 years. Now if you use Germany as Ze Benchmark, then every non-German country in the world can be said to suffer from lack of competitiveness. But if instead you look at other important trading partners, including the UK, the US, Spain, Italy, then France does not suffer from any competitiveness problem.

      http://www.ecb.europa.eu/stats/exchange/hci/html/hci_ulct_2013-01.en.html

      Besides, even if it did, say if it had unit labour costs as high as the Netherlands or Italy, it wouldn't even matter all that much in the grand scheme of things.

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    3. and sure enough Paul Krugman has finally read my comment here!

      http://krugman.blogs.nytimes.com/2013/11/09/more-notes-on-france-bashing/

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    4. And PK doubles down:

      24 Mar 24 2014

      French Wages Are Not The Problem

      In yesterday’s Times, Steven Rattner grudgingly admits that expansionary monetary policy in Europe may be a good thing, but bemoans the lack of adjustment, and gives us this chart:

      So France, like Italy though not quite to the same extent, has a problem of unsustainable growth in labor costs. Right?

      No, no, no.

      The way Rattner presents this, you’d think that falling unit labor costs are always a good thing. But that’s not at all true. In general, we want a small amount of inflation in modern economies, both to ease adjustment and to help avoid the zero lower bound; the Fed’s target is 2 percent, the ECB’s target is “close to but below” 2, and there’s a strong case that both targets should be higher. And if overall prices are rising 2 or 3 percent a year, unit labor costs should be rising at roughly the same rate. We certainly don’t want falling labor costs as the norm.

      So how do major European economies stack up against what should be happening? Like this:
      European Commission

      So, has the euro area as a whole had excessive labor cost growth? No — inflation has if anything been too low. Has France had excessive labor cost growth? No — it has grown only at the overall euro rate.

      Yes, Italian costs have risen too much, mainly because of terrible productivity performance. But the other country that’s way out of line isn’t France — it’s Germany, whose costs have risen much too little.

      French labor costs are not a problem; German labor costs are. And it’s depressing, in at least two senses, that so many people don’t get that.

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  9. Rik3 September 2013 08:34

    "Holland looks to be able to stand on its own 2 feet. It has a basically viable economy even if the EZ would fall apart (would very likely team up with Germany anyway). Its RE bubble looks to be nearly empty (according to local specialists, I am a bit more of the see first.. category). Economy is a bit of a mess but not a real debtor risk (and without printing being necessary)."

    It's painful to read that kind of nonesense. France would highly benefit from stepping out of EZ because they would be able to devaluate which is what they used to do which make it cost competitive again. EZ has put every country in a German style framework, while most weren't fit for that(and no, it's not the only possible or even dominant model) and that's the real criminally stupid part. Euro countries outside the EZ have done relatively better because they still manage their currency.

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    1. You are completely missing the point which is that France at present is within the EZ framework and has to go with the rules that go with that framework. Fine (and probably right that it would function better outside the EZ), but that is not how the facts are. You are part of the EZ.
      So we simply have an uncompetitive France.

      Same with if the market is right or not. The fact is that important marketplayers do not have confidence in France and that very likely it is held upright by its banks doubling down and the implicit/supposed German guarantees. This simply means you (obviously French) have a huge credit risk problem. Banks cannot go on for ever and the situation doesnot point in any way into the direction of a structural solution as well. A courtruling in Germany or a unfavourable election there would spoil the other pillar of dubious stability.
      If you are seen as a credit risk you have one (from the debtor side) it is as simple as that.

      So summarised you are uncompetitive and have a credit problem.

      Problem being as well re the EZ it will be a dangerous road stepping out of the EZ. You will almost certain face a considerable devaluation and a considerable increase in interest rates (which will likely kick the bottom out of your RRE market plus make the gov deficit structurally already too high even higher (because of higher borrowing costs).
      The structural policies of kicking the can as far as possible also show that the country doesnot have the stomach to step out of the EZ and face the consequences thereof.

      Your RE market is highly overpriced even at todays data (and compared to similar EU countries with similar characteristics). If you are having to make adjustments to become more competitive it even will get worse. If you have experts that say otherwise I would suggest you take other experts.

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    2. OK, so let's say every country inside the EZ (except perhaps Germany) will do as you suggest: play by the rules; hence increase their competitiveness. That basically means exporting at a lower price and cut spending. Let's also assume every country inside the EZ will thus try to lower their import relative to exports. Yet most of the trade is done between countries inside the EZ. How is the situation better after that?

