Periodically, the European Commission puts out a new report or paper on how it is going to fix the unfixable mess that the Eurozone continues to wallow in. I say unfixable because all of the proposed reforms refuse to confront the original problem, which, at inception, the monetary union builders considered to be a desirable design feature – a lack of a federal fiscal capacity. They now know that this is the major issue but cannot bring themselves to deal with it directly. The politics won’t allow that. Everyone knows that Germany will veto such a development immediately and that would be the end of it. The latest report (May 31, 2017) – Reflection paper on the deepening of the economic and monetary union – maintains the inertness that was characteristic of previous ‘grand’ statements, such as the White paper on the future of Europe and the way forward (March 1, 2017) and the The Five Presidents’ Report: Completing Europe’s Economic and Monetary Union (June 22, 2015). So not much has happened in 2 years, despite the unemployment rate still hovering around 9.5 per cent, other than many workshops, conferences, reports, speeches, meetings in salubrious surrounds where the catering is the highlight and the conclusions moribund.



The latest Report – Reflection paper on the deepening of the economic and monetary union – adds another 40 odd pages to the already high pile of talk with little meaningful action.

The self-stated aim of the ‘reflection paper’ is to set:

… out possible ways forward for deepening and completing the Economic and Monetary Union up until 2025.

We learn there are “concrete steps that could be taken” by 2019 and “options for the following years”.

But the devil is in the non-committal nature of the words.

Within a context where the draftees claim the “single currency is one of Europe’s most significant and tangible events” – which we can agree on as long as we add the qualifier ‘disasters’ to the “significant”, the Report maintains the line that the single currency is the key to “prosperity” because it:

… more stability, more protection, and more opportunities ..

I wonder which data this crowd look at.

Which suburbs they walk around.

Which food banks they visit.

The Report is in denial of these failures.

It concludes that the “‘Monetary’ pillar of the EMU is well developed” referring to the conduct of the ECB.

But, in seeking a deeper integration, it assesses that the:

“Economic” component is lagging behind, with less integration at EU level hampering its ability to support fully the monetary policy and national economic policies. This is symptomatic of the need to strengthen political will to cement the “Union” part of the EMU. More trust is needed across the board, among Member States, between Member States and EU institutions, and with the general public.

What does that mean?

Well, according to the ‘reflection paper’:

There is not one, single answer.

To which I say, sorry, there is a single answer and that answer is beyond the cultural and political possibilities of the collective Member States.

I will come back to that at the end.

The ‘reflection paper’ is quite amazing in its continued self-praise of the policy makers and structure and performance of the Eurozone.

We read, for example, that:

1. “The architecture of the euro area is as robust as it has ever been” – which might have been supplemented by ‘prone to crisis and instability’.

2. “major new steps were also taken by the other EU institutions to strengthen the integrity of the euro area” – by which they mean the destruction of Greece and Cyprus, the increased rigidity of the Stability and Growth Pact, the turning a blind eye to Spain’s violation of the fiscal rules so it could resume growth in time for the PP to be re-elected, and more – see Chaos in Europe and the flawed monetary system.

3. “A new Investment Plan for Europe – also known as the “Juncker Plan” – was launched” – which has so far been a dismal failure and was underfunded from the start – see Hype aside – the Juncker Plan – a failure from day one.

4. Youth guarantee – see 4 years later – the European Youth Guarantee is an under-funded failure.

The proposed solutions?

The ‘reflection paper’ offers a number of suggestions for “completing the Economic and Monetary Union” to reduce the divergences that have arisen despite the claim that that the euro would ferment convergence.

Per capita income has divergent dramatically.

Unemployment disparities across regions and nations are much higher.

Investment rates are divergent and remain low in most nations.

Public infrastructure is crumbling and grossly underfunded with weak productivity growth.

So the ‘reflection paper’ proposes “further steps towards Economic Union” to create a “sustained re-convergence across countries”.

How?

The ‘reflection paper’ says that:

the euro area economies need to get on a stronger path of growth and prosperity … will benefit from — a sustained re-convergence across countries … This requires structural reforms to modernise economies …

Which at that point one concludes – progress stopped – déjà vu – whatever.

But there is more!

The ‘reflection paper’ goes on to discuss the public debt situation and how “the crisis exposed the limits of individual Member States in absorbing the impact of large shocks.”

We read that:

1. “in several countries, the limited availability of fiscal buffers and the uncertain market access to finance public debt meant that this was not enough to counter the recession” – which was a design feature. The operation of the automatic stabilisers alone (without any discretionary shift in fiscal policy) in many countries pushed their fiscal balances over the Stability and Growth Pact threshold.

The EUs response – enrol the nation in the Excess Deficit Mechanism and demand austerity. That is why the early recovery in the Eurozone, which followed the recovery of the US was quickly terminated and the monetary union plunged back into recession.

The “limited availability of fiscal buffers” was designed – it was deliberate because Germany didn’t trust its partners to run fiscal policy responsibly.

Further, the “uncertain market access to finance” occurred because the nations use a foreign currency which carries default risk and the ECB refused to publicly back the deficits of the Member States.

It claimed the Treaty prevented them from doing so, but that didn’t stop them introducing the Securities Markets Program in May 2010, which effectively funded fiscal deficits around the union and prevented the Eurozone from collapsing at that point.

The whole public debt crisis could have been prevented in 2009 if the ECB had have said it would do whatever it took to ensure fiscal spending was sufficient in Member States to ensure real GDP and employment growth returned to pre-crisis levels quickly.

