Options for Europe – Part 37

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]

The European Council meeting in Strasbourg on December 8-9, 1989 considered the report produced by this ‘High Level Working Party’, ratified the July 1, 1990 starting date agreed to in Madrid, and determined that the IGC would meet, “under the auspices of the Italian authorities, before the end of 1990” (European Council, 1989c: 8). The timing of the IGC, after the starting date of Stage 1 of the Delors Plan, was clearly designed to retain the focus on the transition to stages 2 and 3, as part of the ‘single process’ as conceived by Delors. Accordingly, once stage 1 had begun, nations, by implication, were committed to seeing the process through. It also noted that it would present a new “composite paper on on all aspects of the achievement of Economic and Monetary Union which will take into account all available analyses and contributions” (European Council, 1989c: 8). The paper would be considered at a special meeting of the European Council in Dublin on April 18, 1990. Standing alone was the United Kingdom, which opposed any treaty change to faciliate a single currency.

A discussion paper by economists Daniel Gros and Jean Pisani-Ferry (1989) which was presented at one of the informal EMU workshop that the European Commission ran in late 1989, argued that the central issue to be decided related to fiscal policy. They recognised that many thought that “a monetary union is politically acceptable only if it provides at least some ‘insurance’ scheme in the form of automatic income transfers among participating regions” (Gross and Pisani-Ferry, 1989: 14). They were referring to the perceived need to create a federal fiscal capacity to provide relief to regions (member states) within the federation at times when local economies were in recession. They concluded that this “raises the issue of the appropriate level and role of the Community budget” and that such transfers could be achieved via a “Community wide unemployment insurance scheme or via some sort of fiscal equalisation mechanism” (Gros and Pisani-Ferry, 1989: 14). They disputed the notion that private credit markets are “efficient” and concluded that they “cannot discipline public budgets” (Gros and Pisani-Ferry, 1989: 14), which referred to the claims by some that the private lenders would soon stop providing funds to Member State governments if they perceived the fiscal positions were shaky and that the risk of debt default was high. In that context they supported tight fiscal constraints.

There was no consensus on that point though. On November 27, 1989, the Danish Government released its ‘official report on the EMU’, and, while they agreed “that monetary financing of budget deficits cannot take place” (Ministry of Economic Affairs, 1989: 2) – the Bundesbank mantra – they were “sceptical” about the proposals in the Delors Report concerning binding rules on budget deficits. They argued that “such rules are not necessary as budget deficits in the future will be financed in the market” (Ministry of Economic Affairs, 1989: 2), which means that nations would soon run out of money if they were running deficits higher than the market assessed their creditworthiness could bear. There was no mention of the role of fiscal deficits in countering aggregate demand slumps and protecting employment. Those ‘functional finance’ considerations, which we will return to later in the book, had disappeared from the debate. It was all about rules and constraints so as not to ‘compromise’ spending discipline.

On April 19, 1990, the German federal chancellor Helmut Kohl and French president François Mitterrand sent a joint letter to the Irish Presidency of the European Council, urging the upcoming Council meeting (on April 28) to “accelerate the political construction of the Europe of the Twelve” and to bring together the IGC on economic and monetary union with the proposed IGC on political union (Agence Presse, 1990).

Throughout 1990, various workshops were organised by the European Council, who handpicked economists to present papers. The academy had, however, fallen so tightly under the spell of Monetarism, that there was little room for disagreement. A collection of so-called ‘background studies’ that had been presented to various fora in the build up to the IGC was published by the European Commission’s own journal European Economy, in 1991. There were three papers covering ‘Macroeconomic policy and public finance’.

Van Rompuy et al. (1991: 109) define a federal system in terms of “a multi-level public sector” including the “supply of public goods and services, taxation, redistribution and stabilization functions”. In relation to the ‘macroeconomic stabilisation function’, which was the most contested by Monetarists seeking to distance themselves from the dominant Keynesian position they usurped, Van Rompuy et al. (1991: 112) ask which level of “which government should stabilize the economy” when there are “nation-wide positive or negative shocks” (meaning fluctuations in total spending which disturb production and employment levels). They correctly point out that “lower levels of government will have no incentive to use fiscal instruments to stabilize the overall economy” (p. 112) and conclude that the “way out of this dilemma is a coordinated stabilization policy” (p. 113). To reduce the ‘coordination costs’ this capacity should be assigned to the central government. Van Rompuy et al. (1991: 113) conclude that “a federal stabilization function necessitates the exclusive use of some fiscal instruments in such a way that it cannot be disturbed by the independent action of lower-level governments”. They should have gone further and noted that this federal function is intrinsic to the way in which federal treasuries and central banks coordinate their actions in mature federations. It makes little economic sense to central the currency issuance capacity but then leave fiscal policy mainly to ‘state’ governments. In the end, they conclude that this issue “remains a delicate question” and failed to endorse a large federal fiscal function, despite acknowledging the presence of the same in mature federations.

