The EMU reform ruse – Part 1

On October 31, 2017, my blog – Europhile Left deluded if it thinks reform process will produce functional outcomes – countered some of the nonsense coming out of Europe (from the so-called progressive side) that the Eurozone hadn’t failed when judged by it bias towards mass unemployment and increasing precariousness of its citizens. I particularly noted the terrible record in terms of youth unemployment and NEETs. Yesterday’s blog – Massive Eurozone infrastructure deficit requires urgent redress – documented how much damage the austerity bias of the Eurozone has caused to essential productive infrastructure – human and physical and the ridiculous underinvestment by governments locked into mindless Stability and Growth Pact (and its recent derivatives) rules. Unphased, the Europhiles keep telling me that reform processes are underway and that we need to be patient. That the glorious vision outlined in the October 1990 European Commission Report – One Market, One Money Report, which, apparently outlined a vision of domestic-demand driven convergence bliss for the Economic and Monetary Union. I analysed that Report in detail in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale – and have to say that anyone who holds it out as a plan for the future must have been reading a different report or affected by heavy drugs. Today, I am considering recent reform proposals put forward by German academic Fritz Sharpf, who considers the neoliberal Eurozone experiment has failed but can be resurrected without abandoning the essential mechanics of the monetary union. Tomorrow, I will start to consider a so-called progressive proposal that breaks the EMU into two tiers – a Northern hard currency zone and a ‘Southern’ zone where nations reintroduce their own currencies, but peg them against the euro with ECB support. It will not surprise regular readers to know that I disagree with Sharpf’s reform agenda.

The European Commission’s – One Market, One Money Report – was published soon after the Delors Report came out, which provided the blueprint for the Treaty of Maastricht.

At that time, there was very little detailed economic analysis provided to support the excess of hubris coming out of the Delors process.

Charles Wyplosz reflected in a 2006 article that:

Policy-makers rushed to negotiate a detailed agreement, having no time for detailed economic analysis

[Reference: Wyplosz, C. (2006) ‘European Monetary Union: The Dark Sides of a Major Success’, Economic Policy, 21(46), April, 207-247.]

The One Market, One Money Report was one major piece of analysis published by the European Commission in 1990 that sought to provide some analytical backing to the Delors Plan.

The analysis used deeply flawed economic models (including the notoriously poorly performed IMF Multimod model), which generated sympathetic results reflecting the assumptions made.

These models are held out as ‘neutral’ tests of policy propositions but are, in fact, so laden with theoretical biases that they are incapable of providing the role of the ‘independent umpire’. The expression GIGO (Garbage In, Garbage Out) is apposite.

It was 341 pages of guff. Self-reverential guff designed to advance the neoliberal vision that has become the Eurozone.

Further, the Report’s construction of ‘macroeconomic stability’ in the analysis was solely in terms of “better overall price stability”.

The Europhiles all talked about a broadening of domestic markets as a result of the EMU. But, even the Report admitted that it was reasonable to assume that:

… the degree of integration of markets will be high for capital, still limited but increasing for goods and services, and low for labour.

One could say the Internet has done more for increasing integration of goods and services markets than the EMU has ever done or could do.

But the point is that the Report was not about Member States being able to maintain robust domestic demand to ensure full employment. It was about price stability more than anything else. And the model was the German model or “the reputation for monetary stability of its least inflationary Member States” – same thing.

The authors admitted that while stability (low inflation) and growth would be part of the overall macroeconomic performance of the proposed EMU, a “quantified estimate of the potential impact of EMU is not feasible” (p.9). Their modelling could only predict lower output variability rather than stronger growth.

The analysis also asserted that while an independent central bank should be created, “the case for centralized powers over budgetary policy is much weaker” (p.13).

It claimed that the EMU would enhance:

… autonomy (to respond to country-specific problems), discipline (to avoid excessive deficits) and coordination (to assure an appropriate overall policy-mix in the Community.

This was the mantra to get France (the autonomy bit) and Germany (discipline) to agree. But in that compromise it became obvious that the latter would dominate rather than the autonomy.

It further lathered this by saying that “the loss of monetary and exchange rate policy as an instrument of economic adjustment at the national level … should not be exaggerated … the … EMU will reduce the incidence of country-specific shocks” and:

Relative real labour costs will still be able to change; budgetary policies at national and Community levels will also absorb shocks and aid adjustment, and the external current account constraint will disappear.

However, in almost contradiction of itself, it recognised that if tight fiscal rules were used to coordinate national-level fiscal policy positions then the ability of nations to absorb ‘shocks’ in economic activity would be reduced, especially given that the capacity for exchange rate adjustment would be eliminated.

Yet, they still advocated tight fiscal restrictions.

The report recognised that “national level stabilization and adjustment in the case of country-specific disturbances” (for example, a collapse in private spending as occurred in many nations in 2008) “requires flexibility and autonomy, at least within a normal range of sustainable public deficit and debt levels” (p.23).

