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Options for Europe – Part 95

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).

Part III – Options for Europe


Chapter 1 – Introduction



The smooth operations of the customs union and the CAP logically required a system of fixed exchange rates or, at least, a degree of currency stability. The on-going currency instability in the mid-1970s combined with the persistent balance of payments deficits in many European nations led nations such as Italy, Denmark and the United Kingdom to defy the EEC customs union rules and impose import restrictions. The legal framework of the ‘European Project’ was under threat. Schmidt and Giscard d’Estaing developed a joint strategy to replace the ineffectual ‘snake’ with a more integrated level of monetary cooperation. This led to the introduction of the European Monetary System (EMS) in 1979. The most significant innovation was the so-called Exchange Rate Mechanism (ERM), a Belgian-proposed compromise to resolve more Franco-German conflict over the way foreign exchange intervention would be managed. The ERM required the participating central banks to intervene to maintain the agreed bi-lateral parities. Importantly, the intervention was supposed to be symmetrical but the reality was different and the system inherited all the problems that the Bretton Woods system had exposed. The adjustment always fell on the nations with balance of payments deficits (weaker currencies) and required them to reduce domestic growth and increase unemployment in order to ease the downward pressure on their currencies. This reality was politically unsustainable.

The EMS was effectively just an agreement to limit currency fluctuations between the Member-States and provided no real scope for an economic and monetary union as presented in the earlier Werner Report. The decision to consider the establishment of a European Monetary Fund – a European central bank – was effectively abandoned by the end of 1980. The Germans didn’t want the Fund to have central banking functions given that this would compromise the Bundesbank’s capacity to maintain price stability. Legal complexities were put forward by the Germans as a means of undermining the development of the Fund, while the French Gaullists rehearsed their usual pre-occupation about losing sovereignty to a supra-national body. Once the socialists were elected in France in 1981 all talk of the Fund evaporated. What was left was a voluntary arrangement between central banks about reducing currency fluctuations which had limited political support and the economic divergences among the signature nations were of such magnitudes, that this arrangement would be constantly stressed to breaking point.

The election of François Mitterand in 1981 saw a temporary reprieve for the French from the austerity imposed under Giscard d’Estaing and Raymond Barre. Unemployment was rising sharply and Mitterand’s government immediately set about doing what a sovereign government should do – and that is, to use its fiscal and monetary policy capacities to advance the welfare of their citizens by expanding employment opportunities, reducing unemployment and expanding the social wage. The problem was that the French were not willing to abandon their commitments under the EMS to keep the Franc within the agreed bands. They wanted everything – political popularity by reducing unemployment and improving living conditions within France, a straitjacket on German pretensions to European power, and Germany to underwrite the income support mechanisms defined by the CAP. On the one hand, domestic policy sovereignty was crucial if it was to lower unemployment and this predicated against their involvement in the ‘European Project’ as it was being defined by the EMS. On the other hand, the desire to undermine German influence and to find a way to fund their farmers under the CAP forced them to engage in the ‘European’ dialogue. They could not juggle all these balls for very long.

By the third currency realignment in March 1983, the French were at the crossroads and the incompatibility of these competing ambitions was obvious. At that point, France had a choice. It could retain policy sovereignty freedom to pursue its legitimate domestic objectives by letting the Franc float or staying within the EMS and subjugate their domestic policy freedom to the dictates of the Bundesbank. History tells us that the French government fell lock-step into the expanding neo-liberal economic consensus, which used rising unemployment as a policy tool to keep inflation in check. The French socialists became part of the neo-liberal political convergence that captured social democratic parties in most advanced nations during this period. From 1983, Jacques Delors strengthened the neo-liberal program that Raymond Barre had begun and the reduction in domestic inflation that resulted from the ‘scorched earth’ approach was celebrated as the first serious sign towards a convergence reality, while the sharp rises in unemployment were brushed under the carpet and forgotten. Various bureaucrats, supported by free market academics worked overtime to convince everyone that the unemployment was not a result of a lack of jobs created by excessively restrictive fiscal and monetary policy, but rather a sign that people were not searching for work hard enough and were lulled into a welfare-dependent lassitude.