In the same volume, Frederick van der Ploeg (1991: 136) noted that once exchange rates are fixed between nations, “stabilization policy is more difficult to conduct in the face of country-specific shocks’. He proposed to establish a “European Federal Transfer Scheme (EFTS)” to provide fiscal transfers to member states, in the face of an independent central bank which exerts deflationary discipline, which “leads to too low inflation” (van der Ploeg, 1991: 136). He also summarised the problems that the proposed system would face if, for example, there was a shift in spending away from British goods towards French goods. In a non-EMS world, the exchange rates would move (Pound down, Franc up) and the governments might also adjust their fiscal positions (British deficit up, French down) to further attenuate the effects of such a spending shift. van der Ploeg (1991: 144) concluded that “there is a danger that politicians will go along with the idea, advanced by the Delors Committee, that there should be constraints on too high budget deficits” which would prevent such discretionary responses to the rising unemployment in Britain and the risk of inflation in France. He noted under the Delors Plan fiscal policy is “likely to be pro-cyclical” (p.144), which means that with fiscal rules in place, which constrain the size of the deficit, a nation experiencing a slowdown in economic activity would lose tax revenue as a result of the declining employment and its deficit would automatically increase. The government would have to impose discretionary cuts to spending and/or raise taxes to offset the cyclical rise in the deficit. In other words, governments would be cutting net spending at the same time as their economy was deteriorating, which would is the anathema of sound fiscal policy practice. In this context, van der Ploeg (1991: 144) concluded that “These are the main reasons why in the presence of asymmetric real shocks a float is to be preferred to EMU”. The example he used to demonstrate his case against the proposed structure of the EMU is exactly what has subsequently happened as a result of the GFC.

His proposed EFTS, which would transfer income from expanding nations to declining nations, represented a minimalist federal fiscal function. He speculated that Delors didn’t consider such a scheme because it would reduce the incentive of unemployment individuals in a declining region (nation) to shift to growth areas. The overwhelming conclusion of his analysis was that an EMU without some form of federal fiscal role “performs badly when Member States are hit by country-specific shocks” (van der Ploeg, 1991: 146).

The final paper in this volume by Charles Wyplosz focused on two questions: (a) should there be fiscal rules which would “limit national fiscal policy indepdendence”, and (b) does the EMU “require an EC-wide fiscal policy?” (Wyplosz, 1991: 165). He notes the bias among economists to couch these questions “under the code-name of fiscal discipline” and talk about ‘reasonable’ fiscal positions (p.165). But, reasonably, he notes that it “is not clear … what reasonable, or indeed disciplined, fiscal policies really are” (p.165). While the analytical framework, Wyplosz deployed is questionable, he concluded that “budget deficits – possibly even long-lasting ones – do not necessarily form an indication of fiscal laxity. There exist a large number of reasons which make public deficits and debts socially desirable” (Wyplosz, 1991: 172). Overall his rather conservative advice to the European Council was that “extreme caution should be exercised before setting binding rules … [and] … Without the exchange-rate instrument, fiscal policies may well be called upon to provide a substitute way of dealing with national shocks” (Wyplosz, 1991: 182).

That sort of advice was clearly ignored. On May 22, 1990, the Economic Policy Committee published an ‘opinion’ for the European Council entitled ‘Requirements for the Achievement of Closer Convergence of Public Finance in the Member States’. This paper established the “principles”, which should govern fiscal policy in the Member States under an EMU. The principles were (Economic Policy Committee, 1990: 1):

– the avoidance of monetary financing of budget deficits;

– the avoidance, or at least reduction, of excessive budget deficits;

– the reduction of excessive levels of public debt;

– the improvement: of the structure of budget revenue and expenditure;

– the reduction of excessively large ratios of public expenditure to national product

The paper was accompanied by a statistical annexe with one table presenting the “Relevant macroeconomic variables” to guide discussion (Economic Policy Committee, 1990: 1). The unemployment rate or employment growth rates were not considered to be relevant. In fact, there was no mention of the persistently high unemployment rates in the Member States at the time the paper was presented. This paper exemplified the way in which the Monetarist doctrines had excised the responsibiliities of government to maintain high employment rates from any discussion of fiscal policy parameters. Now the discussion of fiscal policy was a stand-alone exercise with an internal logic defined by deficit to GDP and public debt to GDP ratios. The discussions rarely discussed the ‘functions’ of government deficits. Instead, the assessment in this paper, among others centred on whether the deficits were “reasonable”, “excessive” or otherwise, with little definition on how we might demarcate those assessments.

