Economic rationality long gone in Europe

Published in Newsroom.co.nz (Wellington), 18 May 2021

It was an urgent warning that German newspaper Süddeutsche Zeitung published last week. Its authors warned of rising inflation, “massive social upheavals” and further political polarisation.

They worried about the weakened European banking system, the political future of the European Union and the state of the European economy.

They called for radical reforms in Europe’s monetary and fiscal policies.

Though such concerns are not unusual these days, the list of co-authors behind this open letter is. It includes the chairs of corporate heavyweights Linde, Munich Re, and Deutsche Post and Deutsche Bank.

They further include a former Vice-President of the EU Commission (Günther Oettinger), a former Social Democrat Finance Minister (Peer Steinbrück), a former Christian Democrat chancellor-candidate (Edmund Stoiber), a former Vice-President of the Bundesbank (Franz-Christoph Zeitler) and one of Germany’s most prominent economists (Hans-Werner Sinn).

These people are not fringe voices. They are a cross-party selection of the German business and political establishment.

To add further weight to their extraordinary document, they highlighted that it resulted from consultations with officials like Bundestag President Wolfgang Schäuble (CDU) and Bundesbank President Jens Weidmann.

Just as extraordinary as the list of participants in this open letter project is the broadside that it delivers. It is an outright attack on both the European Commission and the European Central Bank (ECB). It is unheard of coming from the top echelons of Germany.

The authors concede the ECB’s “ultra-expansive monetary policy” has worked in one sense. It stabilised the economies of some members of the Eurozone. These countries are not mentioned, but this is obviously a reference to Greece, Italy, Spain and Portugal – and potentially France, too.

However, in the letter writers’ view, the risks for zero interest rates and the central bank money creation now outweigh such benefits. It is not just a risk to price stability, they see but a more structural problem. When the ECB bought government debt, it created an illusion. That was “the illusion in the euro area member states that they will be able to finance rising government spending permanently at zero and negative interest rates, even without growth-enhancing reforms.”

Indeed, there has been a marked shift over the past decade in the conditions attached to support measures for individual countries. When Greece teetered on the brink of bankruptcy between 2009 and 2014, it was always bailed out in the end. However, for any such bailout, there was always at least the expectation that Greece would embark on economic reforms.

At the time, the European Union even brought in the International Monetary Fund (IMF) to ensure there would be even more reform pressure on Greece. Whether Greece then actually delivered enough reforms is a different question. But at least the official deal was financial support in return for economic reforms.

The letter writers note there no longer exists such conditionality. They go further and note the “ECB’s actions give the impression the Eurozone can only be maintained by breaking the rules formulated by member states themselves (for example, Maastricht criteria, no-bail-out, ban on monetary state financing).”

Once again, they have a point. Practically every fundamental rule on which the Euro once rested has been broken. They could have included that it was Germany itself which first violated the Eurozone’s fiscal deficit rules in the early 2000s, thus setting a precedent for bad behaviour. But that omission does not diminish the rest of their argument.

With the ECB now operating outside its erstwhile mandate of maintaining price stability, the writers identify several risks. Not just the return of inflation: that one is obvious. But beyond that, they see the risk that negative interest rates zombify the economy while removing pressure on governments to pursue growth-enhancing policies.

This, in turn, creates an expectation on governments to cover all economic risks and intervene wherever companies struggle. No wonder that state activity will grow when governments find it easier and cheaper to refinance. It is even easier when some EU members will free-ride on other members’ budgets, as with the EU’s new path of taking on joint debt.

For fiscal policy, the writers thus call for more discipline and a reduction of debt-financing. They want to see the previous fiscal rules like the ‘no bailout clause’ restored. Of course, they also emphasise the need to implement structural economic reforms to increase the EU’s competitiveness.

But just fiscal and economic reforms no longer do when it is actually the ECB that calls the shots in the European economy. Therefore, it is crucial that the ECB changes its course because without that, no other economic reform would follow.

So the core demands on the ECB are “to concentrate on its core task of ensuring price level stability”. That would mean to “gradually reduce the volume of government bond purchases initially and, once the Corona crisis has been overcome, to reduce the stock of government bonds it holds and the inflated money supply again.”

This re-orientation should also mean political neutrality. The ECB should not prefer one country’s government bonds over another country’s (as it does now). Nor should it agree to write off an individual country’s debt, either formally or hidden. It should also withdraw from policies outside its mandate such as climate change and leave these policy areas to elected governments.

Looking at the letter, its description of the economic and political status quo is mainstream. Few economists would deny the dangers the authors describe.

The letter writers also advocate for a European Commission and an ECB playing by the rules EU members agreed to when they established the Euro. As far as rallying cries go, they do not come more self-evident than that.

Still, in today’s context, the call for a return to fiscal and monetary normalcy (or indeed legality) has a whiff of radicalism. Which probably makes these German establishment figures counterrevolutionaries of sorts.

So, to reiterate, the writers are as mainstream as they come. Their positions were mainstream only a few years ago. Their demands are to comply with European Treaty Law.

Yet, sadly, it is all of the above which makes the likelihood of anyone in power listening close to zero. The times of economic reason and rationality are long gone in Europe.

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