And they drew on the false authority of the “model simulations” that claimed to show that:

… the Community would have been able to absorb the major economic shocks of the last two decades with less disturbance in terms of the rate of inflation and, to some extent also, the level of real activity.


History has proven those statements very wrong indeed.

Fiscal policy has two components: (a) the taxation and spending settings chosen on a discretionary basis by government and deemed suitable to achieve its socio-economic goals in normal times; and (b) the cyclical or automatic stabiliser component, which refers to the impact of economic activity on the fiscal outcome.

Thus, when economic activity stalls and employment falls, taxation revenue gained by the government declines and welfare payments associated with unemployment tend to rise.

The result is that the fiscal deficit (the difference overall spending rises. Imposing rules on the capacity of fiscal policy to make these adjustments ensures, in most cases, that an economic downturn will cause higher unemployment than is otherwise the case.

I showed in my 2015 book that the GFC shock was so large that the automatic stabilisers alone pushed fiscal deficits above the 3 per cent fiscal threshold that triggered the Excessive Deficit Mechanism and the relentless imposition of austerity that killed growth and drove up unemployment for many years after.

The model simulations were totally wrong. Not just a little bit wrong.

Which was no surprise to anyone who knows how they work and is not intent on using them to pervert the transparency of the political process.

And despite acknowledging that the fiscal rules would inhibit the Member State capacity to respond to a crisis, the Commission report concluded:

Budgetary discipline, in order to avoid excessively high deficits, will need to be intensified …

In other words, they knew that if there were major reduction in total spending (from whatever source), the stabilisers built into the national government fiscal policy would be prevented from working in a normal and flexible fashion by the uniform and tight fiscal rules.

In that context, they knew that unemployment would rise sharply and persist and fiscal deficits would rise, and the only way that nations could obey the proposed fiscal rules would be to attack domestic wages, pension entitlements and public services and infrastructure provision and further push up unemployment.

The economists advising the European Commission knew that but left it unstated and the politicians did not tell the ‘people’ that this was a likely outcome of what they were doing in their name.

The maladministration was stark and the denial was on a grand scale.

The Report’s recommendations were also contrary to the available evidence at the time, which suggested that when central banks prioritise inflation over other macroeconomic goals (such as high output and income growth, and lower unemployment) the real losses arising from lower real output growth and higher unemployment are substantial.

In my 2008 book with Joan Muysken – Full Employment abandoned, we argued that this is not due to the way the central bank is organised (‘independent’ or otherwise).

Rather, it is the ideology that accompanies the ‘inflation first’ monetary policy obsession that damages the real economy because it requires a bias towards fiscal austerity.

Notwithstanding the uncertain effects of interest rate variations, the explicit or implicit fiscal rules restrict the capacity of government to maintain adequate levels of spending in the economy.

Disinflationary monetary policy and tight fiscal policy can bring inflation down and stabilise it, but it does so by creating mass unemployment.

The economists advising the Commission largely ignored the likelihood that these costs would be substantial for the EMU.

They were content to recite the Monetarist doctrine that prioritising a low inflation regime would have little or no negative real output consequences, and would, instead, maximise the growth potential of the economies in question.

Contrary evidence was ignored.

The economists and politicians also knew that these issues were too complex for even the popular press to pick up on and so the evidence could remain ‘buried’ in the arcane world of academic journals and books and the public would be none the wiser.

The 1990 European Commission report, which was the first major attempt at evaluating the costs and benefits of the proposed EMU, concentrated on lesser costs and benefits (for example, not having to change currencies at borders) and ignored the fact that the system they were designing would inevitably create a major recession with entrenched mass unemployment.

It was Groupthink and denial in practice – and millions of European citizens would be deliberately rendered jobless as a result.

Once the Treaty was signed in March 1992, the European Commission and a phalanx of sympathetic economists set about ‘backfilling’ to justify the arbitrary fiscal rules.

They produced a plethora of research papers and reports, which they claimed provided intellectual and evidential authority to justify the decisions that had been made and to ‘prove’ the Treaty parameters were sound.

It was theatre, of the high farce variety.

But the Europhile Left still hold these documents out as authority – as a guide to what the EMU might become if there are a few reforms – like bringing German current account surpluses down to less than 3 per cent, when they have been hovering around 8 or 9 per cent for years with no dynamic to bring them down in sight.

The One Market, One Money Report is among the last document I would ever wheel out to justify anything progressive.

Its sole purpose was to try to justify the rushed Delors Report that denied all the previous reports into possible monetary union and which had concluded, that at the very least, a federal fiscal authority with democratic oversight through the European Parliament would be required.

Fritz Sharpf in his recent proposal to reform the EMU (December 2016) – Forced Structural Convergence in the Eurozone – Or a Differentiated European Monetary Community – noted the One Market, One Money Report articulated the “neoliberal or monetarist” doctrine and was “certain of the additional economic benefits that the single currency would generate”.