With the IGC approaching, the European Commission presented its own position paper for the December IGC (Commission of the European Communities, 1991), on August 21, 1990 (sometimes known as the Christophersen Report), which basically rubber-stamped the Delors Plan and emphasised the need for a single currency. The primary macroeconomic function exercised at the Community level would be monetary policy and that (Commission of the European Communities, 1991: 19):

The Community’s monetary policy and the institution responsible for it need to be committed explicitly to the objective of price stability. Given this priority, they have to support the general economic policy objectives defined at Community level by the competent institutions. The stability commitment needs to be written into the basic legislative texts … [and] … the new Community monetary system also needs to enjoy a high degree of independence vis-à- vis national governments and other Community bodies.

The Report constructs discretionary fiscal policy as a “threat to monetary stability” and as a result of the “potential threat of budget deficits and their financing … additional provisions” are required (Commission of the European Communities, 1991: 24). These include the familiar provisions that were discussed above and were written into the Maastricht Treaty change:

(a) no monetary financing of public deficits or market privileges for the public authorities concerning the placing of public debt;

(b) no bailing-out; in the case of imbalances, a Member State could not benefit from an unconditional guarantee concerning its public debt either from the Community or from another Member State.

Further “excessive deficits must be avoided” (p.24) although the amorphous nature of when a deficit becomes ‘excessive’ is not specified. Yet, in this vague world, the Report concludes that “some yardstick would seem necessary for the identification of excessive deficits” (p.24). As we will see, the yardstick that finally entered the picture was an arbitrary deficit to GDP ratio written on the “back of an envelope” one night by an adviser to François Mitterand, so that the French could be taken seriously in the whole process.

[TO BE CONTINUED]

[WITHIN REACH OF MAASTRICHT NOW]

Additional references

This list will be progressively compiled.

Agence Europe (1990) ‘Letter by the German federal chancellor Helmut Kohl and French president François Mitterrand
to the Irish Presidency of the European Council’, April 19, 1990.

Commission of the European Communities (1991) ‘Intergovernmental Conferences: Contributions by the Commission’, Bulletin of the European Communities, Supplement 2/91.
http://ec.europa.eu/economy_finance/emu_history/documentation/chapter13/19900821en179contribbycommis_a.pdf
also contains ‘Economic and Monetary Union, SEC (90) 1659, 21 August 1990′.

Economic Policy Committee (1990) ”Requirements for the Achievement of Closer Convergence of Public Finance in the Member States’, European Commission, May 22, 1990.

European Council (1989c) ‘Conclusions of the Presidency, European Council’, Strasbourg, 8 and 9 December 1989.
http://www.european-council.europa.eu/media/849019/1989_december_-_strasbourg__eng_.pdf

European Commission (1991) ‘The economics of EMU: Background studies – One market, one money’, European Economy, 44, Special Edition No. 1.

Gros, D. and Pisani-Ferry, J. (1989) ‘Costs and Benefits of EMU’, EMU Work Program, October 11, 1989. http://ec.europa.eu/economy_finance/emu_history/documentation/chapter13/19891005en19informalemu.pdf

Ministry of Economic Affairs (1989) ‘The Danish Government’s Official Report on EMU’, Copenhagen, November 27, 1989.
http://ec.europa.eu/economy_finance/emu_history/documentation/chapter13/19891127en09danishgovernments.pdf

van der Ploeg, F. (1991) ‘Macroeconomic policy coordination issues during the various phases of economic and monetary integration in Europe’, 136-164.

Van Rompuy, P., Abraham, F., and Heremans, D. (1989) ‘Economic Federalism and the EMU’, in European Commission (1991) ‘The economics of EMU: Background studies – One market, one money’, European Economy, 44, Special Edition No. 1, 107-135.

Wyplosz, C. (1991) ‘Monetary union and fiscal policy discipline’, in European Commission (1991) ‘The economics of EMU: Background studies – One market, one money’, European Economy, 44, Special Edition No. 1, 165-184.

That is enough for today!

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