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    3. Competitiveness is global not regional. It doesnot matter of you sell your stuff to the white cat or to the black cat, as long as you sell it.
      By nature it is of course impossible that EZ combined has a trade surplus with the EZ. That is a zero game.
      Most countries in the South should therefor try to sell their stuff on the world market that has by far the highest chance of success.

      However as they are not competitive and not only pricewise that will be a problem. They have not really local companies that could pull off that trick (be it in EZ/EU or outside).
      It is not only a labourprice issue.
      Look at Greek vs Germany. Latest Greek exports dropped much more than the other way around. Simply because Greece and several others have totally missed the competition from especially the East. And there will be very few new investments as other (non wage) costs have hardly dropped. As a consequence thereof Greece is still way too expensive and investors interested in Europe on the cheap go for Rumenia, Bulgaria, Turkey and alike, but not for Greece.
      It clearly shows that the North is not really interested in alot of the things the South makes. So also from that angle they have to look outside. And that is likely a problem as said as they miss in general the stuff to make that a success. Products are too expensive, quality is dubious often and the international salesforce is crap.

      It is a matter of degree of course. But it is hard to see unless the German taxpayer fills the (black-) hole that countries like Greece and Portugal will go deep South. Italy has the products but the organisations to make it a success internationally are often crap. If they succeed in that (which I donot see them doing) they might have a chance. Spain has nothing it will be a story of 'close in Spain open in Rumenia or Slovakia', so simply looks a goner. France has the basics but should reduce productioncosts in the widest sense and innovate more. Also a big if (but with potential if they wake up at least).
      Alternative is leave the Euro (and the EU as these 2 are linked legally and you will not get 28 countries to agree on a treaty change on very short notice (which would be necessary). Which as you can imagine would create another, maybe even bigger, mess.

      Looks like the time for unconvenient choices is not that far away anymore for most of the South. And for the North as well only in another way. Either pay permanently for huge transfers or it might be that a lot of (then ex)EZ countries might find you less sympathetic. Hard decisions and Europeans however not go well together. Most likely donot know how to write it.

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  10. Olli Rehn and the economic rules that the European Union enforces on the member states epitomizes how the union has caused the end of democracy in Europe.
    In Holland the economy is suffering because of the 3% rule. If we had a real democracy we would have been able to vote on having a larger deficit.

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    1. Do you really think the present situation in that respect is sustainable?
      As I see it it is one big Catch 22.

      On one side you have no platform in eg your country for mutual liability within the EZ. Which leads to Maastricht and similar 3% rules. To try to avoid one country bringing others in problems. As that is the idea behind it.
      Combined by no effective means to enforce them. Olli didnot have much choice there in the South really but granting permission. He simply was adjusting the rules to the facts on the ground. Nothing to do with enforcement.

      From the other side you get basically creditworthy (also structurally unlike France and possibly Belgium) countries like yours having to go with rules (the 3%) that have no platform in the current situation as well.

      Summarised over left or over right the present set up has no platform and definitely no stable platform. Which it should have had (at least one of those) in order to make it work in a more structural way.

      Looking at your polls the Euro-sceptic parties (in degree) are at around 50% of the vote now and (rapidly) rising.
      There is simply a huge political electoral problem. Similar or even bigger than in the UK with UKip and In-Out referenda.
      The traditional parties simply missed that you can push things through people's throat only when they:
      -forgot it at next election time;
      -see it basically as irrelevant;
      -there is no political competition.

      Well, this doesnot tick any of these boxes. The problem will be there next election (at least the consequences thereof). People really en masse base the decision for whom to vote on it. And you have Eurosceptic parties in your parliament in all sorts and measures.
      I would say the present governing parties have a big problem at hand (which the polls confirm).

      There is clearly a democratic deficit in this. But as the facts are now it only defers the democratic outcome. And likely messes things up in that process. As things are horribly managed politically (as I see it) you could face all sorts of surprises in the process. A lot of those hardly to look forward to.