It didn’t take long for EMS to descend into a shambles. Between March 1979 and March 1983, there were seven currency realignments and eleven up to January 1987. The realignments were of such a scale that it was clear that the EMS would not survive unless the non-German Member States within the system fundamentally reoriented their domestic economic and monetary policies to follow the restrictive stance taken by the Germans, the so-called ‘Modell Deutschland’. The Bundesbank effectively forced the devaluations on the French Franc in the early years of the EMS by refusing to reduce its own interest rates to quell the outflow of capital from France. By giving primacy to fighting inflation, Germany became the authority in Europe. Despite their pretensions to French leadership in Europe, the French politicians on both sides of politics succumbed to the requirements of ‘Modell Deutschland’. In effect, the decision by the EMS Member States to peg against the Deutsche Mark, meant that the Bundesbank became the central bank for the EEC. The other nations subjugated their own policy independence. For all of France’s historical concerns for maintaining sovereignty and rejecting supra-national European institutions, it took the Socialists in 1983 to give up that freedom, and then not to Brussels, but to Germany – of all nations. Once the Germans had won that ‘war’, the French became increasingly motivated to support a separate European Central Bank to wrest some control back from Germany.

After France began to toe the ‘correct’ ideological line, the longed for ‘convergence’ in economic policies and outcomes began to emerge and the currency instability reduced. There were also external developments that helped reduce the pressure on the Deutsche Mark and, hence, the other European currencies, including the US stimulus following the severe recession in 1982, which saw the US dollar strengthen. The European political classes started to declare the EMS a success, which motivated them to pave the way to Maastricht. But unemployment rates had risen sharply in the first several years of the Monetarist economic policy onslaught and remained at elevated levels throughout the 1980s – the years of Eurosclerosis.

Once the French realised that instead of a European-level body compromising their policy sovereignty it was the Bundesbank that was in control, their attitude to fast-tracking a full European monetary union changed. The acrimony between France and Germany broke out into the open in 1987. With the US dollar falling in value towards the end of 1986, new pressure was placed on the Deutsche Mark to revalue. In the fallout, the French Franc fell to the lower end of the agreed EMS parity range. The French government did not wish to devalue nor could they reasonably maintain the parity without worsening the unemployment that the fiscal austerity had wrought. The French and Italians also worked out that the Bundesbank effectively set the interest rates for all EMS nations, irrespective of whether the rates that suited Germany were appropriate elsewhere. In turn, while the formal EMS understanding placed equal burden on the central banks to maintain currency stability, the reality was, that the nations facing downward pressure on their currencies had to do the adjustment because the Bundesbank increasingly refused to share the burden, given that the Deutsche Mark was stronger and intervention would mean the Germans would have to sell Deutsche Marks in currency markets, an operation they feared would ignite domestic inflation.

In 1986, Mitterand appointed the right-wing neo-Gaullist Jacques Chirac as his Prime Minister. Chirac wanted to be France’s Margaret Thatcher and appointed Édouard Balladur as the Minister of Economy, Finance, and Privatisation to spearhead the revival of the neo-liberal agenda, selling off public companies and abolishing the wealth tax as part of the much-vaunted, but never to materialise, ‘trickle down’ growth strategy. He was also the vanguard for France’s now very pro-European stance. France also pressured the Ecofin members to push for more symmetry in the EMS intervention mechanisms. The Bundesbank made it clear it would not accept changes that would force it to weaken its emphasis on price stability, which effectively meant it did want to be forced to sell Deutsche Marks to help the weaker currencies maintain parity. The Germans argued that nations should abandon capital controls and rely more on interest rate differentials to manage the currency parities. The Basel-Nyborg agreement reached in 1987 was a triumph for the Germans and proposed less frequent currency realignments and wider interest rate differentials.

