Options for Europe – Part 45

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]

What was agreed at Maastricht and what was not

Despite the huge expense that resulted from flying high-paid officials around Europe to attend countless meetings and briefings and paying various consultants top rates to provide advice to these officials, the European Council meeting in the Limburg Statenzaal in Maastricht on December 9 and 10, 1991, virtually rubber-stamped the Delors Report which had been made public in April 1989. The Delors Plan had been agreed at the Rome Summit in October 1990 as the EMU model to go forward with. Essentially, the Maastricht Treaty took the existing yet doomed EMS; tweaked it a bit with the hope of some, yet to be agreed fiscal constraints that would make it even more unworkable; added the creation of an undemocratic policy unit (the European Central Bank) which absorbed, and, hence, negated the most basic function of any responsible government – the capacity to issue its own currency. And this was hailed as the grand vision for a modernised Europe. But, of-course, all of these changes were still less than precise and would take the rest of the decade to implement. Further, typical of European politics, where the elephant in the room was always the desire to stop any further wars involving Germany invading France, the timing and nature of the transitional stages laid out in the Delors Plan were not without controversy.

But the Treaty on European Union that emerged inserted ‘Title VI – Economic and Monetary Policy’ – which contained four separate ‘chapters’ – Chapter 1 Economic policy, Chapter 2 Monetary policy, Chapter 3 Institutional provisions, and Chapter 4 Transitional provisions. The plan was for a complete Economic and Monetary Union (EMU) by the end of the 1990s. I am sure a few Dutch delegates in the Statenzaal muttered ‘eindelijk’ (‘finally’) when the signatures of the relevant Member State leaders crossed the paper.

Four protocols were established to flesh out the legal details for the Chapters in Title VI.

Chapter 1 – Protocol 5 on the excessive deficit procedure

Chapter 2 – Protocol 3 on the Statute of the European System of Central Banks and of the European Central Bank

Chapter 4 – Protocol 4 on the Statute of the European Monetary Institute

Chapter 4 – Protocol 6 on the convergence criteria referred to in Article 109j of the Treaty establishing the European Community.

Under Economic Policy, it was clear that governments would now be under “multilateral surveillance” (Maastricht Treaty, 1992: 17) which would coordinate policies across the Member States to ensure that “Member States … avoid excessive government deficits” (p. 19). Excessive is defined according to a “reference value” defined under the excessive deficit protocol.

Specifically, these values were (p. 29):

– 3% for the ratio of the planned or actual government deficit to gross domestic product at market prices;

– 60% for the ratio of government debt to gross domestic product at market prices.

The familiar and arbitrary rules that had no real foundation in any economic theory. A punitive regime was specified whereby the European Council could “impose fines of an appropriate size” on a nation that has ‘excessive deficits’, thus ensuring that perverse fiscal dynamics would be the norm. That is, a fiscal deficit could easily exceed the 3 per cent ceiling if there was a major recession and taxation revenues fell. The appropriate policy response would be to inject a spending stimulus into the economy, push out the deficit further and watch the economy recover and the deficit to GDP ratio fall again as the increased employment delivered more tax revenue and GDP grew. The rule after all is a ratio – size of the deficit on the top (numerator) and the market value of GDP on the bottom (denominator). The ratio falls in a recovery because the numerator falls and the denominator increases.

The logic of the excessive deficits rule is to bully governments into taking exactly the opposite action to what responsible fiscal practice would specify. In other words, it requires governments pursue what economists refer to as ‘pro-cyclical’ fiscal policy changes, which just means that the government are forced to cut spending at a time that private spending is weak. The policy thus compounds the problem by making the economic cycle worse. Responsible fiscal practice is counter-cyclical – governments should increase their net spending when the economic cycle is deteriorating. If encouraging governments to adopt ill-advised fiscal strategies wasn’t enough, the protocol of imposing fines on a nation that was caught in recession represented lunacy to anyone who really understood what was going on and wasn’t blinded by the Monetarist ideology.

