In defence of the Eurozone and its policies

John Quiggan has written an interesting critique of the Eurozone that is far more objective and detailed than other critiques I have read. Nevertheless I believe it to be wrong.

One of the effects of the "great moderation" was the idea that (preferably independent) central banks should use monetary policy to keep inflation within a certain band. Now that neo-classical economics has been discredited, the time is obviously right for questioning this policy. To my horror, however, the consensus seems to be that the inflation band should be looser and higher - I have argued that it should be tighter and lower, and that absolute price stability be the goal.

The result of this debate is an eventual "Godwinisation" of each other's point of view. The new economic consensus of higher inflation is critiqued by those who yell "hyperinflation" and remind everyone of the 1970s, while the old economic point of view is critiqued by those who yell "deflation" and remind everyone of the 1930s. The result seems to be the assumption that anyone who reminds anyone else of a time period when prices either rose or fell as the basis of their argument automatically loses the argument (see Godwin's Law)

The lessons of the 1930s and the 1970s is very clear - price stability is essential. In the 1930s, deflation in the US hovered around 10%; this was not price stability since prices kept dropping. In the 1970s, inflation in the US hovered around 10%; this was not price stability either since prices kept rising. During the neo-classical revolution of the early 1980s, it was decided that inflation should be handled exclusively by monetary means (increasing or decreasing interest rates) in order to keep inflation within a "band".

Yet the desire for price stability - neither too much inflation nor too much deflation - has its roots more in the Wirtschaftswunder of post war Germany and its policies of Ordoliberalism than in anything post-disco or neo-classical. In fact I would argue precisely that a heavy dose of Ordoliberal policies is exactly what Europe and the US needs.

But then we need to add to this mix the theory of optimum currency areas proposed by Robert Mundell. Quiggan is the first econ-blogger I have seen who has actually mentioned this principle when critiquing the Eurozone. Others, including Krugman, have been railing recently against the existence of the Euro but have failed to even mention Mundell or his theories. Mundell, of course, was instrumental in creating the theory of an optimum currency area and his work eventually led the European Union to introducing a single currency.

But is an optimum currency area a neo-classical idea? That appears to be the assumption amongst critics of the Euro, which means that their dismissal of the Euro as a practicable idea neatly fits into their dismissal of neo-classicalism. Yet there are no neo-classical economists in the English speaking world who supported the Euro's creation back in 1999. We certainly didn't see neo-classical economists arguing for a unified North American Currency shortly after NAFTA. In fact, most neo-classical economists derided the Euro as yet another example of creeping socialism in western Europe, usually while writing words such as "inflexible" and "sclerotic" and "old" and "too generous".

My argument is that neither the Eurozone nor price stability is a result of (now discredited) neo-classical economics. I myself have come to the inevitable conclusion that neo-classicalism has run its course and ideas that "governments can't do anything right; the free market is more efficient; deregulate" are now subject to massive qualifiers (eg taxpayer funded universal health care is more efficient and more effective than a system dominated by the free market, such as in the US). Rather than minimising government influences upon the economy, policy makers must now reconsider re-regulation of certain industries to ensure that the market reaches its potential without causing harm to the society it exists in; to reconsider nationalisation of certain industries where it can be proved that government control is more efficient and serves society better. If that sounds like a good solution to neo-classicalism, you're right: it's Ordoliberalism, and Ordoliberalism applied across a continent of separate countries can achieve far more when prices are stable and when a single currency is used.

For us in the English-speaking west, we are quite ignorant of the hoops that nations have to jump through in order to become members of the European Union and to then, after time, adopt the Euro. A series of measurable outcomes must be met, called the Community Acquis. Many of these outcomes are neo-liberal in tone, such as free trade between member nations, and free movement of capital. Others are almost socialist in tone, including environmental laws, competition policies and employment policies. In short, Acquis is very Ordolibeal in tone, and offers the assurance of a level playing field for a single currency to operate in.

It is my opinion that many in the English speaking west desire the Eurozone to collapse, either to vindicate their positions or as a way to move their focus away from the US and its problems. Europe and the Eurozone certainly have major problems, not the least being the debt crisis that they are in. Yet those who have actually studied debt levels closely (such as myself) have argued that the US is in a worse debt situation than Europe, yet no one speaks about the breakup of the US or the rise of state based currencies - the US is, after all, its own optimum currency area. Since such an outcome is unlikely in the US it should be similarly, if not more, unlikely to happen in the Eurozone.

Europe's debt crisis will wane somewhat as the recovery continues. Germany is already posting strong GDP numbers (which contradicts Quiggan's statement that "in GDP terms, Germany's recovery has not been that strong") and this will help boost the economy of the Eurozone as a whole, including the problem PIIGS.

I'm sorry, but I agree with Eurozone economists on this issue: Price Stability must be maintained no matter what the economic situation, and a single currency will always be better than many.

1 comment:

Terje said...

I would refer to a common "unit of account" in the last sentence but otherwise I broadly agree with the conclusions you have written here.

The ECB should remain focused on price stability. I don't think it should be preoccupied with bailing out Greece etc. If Greece has a problem then they can always default, and now probably should.

There is a school of thought that thinks the world should return to a gold standard. That a gold standard would provide price stability and a common global unit of account. You may not agree with this path to price stability and a common global unit of account but you should acknowledge the idea. It comes typically from classical economists.

The monetary objectives of the ECB are in my view superior to the monetary objectives of the FED. The ECB should remain entirely focused on price stability. The FED should be reformed so that price stability is it's only monetary objective.