In early 1988, Balladur intensified the French government’s anti-Bundesbank agenda because he realised that without capital controls, the French economy would be more sensitive to the deflationary stance of the Bundesbank and that France would have to continue to use higher interest rates to maintain the Franc parity. French politics, let alone national pride, would not tolerate that reality. Balladur started agitating for a common European currency, a strategy designed to eliminate the Deutsche Mark forever. What the French thought would happen if they succeeded in gaining a common currency and replacing the Bundesbank with European Central Bank is another matter. They clearly found out in 2008!

For their part, the Germans were very sensitive to the growing anti-Germany sentiment. They saw the ‘European Project’ in terms of restoring the nation’s place in Europe, whereas the French saw it from the perspective of stopping Germany invading them again. The German Foreign Office took the diplomatic decision to push for the union to quell the on-going criticism of the ugly German, which threatened to derail the progress that the nation had made in restoring its image in the post World War II period. So the French pushed for monetary union to undermine the dominance of the Bundesbank despite their historical distaste for ceding domestic policy discretion to supranational bodies, while the Germans signalled they would go along with the union as part of their vision of their place in a Europe where less than half a century before they had devastated with their extreme politics of anthropological supremacy. The German willingness to advance the common currency was highly conditional, however, and reflected the dominance of the Bundesbank. Neither motivation encouraged confidence in what would be created.

The 1988 memorandum issued by Helmut Kohl’s Minister of Foreign Affairs, Hans-Dietrich Genscher was an exercise in German precision, balanced by a concern to placate the concerns of the French so that a truly ‘federal’ solution could be achieved. Genscher recommended the establishment of a single currency mediated by a European Central Bank, which would maintain the deflationary strategy of the Bundesbank and assuage German concerns about inflation. The proposal motivated the European Council to establish the working party headed by Jacques Delors, to develop a detailed implementation plan for the creation of an economic and monetary union.

The Delors Committee had to walk the tightrope between French and German sensitivities, in much the same way as European negotiating teams had done since the end of World War II. The Committee was dominated by central bankers with the Economics and Finance ministers excluded because Delors figures that the Monetarist-orientated central bankers, who promoted the primacy of deflationary monetary policy and the subjugation of fiscal policy to that end, would come up with a consensus fairly quickly. The addition of some conservative mainstream economics professors meant that the Committee members were all firmly wedded to the new era of neo-liberalism and the abandonment of Keynesian macroeconomic policies in favour of the hard-line pursuit of price stability.

The ‘Delors Plan’ released in 1989 reflected the ideological biases of the neo-liberal oriented Committee. Whereas the Werner and MacDougall reports had both emphasised the need to develop a ‘federal’ fiscal capacity to complement the creation of a European central monetary authority and allow the union to address major private sector spending fluctuations in an effective manner, the ‘Delors Plan’ eschewed the discretionary use of government spending and taxation powers in favour of strict rules. In other words, the ‘Delors Plan’ was effectively, dealing fiscal policy out of the game and constructing what economists call counter-stabilisation policy purely in terms of monetary interventions (interest rates adjustments) to stabilise the price level. Werner had recognised, that at times, government deficits would have to rise significantly as economic activity fell not only because tax revenue declines as less people are in employment, but also because governments have to inject stimulus spending to get the economy moving again. The Delors Plan was in stark contradistinction to that Keynesian orthodoxy.

While it had been the French vehemence that pushed Europe to this stage, the Delors Plan was all German, reflecting the scheme laid Hans-Dietrich Genscher in his February 1999 memo, which was supported at the time by the Bundesbank President, Karl Otto Pöhl. What emerged was clearly the Bundesbank model – an independent central bank focused mainly on maintaining low inflation and little scope for national governments to use deficits. The Report reflected the dominance of the Monetarist agenda in economics. It exemplified Groupthink in operation. The Delors Committee constituted an ‘epistemic community’ in that it was dominated by central bankers who regularly met and held a similar world views about the primacy of monetary policy and the need for fiscal policy to be a passive support to the deflationary strategy defined by the Bundesbank.

