Options for Europe – Part 34

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).

[NEW MATERIAL TODAY]

Jacques Delors delivered his Report to the European Commission in April 1989, and it was considered by the European Council at its Madrid summit on June 26-27, 1989. The Council resolved to accept the Delors Report and launch the first stage of the process which would lead to economic and monetary union on July 1, 1990. They also resolved to hold an ‘Intergovernmental Conference’ to help map out the subsequent stages outlined in the Delors Report, although no date was specified for this meeting (European Council, 1989). The Council said that the “realization” of the Delors Plan “would have to take account of the parallelism between economic and monetary aspects, respect the principle of subsidiarity and allow for the diversity of specific situations (European Council, 1989: 11).

What was this principle of subsidiarity?

[THEN THE SECTION THAT I WROTE ON FRIDAY FEBRUARY 21 https://billmitchell.org/blog/?p=27156 ON SUBSIDIARITY WHICH ENDED WITH THE FOLLOWING PARAGRAPH FOLLOWS]

When the Delors Committee was invoking subsidiarity in its thinking of how to design the economic and monetary union, they were so embedded in free market economic thinking that they failed to understand the imperative for a federal fiscal or treasury competency. The fact is that the lower entities could not achieve their ends in a modern monetary system if the currency-issuing level of the system was constrained in the way it could deal with negative and asymmetric changes in total spending, whether generated from within the system itself or imported through trade from negative developments in other nations.

[AND NOW PICKING UP FROM THERE TODAY]

As we saw earlier, the Werner Report had stressed that, in addition to the creation of a European Central Bank, which would presumably be the issuer of the new single currency, that “transfers of responsibility from the national to the Community plane will be essential” for the conduct of economic policy (Werner Report, 1970: 10). But Werner went further than that. The Report noted that on “the institutional plane … two Community organs are indispensable: a centre of decision for economic policy and a Community system for the central banks. These institutions, while safeguarding their own responsibilities, must be furnished with effective powers of decision and must work together for the realization of the same objectives. The centre of economic decision will be politically responsible to a European Parliament.” (Werner Report, 1970: 26).

While the Delors Proposal bore some similarity with the Werner Plan (for example, three stages in the transition culminating, the first two dealing with convergence in policy etc, with the third stage culminating in the introduction of the single currency) it also deviated, starkly, from Werner’s vision for a European level fiscal policy function. The Delors Committee misused the subsidiarity concept to avoid recommending a powerful European-level economic function. Fiscal capacity and national budget policies would remain at the Member State level, in the domains of what would become currency-users, where formerly, they had been currency-issuers. The European-level oversight would be limited to imposing arbitrary, but binding fiscal rules (size of deficits and public debt holdings) and, importantly, prohibut the newly created central bank from directly providing loans to embattled Member State governments in times of need. The democratic component that Werner stressed – giving the European Parliament responsibility for economic policy decisions at the Community level – was not included in the Delors Plan.

The Werner Plan thus considered an economic and monetary union would push Europe towards a political union, with the European Parliament being at centre stage. The Werner Report (1970: 12) had said that “these transfers of responsibility represent a process of fundamental political significance which implies the progressive development of political cooperation. Economic and monetary union thus appears as a leaven for the development of political union, which in the long run it cannot do without.” The Delors Report (1989: 13) constructed the economic and monetary union in terms of the continuation “of individual nations with differing economic, social, cultural and political characteristics” and the “existence and preservation of this plurality would require a degree of autonomy in economic decision-making to remain with the individual member countries.”

There were several reasons cited for the change in thinking in the Delors Report, not the least being the fact that the French, which had rejected Werner’s vision, maintained hostility to ceding too much economic power to a European-level institution. It is also true that, while the Werner Report was seen as a way of holding onto the supposed security of the Bretton Woods type currency arrangements, the Delors Report was a logical development of the 1986 Single European Act (Giovannini, 1990).

But the shift in ‘design’ of the economic and monetary union in the Delors Report was typically justified by appealing to changes that had occurred in the world economy in the decade following the release of the Werner Report, including the demise of the Bretton Woods system, the introduction of the EMS, the inflation spikes that followed the two oil price hikes in the 1970s, and the opening up of global financial markets. But all these ‘reasons’ just provided a smokescreen to what had really changed. The fact is that the Monetarist disdain for using discretionary fiscal policy as a means of smoothing out variations in the economic cycle caused by fluctuations in private spending and maintaining low levels of unemployment was now triumphal. The promotion of the sanctity of the free market and the dislike for state involvement in the economy beyond setting property rights had completely transformed the way policy makers thought.

This homogeneity of thinking or cognitive biases is referred to as Groupthink, which refers to “the tendency among homogeneous, cohesive groups to consider issues only within a certain paradigm and not challenge its basic premises” (IEO, 2011: 17). Referring to the reaction of the IMF staff to the GFC, the IEO (2011: 17) said that:

The prevailing view among IMF staff – a cohesive group of macroeconomists – was that market discipline and self-regulation would be sufficient to stave off serious problems in financial institutions. They also believed that crises were unlikely to happen in advanced economies, where ‘sophisticated’ financial markets could thrive safely with minimal regulation of a large and growing portion of the financial system.

By the end of the 1980s, this view had infiltrated the academy, the major multilateral institutions, treasuries and central banks across the advanced world. Policy making was in the thrall of the self-regulating, free market myth. This group was also trapped in what is referred to as ‘confirmation bias’, which the IEO (2011: 17) says “refers to the tendency of people to only notice information consistent with their own expectations and to ignore information that is inconsistent with them”. Going into the Delors Committee were a group of men who argued that the EMS had overcome its initial difficulties in the early 1980s and provided the necessary currency stability to ensure inflation fell by the end of the 1980s. They ignored the persistently high unemployment that the deflationary biases in economic policy across Europe had caused.

The Italian macroeconomist, Franco Modigliani reflected on European macroeconomic policy and the persistently high unemployment in the period after the oil price rises:

Unemployment is primarily due to lack of aggregate demand. This is mainly the outcome of erroneous macroeconomic policies … [the decisions of Central Banks] …inspired by an obsessive fear of inflation … coupled with a benign neglect for unemployment … have resulted in systematically over tight monetary policy decisions, apparently based on an objectionable use of the so-called NAIRU approach. The contractive effects of these policies have been reinforced by common, very tight fiscal policies (emphasis in original) (Modigliani, 2000: 3).

[TO BE CONTINUED]

[TOMORROW WE MOVE ONTO TREATY OF MAASTRICHT]

Additional references

This list will be progressively compiled.

European Council (1989) ‘Documents Dossier, Madrid Summit, June 26-27, 1989’. http://aei.pitt.edu/1453/1/Madrid_june_1989.pdf

Giovannini, A. (1990) ‘European Monetary Reform: Progress and Prospects’, Brookings Papers on Economic Activity, 21(2), 217-92.

Goodhardt, C. (1990) ‘Economists’ perspectives on the EMS: A review essay’,

Independent Evaluation Office (IEO) (2011) IMF Performance in the Run-Up to the Financial and Economic Crisis: IMF Surveillance in 2004-07, Washington, International Monetary Fund, February 9, 2011. http://www.ieo-imf.org/ieo/files/completedevaluations/Crisis-%20Main%20Report%20(without%20Moises%20Signature).pdf

Modigliani, F. (2000) ‘Europe’s Economic Problems’, Carpe Oeconomiam Papers in Economics, 3rd Monetary and Finance Lecture, Freiburg, April 6.

That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.