Further restrictions on the flexibility of economic policy for democratically elected governments were specified in Article 104 which prohibited “Overdraft facilities or any other type of credit facility with the ECB or with central banks of the Member States … governments …” as the direct purchase “by the ECB or national central banks of debt instruments” issued by governments (p. 18). The noose was well and truly tightened and it was only a matter of time before it would start causing damage. A later chapter on overt monetary financing explicitly considers the logic of banning central bank purchases of government debt.

Under the Chapter on Monetary Policy, the primacy of the price stability objective was canonised as an article of deep religious faith. The Bundesbank culture was now successfully embodied in European law. While Article 2 in the Treaty suggested that the aim of the Community was to foster “a high level of employment and of social protection” (p. 6) the decision to create a dominant central bank, separated from democratic oversight, who had no responsibilities to promote growth if there was any “prejudice to the objective of price stability” (p. 21) was telling. Piodi (2012) notes that the European Parliament was concerned that there was “disconnect between monetary policy and the other Community’s policies” (p. 64). Further, the European Parliament raised the lack of clarity on what “price stability” actually meant. What would the price stability target be?

The main sources of contention then were the transitional provisions. The Treaty ratified the decision of the Rome European Council meeting in October 1991 to introduce Stage II of the EMU transition on January 1, 1994. Accordingly, the vehicle that would finally become the European Central Bank, the European Monetary Institute (EMI) would be established and put into operation, even though monetary sovereignty would remain at the Member State level. The EMI was intended to start the process of coordination of national monetary policies and set up the machinery that would take over the individual monetary policy operations of the Member State central banks.

This set in motion a new struggle. On October 29, 1993, the European Council held what was termed an ‘Extraordinary’ meeting (being out of normal schedule) in Brussels. It was, of-course, an extraordinary meeting in another sense because it sealed the fate of the EMU, which would enter Stage II just two months later. It was decided that the new European Monetary Institute (EMI), which would begin operation on January 1, 1994, would be headed by Baron Alexandre Lamfalussy, who was at the time the general manager at the Bank of International Settlements. It also decided to locate the EMI in Frankfurt, very near to where the Bundesbank had been located since 1972, even though, in the first instance it mostly worked out of Basel (where Lamfalussy was located) while it acquired office space in what was to become known as the Eurotower. The building was the original homeof the old German ‘Bank für Gemeinwirtschaft’ building, which was originally a very powerful bank owned by the trade unions and intended to provide services on a cooperative basis to workers to give capitalism a ‘human face’. Ironic really.

As would be expected there was an almighty struggle among the political leaders to win the location of the EMI, which played out along familiar lines. The candidates included London, Amsterdam, and Frankfurt Am Main. Britain didn’t want Frankfurt to be the location because it feared London would lose its financial dominance to Germany (Ungerer, 1997 : 273). There was some talk of it being located in Bonn, given that Berlin was about to become the seat of the Federal German government and there would be plenty of office space available. The Dutch wanted it to be in Amsterdam even though there wouldn’t have been much office space available! There was some talk that the European institutions should be spread around across the 12 member states. But it was the urgings of Helmut Kohl that won the day. He was determined to situate the EMI (and then the ECB) in Frankfurt as ‘compensation’ to the German people for losing their beloved Deutsche Mark, which had been their “symbol of post-war stability” (Ungerer, 1997: 273). It seemed to slip the attention of the Germans that every other nation that was entering the EMU were also losing their individual and presumably beloved currencies!

The decision on location and choice of Lamfalussy was also referred to the European Parliament, even though matters relating to Economic and Monetary Union were among the excised areas from the new “codecision’ powers (with the Council of Ministers) that were bestowed on the European Parliament under the Maastricht Treaty, which came into force on November 1, 1993 (European Communities, 2009). The appointment of Dr Lamfalussy was thus not within the scope of powers held by the European Parliament but was considered a courtesy by the European Council. It did establish a new procedure, however, where the European Parliament now runs ‘hearings’ where candidates nominated by the European Council appear and make their case for appointment. This process is meant to inject some democratic element into the appointment system for the head of the European Central Bank but is another of those talk fests that have not legal status, unlike the appointments process in the US where the Congress can reject a Presidential nomination for Federal Reserve Governor.