That would have been the end of it.

2. “In particular, it is important to avoid ‘pro-cyclical’ fiscal policies” yet the report praises how the ” EU fiscal rules – the Stability and Growth Pact – have been reinforced over the years”.

While there is some flexibility in the allowable deficit limits, the experience of the Eurozone has been clearly to demand ‘pro-cyclical’ fiscal policy responses at a time when strong counter-cyclical responses were required for extended periods.

So in terms of the proposed “further steps towards Fiscal Union”, all we get is:

sound public finances … complementing common stabilisation tools … the combination of market discipline and of a shared rulebook …

Which even in the Groupthink speak of the European Commission doesn’t tell us much more than what is already on the table – which is not much at all.

The language or specifics have not changed since the release of the Five Presidents’ report – Completing Europe’s Economic and Monetary Union in June 2015.

Please read my blog – The five presidents of the Eurozone remain firmly in denial – for more discussion on this point.

Instead, the ‘reflection paper’ continues to extol the virtues of the “‘Six-Pack’, the ‘Two-Pack’ and the Treaty on Stability, Coordination and Governance” (the fiscal compact),

A federal riskfree asset?

They note that no such asset exists but conclude that “developing a safe asset for the euro area raises a number of complex legal, political and institutional questions”.

One word: Germany. They will never allow debt mutualisation in the Eurozone, which is the implication of a safe asset.

They also suggest that rules should be developed to prevent (or discourage) ‘home banks’ buying “home-sovereign bonds” which would break the “bank-sovereign loop”.

And, further worsen the plight of the less attractive nations in the face of the private bond markets.

A fiscal union

The only real mention of a federal fiscal capacity is the proposal to create “a macroeconomic stabilisation function for the euro area”.

This would apparently:

… not lead to permanent transfers, minimise moral hazard, and not duplicate the role of the European Stability Mechanism (ESM) as crisis management tool.

In other words, it would not be a fiscal capacity that could insulate economies within the Eurozone that face negative asymmetric shocks at all.

Fiscal policy would remain tightly constrained by the Stability and Growth Pact and its additional components (Six, Two Packs etc).

“Compliance with EU fiscal rules and the broader surveillance framework” would continue.

And what form might this take?

The “protection of public investment from economic downturn and an unemployment insurance” all of which would have to be paid back by Member States.

So no permanent net transfers.

How would this ‘federal’ function be funded?

Waffle follows. ESM or some “new instrument” based on national contributions. No currency issuing capacity to available or to be tapped into via democratically derived legislative fiat.

I noted above that I considered that there is a single answer to the problem despite the millions of words that the European Commission has published over the last several years, which duck and weave around that solution.

The single answer is that for the Eurozone to work it must become a true federation, with a European-level fiscal capacity to ensure that total spending in the Eurozone is sufficient to generate enough jobs to satisfy the desire of the workers is assessed.

The various hybrid schemes that have been proposed by economists in Europe and beyond (unemployment insurance, special blue bonds and the like) will not be sufficient.

That fiscal capacity has to be embedded within the European Parliament to give the policy regime democratic legitimacy. In other words, the European Council, European Commission would not be responsible for Eurozone-wide fiscal policy.

Further, the cult of austerity which biases fiscal policy towards fiscal surplus without regard to the economic circumstances (for example, the state of the labour market) has to be abandoned.

That austerity bias arises because there is a lack of trust among the Member States, something that has been long developed in history and will not change.

The lack of trust and a lack of collective will means that fiscal policy is reduced to being largely pro-cyclical in impact (net government spending falls at the same time as the non-government cycle is contracting) which is the anathema of responsible fiscal policy design and practice.

The ECB also would have to become an integrated part of this new federal government economic capacity, which means policies such as overt monetary financing (OMF) would have to be available. That requires a major shift in thinking and Treaty design and means that the ‘Monetary pillar’ is far from “well developed”.

This federal fiscal capacity would have to allow for the possibility and likelihood of continuous fiscal deficits separate from the automatic stabiliser component – that is full employment deficits – which would allow the non-government sector to save overall and for nations to cope with drains coming from external deficits.

All the suggestions that have been made by the European Commission to date (unemployment insurance, public investment insurance) are all predicated on fiscal neutrality – balanced fiscal positions. In other words, any stimulus in a downturn would have to be paid back in an upturn.

The problem is that a balanced fiscal position (deficit equal to zero) may not be (and is most likely not) the most appropriate long-term position for a nation seeking full employment and prosperity and in trying to impose such balance usually results in fiscal policy becoming pro-cyclical.

Conclusion

The conclusion that anyone who understands these matters would reach is that the differences between the European nations are so great that such a shift towards a true federation is highly unlikely despite the fact that the EMU could function effectively if the capacity was developed.

The other conclusion is that by failing to solve the inherent design problem either by introducing a full federal fiscal capacity or disbanding the monetary union, the European Commission is setting the Eurozone up for the next crisis.

While there is some growth now, after nearly a decade of malaise, the residual damage from the crisis remains. The private sector still has elevated levels of debt, the banking system is far from recovered (particularly in Italy), the property market is still depressed, governments have elevated levels of foreign-currency debt (euros), and the labour market remains depressed.

What that means is that when the next economic downturn comes – and economic cycles repeat – the crisis will be magnified and the mechanisms set in place as emergency measures to deal with the GFC will fail immediately.

It is only a matter of time.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.