The global financial crisis revealed the macroeconomic vulnerability of the EU. Without radical change in the way the macroeconomic policies are conceptualized, implemented and coordinated, Europe will continue to lag behind the USA and the Asian countries.
The biggest EU achievement in the field of the macroeconomic coordination and regulation is the introduction of the euro. The expectations were that the elimination of the exchange rate fluctuations and the implementation of common monetary policy will accelerate growth and facilitate economic integration in the Eurozone countries. However, the results are just the opposite of what has been anticipated. The Eurozone went through dramatic sovereign debt crisis, the economic growth declined, the unemployment increased spectacularly and the eagerness to deepen integration noticeably subsided. Since the Eurozone is at the heart of the EU, the overall economic performance of the Union deteriorated and the position of the EU in the Global Economy weakened. Great Britain even rejects the very idea of being part the EU integration project.
The main reason for this negative evolution is the inappropriate monetary policy prescribed to the ECB by the Treaty on the Functioning of the European Union and the Statute of the Bank. The ECB monetary policy has been driven by superseded neoliberal and monetarist ideas. According to the classical dichotomy and money neutrality postulate (see Lucas, 1995), monetary and real processes can be treated separately. So the central bank must be independent and focused on price stability only. In the same time, the ECB is the only big central bank that continues to use monetary aggregates and possibly intends to continue to do so (see for example Falagiarda and Sousa, 2017), as a supplementary policy instrument in accordance with the monetarists’ prescriptions.
Another theoretical underpinning of the ECB monetary policy is the so called fiscal theory of price level. According to this point of view, a strong connection exists between the government debt and the price level. As to the monetary policy, it is a kind of a game of domination between the central bank and the government. In principle, the empirical research does not confirm this point of view (see for details Daly and Smida, 2014).
Based on these deceptive assumptions, the monetary policy of the ECB has been limited just to the objective of keeping inflation down without explicit responsibility for the real sector and employment. It is believed that the EU Commission and the national governments will take care of the real sector equilibrium. In order to guarantee the central bank independence no explicit mechanism of coordination, relating fiscal and monetary policies was introduced. This is in sharp contrast with the arrangements of the Federal Reserve and the Bank of England. In the USA and the UK the central banks are supposed not only to stabilize the purchasing power of the national currency, but also to be responsible for full employment (see about the origins of the FED fullemployment mandate in Baker, Rawlins and Stein, 2017).
If the EU does not broaden the objectives of the ECB monetary policy to include the real economy, Europe will continue to lag behind its main competitors. In this respect we agree, that the efforts of the EU authorities to stabilize business cycles should be strengthened relative to the activities that have been dedicated to impose structural reforms (De Grauwe and Ji, 2016). The new European Commission initiatives, related to this problem, are articulated by Dombrovskis and Moskovici (2017). Their recently published Reflection Paper also emphasizes on the need for more growth oriented fiscal policy and stronger cyclical convergence, but does not include any change in the ECB policy objectives.
Another problem is the embedded confrontation between the bank and the countries facing problems with government debt financing. In spite of facilitating public debt funding with mechanism similar to the Fed Quantitative Easing, the ECB embarked into a kind of a “chicken game” (see about chicken games in the euro area Schimmelfenning, 2015) with the problem countries with final objective to impose hard budget constraints. The result was an upsurge of problem countries public debt interest rates and further worsening of the financial position of the indebted states. The austerity measures imposed by the ECB and the EU Commission were one of the factors that led to deep recession and high unemployment in most of the Eurozone countries. This is natural result of the policy, subordinated to the rule, that price stability takes precedence in all decisions (Monetary Dialogue, December 2009). Later the ECB changed policy orientation, but it remains uncertain what kind of behavior the bank will adopt in the future, since bank’s mandate remains unchanged. Up to now the new ECB policy testifies certain positive results. Consequently, the Eurozone image improved, but is still below the pre-crisis level (Wiegand, 2017).
This is not to argue that financial discipline does not matter. It is obvious however that monetary policy is not neutral, on the one hand, and that binding coordination between monetary and fiscal policies is indispensable. This excludes the ECB independence in its present form. It is also evident that fiscal restrictions do not guarantee economic recovery. Sustainable macroeconomic environment entails the introduction of coordinated fiscal policies fully supported by the ECB on equal for all countries basis.
The EFSM (European Financial Stability Mechanism), EFSF (European Financial Stability Facility) and later (2012) the European Stability Mechanism (ESM) presuppose IMF type of financial support for sovereign bailout programs, precautionary financial assistance, bank recapitalization program, primary and secondary market support for troubled countries. This means, that in spite of assigning a new connotation to the role of the ECB, the EU introduced a kind of crisis management facility. The ESM, while necessary in case of economic emergency, does not guarantee smooth functioning of sovereign debt markets.