Lamfalussy was a relatively uncontroversial appointment. But the next would once again reignite the Franco-German hostility again. But that is a story for later.

It is interesting to juxtapose the lack of any commitment to growth and full employment in the Maastricht Treaty with the grand policy statements that accompanied the peace at the end of the Second World War. The overwhelming challenge for each nation was how to turn their war-time economies, which had high rates of employment as a result of prosecuting the war effort, into a peace-time economy, without sacrificing the high rates of labour utilisation. Concerns about full employment were at the centre of these policy frameworks released by governments in most nations at the end of the Second World War.

Britain, for example, released its White Paper on Employment Policy in May 1944 which was an important statement on the British Government’s Post-War policy agenda. Its opening statement said (Minister of Reconstruction to Parliament, 1944: 3)

The Government accept as one of their primary aims and responsibilities the maintenance of a high and stable level of employment after the war … A country will not suffer from mass unemployment so long as the total demand for its goods and services is maintained at a high level … the Government believe that widespread unemployment in this country can be prevented by a policy for maintaining total internal expenditure.

The basic rules of macroeconomics that spending equal income were intrinsically related to the desire to maintain a high level of employment. It was left to the British economist William Beveridge to define what was meant by full employment. In his 1944 book – Full Employment in a Free Society – Beveridge said that full employment (Beveridge, 1944: 18):

… means having always more vacant jobs than unemployed men, not slightly fewer jobs … It means that the jobs are at fair wages, of such a kind, and so located that the unemployed men can reasonably be expected to take them; it means, by consequence, that the normal lag between losing one job and finding another will be very short.

Even the conservative weekly The Spectator applauded the sentiment at the time. It said that Beveridge had welcomed the May White Paper on Employment because it represented “a complete break with the old delusions which came to a head in the economic fallacies propagated and acted upon in 1931 … [and] … accepts the responsibility of the Government for averting mass unemployment by maintaining total expenditure on goods and services” (The Spectator, 1944). The old delusions were referring to the British Treasury line during the Great Depression that less government spending and wage cuts would solve the mass unemployment. The alternative, that required government to take responsibilty for ensuring expenditure was adequate to generate jobs for all those who desired them, was the counter view proposed by John Maynard Keynes and others, which eventually won sway. The old British Treasury line was resurrected in the Monetarism of the 1970s and permeated the economic thinking that went into the Maastricht Treaty and the conception by Europe’s leaders of the EMU. The imposition of fiscal austerity during the current crisis reflects the ‘old delusions’ that initially made the Great Depression worse before the more Keynesian policies were introduced.

[NEXT WE MOVE ONTO THE CONVERGENCE CRITERIA AND THEN BLACK SEPTEMBER WHERE IT ALL LOOKED LIKE IT WOULD COME UNSTUCK]

[TO BE CONTINUED]

Additional references

This list will be progressively compiled.

Beveridge, W. (1944) Full Employment in a Free Society, London, Allen and Unwin.

European Communities (2009) Building Parliament: 50 Years of European Parliament History 1958-2008, Luxembourg, European Communities.

European Council (1993) ‘The European Council Brussels Summit 1993’, Brussels, 29 October 1993. http://aei.pitt.edu/1435/1/Brussels_oct_1993.pdf

Maastricht Treaty (1992) ‘Treaty on European Union’, Official Journal, No C 191. http://www.lexnet.dk/law/download/treaties/Maa-1992.pdf

Minister of Reconstruction to Parliament (1944) Employment Policy, London, His Majesty’s Stationery Office.

The Spectator (1944) ‘Sir William Beveridge On Employment’, July 6, 1944. http://archive.spectator.co.uk/article/7th-july-1944/2/sir-william-beveridge-on-employment

Ungerer, H. (1997) A Concise History of European Monetary Integration: From EPU to EMU, Westport, Connecticut, Quorum Books.

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