The Delors Committee justified its rejection of central fiscal authority by appealing to the notion of subsidiarity, a long-standing concept in political theory (as far back to Aristotle and Thomas Aquinas), which became ‘Eurospeak’ in 1989. The idea is generally taken to mean that in a federal structure, issues should be managed at the most decentralised level that is effective. It was argued that the common good required that decision be taken at a level as close as possible to the citizens themselves. The Delors Committee considered this meant that national governments should run fiscal policy. But as British economist John Maynard Keynes pointed out during the Great Depression of the 1930s when he decimated the conservative mainstream economic thinking of the day (the precursor to modern neo-liberalism), there are some functions that have to be performed at the aggregate level in a federal system if the overall system and its components are to function effectively and the common good advanced. It was obvious that the lower entities (in this case, the national governments) could not possibly maintain stable growth and full employment without the European Central Bank underwriting their deficits, a possibility banned in the Treaty. The tight constraints that Delors proposed, which became the Stability and Growth Pact (SGP) rules, meant that national governments would never be able to 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. Subsidiarity was thus conveniently redefined to suit the ideological bent of the Delors Committee.

There were several reasons advanced as to why the Delors Report differed so radically from the Werner Report, 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 – the Groupthink – dominated. 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.


Additional references

This list will be progressively compiled.

Barbash, J. (1982) ‘The Guilds of Academe’, Challenge, 25(1), March-April, 50-54.

Blanchard, O. (2008) ‘The State of Macro’, NBER Working Paper No. 14259, National Bureau of Economic Research, August.

Democracy Now (2007) ‘The Conscience of a Liberal: New York Times Columnist Paul Krugman on Healthcare, Tax Cuts, Social Security, the Mortgage Crisis and Alan Greenspan’, October 17, 2007.

European Commission (2014) ‘History of the CAP’,, Accessed May 26, 2014.

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.

Janis, I.L. (1972) Victims of Groupthink, New York, Houghton Mifflin.

Janis, I.L. (1982) Groupthink: Psychological Studies of Policy Decisions and Fiascoes, Second Edition, New York, Houghton Mifflin.

Goodacre, H. (2014) ‘Economics Departments have fallen behind’, Financial Times, May 23, 2014.

Gordon, D.M. (1972) Theories of poverty and underemployment, Lexington, Mass: Heath, Lexington Books.

Grim, R. (2009) ‘Priceless: How the Federal Reserve Bought the Economics Profession’, Huffington Post, May 13, 2009.

Gross, C.C. (2008) ‘Three before their time: neuroscientists whose ideas were ignored by their contemporaries’, Experimental Brain Research, 192(3), January, 321-34.

Kazin, M. (2006) A Godly Hero: The Life of William Jennings Bryan, New York, Alfred A. Knopf.

Krugman, P. (2009) ‘How Did Economists Get It So Wrong?’, New York Times, September 2, 2009.

Kuhn, T.S. (1996) The Structure of Scientific Revolutions, Third Edition, Chicago, The University of Chicago Press.

Lakatos, I. (1970) ‘Falsification and the Methodology of Scientific Research Programmes’, in Lakatos, I. and Musgrave, A. (eds.) (1990) Criticism and the Growth of Knowledge, Cambridge, Cambridge University Press, 91-195.

Ludlow, N.P. (2005) ‘The Making of the CAP: Towards a Historical Analysis of the EU’s First Major Policy’, Contemporary European History, 14(3), August, 347-371.

Schiller, R.J. (2008) ‘Challenging the Crowd in Whispers, Not Shouts ‘, New York Times, November 2, 2008.

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

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