The real problem is not how to handle, but how to avoid crisis situations without prejudice to sustainable growth. The experience of Poland with the IMF Flexible Credit Line confirms this conclusion (see IMF, 2016). If the objective is to secure the credibility of the ECB and the euro, sovereign debts crisis must be excluded by definition. In fact the ESM itself requires a further strengthening of the pivotal role of the ECB in countries-members government debt management. A good EU macroeconomic strategy should largely aim at transforming the ESM into precautionary financial instrument guaranteeing against tail risks.
Recently the EU introduced macroeconomic policies coordination known as European Semester. The objective was to avoid high budget deficits and to reverse the process of government debts expansion. Taking into account the connection between government debts and current account deficits, the European Semester includes requirements concerning external equilibrium. One could object however that the twin deficit hypothesis is not necessarily true and that even if correct, the causality is supposed to be from fiscal sector to current account and not vice versa. In addition, the introduction of current account constraints contradicts at least two fundamental principles of the EU integration.
First, the EU integration is supposed to contribute to stronger cohesion among countries members as the Treaty of Rome and the other fundamental EU arrangements stipulate. The capital inflow from the more developed to the less developed states is the most important channel of resolving this problem. Imposing limits in this respect goes against the natural trend towards higher income equality in the EU.
At second place the implicit control on capital flows directly contradicts the proclaimed principle of free movement of capital as one of the cornerstones of the EU integration.
The broadening of the scope of the macroeconomic restrictions as well as the over emphasize on the Maastricht criteria goes against the needs of the European economy after the global financial crisis. The after crisis economic development of the EU and the Eurozone in particular demonstrates the need for more stimulating role of the core countries’ economies such as Germany. Stronger domestic demand in the Eurozone core is the best remedy for the ailing southern economies.
Another problem is the growing tax systems divergence in Europe. In terms of taxation Europe is divided into an old and a new part. In the former European communist countries flat income taxation, modest social contributions and low corporate taxation prevail. The old Europe is characterized by progressive tax systems, relatively generous social security and comparatively high corporate taxes. This partition increases social disparities, distorts competition and makes unfair the fiscal redistribution via EU structural funds. The basic principles of taxation in EU should be harmonized taking into account the need for higher social justice and solidarity.
The new planning horizon 2014-2020 adds additional problems. For the first time the common budget declined under the pressure of Great Britain and some other countries. This is movement in wrong direction given the growing disparities among EU member and the emergence of new collective challenges such as the refugee crisis and the new defense spending requirements. The insufficient funding of the common policy objectives narrows the ability of EU to react adequately to the internal and external challenges. Efforts should be taken to increase the common financial resources.
To summarize, the protraction of the economic crisis in the EU can be essentially explained by the inappropriate conceptual basis of the macroeconomic policy of the ECB and the EC, and by the emphasis on crisis management rather than on crisis prevention. The EU needs stronger coordination between monetary and fiscal policies, bigger Eurozone, less fiscal restrictions and stronger integration in the field of taxation. Another emerging problem is the potential conflict between macro prudential and monetary policy, both under the auspices of the European Central Bank. The ECB authority is simultaneously limited in the sense of lack of explicit commitment towards the real economy (absence of full employment mandate) and overextended in terms of potentially conflicting involvement in both monetary and macro prudential policy.
In practical terms the strategic question is how the European crisis management mechanisms can be improved and strengthened. There are several relatively unconnected crisis management and prevention organizational structures in the Eurozone and EU in general. The most important is the European Central bank itself, supported by European Stability Mechanism in the context of macroeconomic adjustment. The EU disposes also with such supplementary arrangements in the field of macroprudential regulation as the Single Supervisory Mechanism and the Single Resolution Mechanism jointly responsible for the banking sector and the European Systemic Risk Board (ESRB), focused on financial system as whole.
Common feature of all these institutions is, as already mentioned, their predominantly ex post problem orientation. The only exemption to some extent is ESM were a kind of early warning system is established. This system however has very narrow objectives. It is limited to the so called program countries, i.e. countries subject to adjustment programs with the objective to guarantee the repayment of the ESM loans.
What is needed in practice is much more comprehensive approach. The Eurozone would be much more stable and predictable if a comprehensive early warning system is put in place. Such a system could cover all Eurozone member states plus EU countries outside the zone but interested in guaranteeing macroeconomic stability. This early warning system must be established under the auspices of the ESM and could work efficiently only if coordinated with ECB, EC, SSM, SRM and ESRB (see about the problems, related to systemic risk measurement and identification in Sibert, 2009). In the same time the Eurozone early warning system should function in close cooperation with the IMF which disposes with global information about the financial system risks.
When threats to the macroeconomic stability in some countries are detected, the ESM must start consultations with the European Central Bank, European Commission and the respective countries in order to prepare package of measures (including preemptive financial support in the spirit of IMF Flexible Credit Line), to counteract risks and secure economic and financial stability. This implies also broadening of the ECB mandate to include full employment objective. The suggested coordinated policies should be implemented irrespectively of whether the origin of the problems is in the fiscal sector, banking system or capital markets. Such a combination of financial resources pooling, preventive actions and coordinated efforts would rule out any significant Eurozone crisis in the future.
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