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  11. Thanks for your insights. However, I would like more on your views explaining what is behind the EU's love of austerity. And what is the connection behind these austerity policies and "attempts to create a de-facto fiscal union"? Perhaps this is a reflection of German preferences and dominance in the EU? Germany, however, probably feels little need for lessons from Anglo-saxon countries. For a start, its development (as did Japan's interestingly) followed the theories of Friedrich List, rather than anything coming out of Cambridge, MIT or Chicago. I think a few people should first of all find out exactly what the German concerns are first, and then respond to their arguments in kind. There has been a lot of "because a model says so".

    I suspect many countries the policy position towards France and Holland and others reflects a desire to deal with fundamental problems in the periphery. Some of this is already hinted at in the comments here: the real problems are structural and relate to strongly inbuilt terms of trade problems which are not going to be solved through massive fiscal disbursement, or helicopter drops in particular. I think there is some concern that large amounts of credit provision will actually make the problem causing distortions worse. If macro stimulus is part of the answer it is going to also have to be considered in context with the fundamental structural problems in peripheral countries. In the pre-Euro era peripheral EU countries "solved" their problems with devaluation - however of course that did not really solve anything at all - they remained peripheral and relatively backward economies. (Which is why optimal currency area talk is also largely irrelevant.) Personally I think the austerity policies are wrong and are having tragic consequences, but a persuasive and succinct analysis that reconciles cyclical and structural issues is the key is the way to persuade German public opinion and German policy makers that macro-economic stimulus can achieve its aims without a return to the bad old days.

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  12. It is easy to blame politicians and bureaucrats for the Eurozone mess. but the way the EU has developed I would suggest has certain similarities to the way ideas like NK macro have as well.

    Each starts with an original idea (e.g. Lucas Critique, peace and cooperation and industrial integration) that seeks to be a complete break from a past that was believed to be completely broken and failing (e.g. Keynesian economics, the nation state) but isn't as broken as many think. Often this idea is idealistic in nature (e.g. microfoundations, free trade and movement) but is flawed in practice. So successive modifications are bolted on make it stronger (e.g. sticky prices, single market and currency) but without reversing any of the original underlying principles of its foundation. Each modification is designed to protect the idea from its critics, not necessarily to make it better performing. Those modifications that are designed to correct policy failure of previous modifications and improve performance are only allowed on the condition that they do not counteract or require the dismantling of those previous modifications. So the idea gets bigger and bigger, but never smaller and more efficient.

    Then when the idea becomes too big and too dominant, it becomes too big to fail. Too many intelligent people have too much time and effort invested in the project to allow it to fail, or for them to be seen to have failed. Call it group-think or the network effect or the critical mass effect, but it means that over time, while the model becomes more and more sub-optimal, the energy required to overturn it becomes ever greater as well. So no-one dares to try.

    Any of this sound familiar?

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  13. There are, and always will be, countries that follow unsustainable policies. And you can get away with it for decades, just look at Japan.
    The only difference in the case of France is that some creditor nations in the EU have been so stupid to share their currency with France.
    If Japan eventually fails, Japanese people will pay the price.
    If France eventually fails, the burden will be shared with the creditor nations in the EU.
    So maybe it was not such a stupid idea after all of France to propose the euro.

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    1. You predict that France will fail...when, exactly? We could be talking about multiple decades, perhaps a century, from now? Are you sure you want to go way out on a limb with such a high-risk prediction?

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    2. Bear in mind that France has not failed since longer than, say, Germany...

      (last sovereign default in Germany is 1948, France 1812)

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    3. I'll add that France represents roughly 15% of the EU GDP, Germany 18%, which is not that different really.
      If France were to leave the eurozone, the impact would not be negligible on the german economy, which is probably the main reason for the continuous support from ECB to french indebted banks today. If France were to get its own currency again, it would certainly be devaluated, which would probably help a lot in competing with Germany, as the industrial hourly work cost is actually less in France than in Germany.

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    4. About France failling: first it remains to be seen, France still gets among the best rates, I'd easily bet on France rather than on those small virtuous countries that looks good for some time and all the sudden get flipped by events.

      If France happened to failed, all neighboring countries including the mighty Germany would pummel with, in the EZ or not. People don't realize that Germany gets most of its surplus inside UE but is still heavily in deficit with, say, China. And of course same would happen if UK, Italy... were to fail.

      As for leaving EZ, it might have been a good idea for France not to get in but now it's in it would be difficult.

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  14. That Olli Rehn is a neoliberal "Betonkopf" should not be news to anyone. All his past statements go in that direction.

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