However, he notes that:

… the EU members of 1992 have been trailing the OECD in cumulative economic growth and that since 1999 growth in the eurozone has been weaker than in the rest of the EU … From an economic perspective, therefore, two of the great triumphs of European integration do not appear to have been particularly successful in comparative terms.

Which is an understatement.

His paper attempts to outline a reform structure and it is being held out as a viable progressive approach to improving the EMU.

Unfortunately, I do not think that Sharpf’s proposals will solve the problems.

By way of background, Fritz Sharpf recognises that:

1. There have been “real politico-economic and democratic costs imposed by the monetary over-integration of structurally heterogeneous “Northern” and “Southern” political economies”.

2. That the EMU did not create “European capacities that could address the diversity of national economic conditions”.

3. The crisis engendered a policy response that “meant to save the common currency by enforcing structural convergence on the ‘Northern model’.

4. This approach is incompatible with “democratic legitimacy on national and European levels”.

5. Before the EMU, the European states used “the instruments of monetary, fiscal, and exchange-rate policy were still employed by European states” which “did allow democratically accountable governments to signi cantly in uence the economic fate of their countries.”

6. The EMU “removed not only the option of currency realignment but also the capacity to in uence the course of the national economy through national monetary policy”. It was a lie to think otherwise. The design of the EMU deliberately took the capacity away from the Member States despite trying to use the subsidiarity smokescreen to assuage those who raised concerns about democratic oversight and effective use of national policies.

7. The ECB’s “‘one-size-fits-all” policy instruments could not respond to structural divergence and the non-synchronized ups and downs and “asymmetric shocks” of the former hard- and soft-currency member economies”. The policy was too lax for fast growing nations (Greece, Ireland, Spain) and too tight for those struggling (Germany in 2002)

8. “It is also understood that blaming the crisis on the scal irresponsibility of debtor governments was, at best, a half-truth for Greece and totally wrong for Ireland and Spain, where scal performance from 1999 to 2008 had been exemplary – and far better than in Germany.”

9. The Euro leaders “decided to ignore the no bail-out rules of the Maastricht Treaty” when the crisis threatened the survival of the EMU but, also, imposed harsh ‘internal devaluation’, deregulation, public spending cuts and attacks on trade unions “to reduce unit labour costs”.

They followed the “model of German recovery from its deep recession in the early 2000s”, which involved cuts to the welfare state, wage moderation and a suppression of domestic demand.

But, as I argued in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale – the EMU was not a German creation. They were dragged into it by Delors and his gang of neoliberal economists.

Sharpf concurs:

… the EMU was not supported by Germany, but by some of the best and the brightest non-German European monetary economists … along with the Delors Commission and the governments of all countries that later joined the single currency.

The deal was sold as one of “convergence”, which, as he notes, is still the mantra (for example, the Five Presidents Report).

Of course, there was no real convergence before the EMU – the Member States were always fighting the opposite, with the consequence of elevated levels of unemployment, particularly in the nations with external deficits.

They had to be continually suppressing domestic demand to ensure their exchange rates stayed within the parameters of the various (failed) exchange rate systems that were tried after the rest of the world abandoned the Bretton Woods system and floated their rates.

The European nations should have realised in the 1970s that any monetary system that tied them together with one exchange rate would not solve the underlying incompatibility of their economies, and the repeating tensions would require continual damaging ‘internal devaluation’.

Domestic demand repression would replace the often realignments of their currencies, particularly against the Deutsche mark and the use of capital controls, which were banned once the neoliberal Single European Act came into force in 1987.

Enforced structural convergence

Sharpf notes that the current policy of “enforced structural convergence” has largely failed.

He identifies “two structural patterns” among Eurozone economies:

Northern economies, which are structurally defined by the combination of a large export sector with an institutional capacity for wage restraint, include Germany, Austria, the Netherlands, Belgium, Finland and presently Ireland as well, whereas Southern economies, which combine a large domestic sector with industrial relations systems that tend to generate wage-push inflation, include not only Greece, Spain, and Portugal, but also Italy and France.

These differences strain any ‘one-size-fits-all’ policy framework. Sharpf notes that while the reforms emanating from the crisis have led to some changes in this framework, it remains a case that “uniform rules” are being enforced and the “immediate impact will again be asymmetric”.

Further, any reforms to date have “not yet created any additional Eu- ropean capacities for macroeconomic management.”

The EMU is locked into a mentality that policy should focus on “reducing unit labor costs in order to improve international competitiveness – and thus to achieve export-led economic growth”.

That policy emphasis has clearly failed.

I have provided many updates through the last decade analysing shifts in Real Exchange Rates as these supply-side policies were enforced.

Following the crisis, the general tendency has been for real effective exchange rates to decline (improved competitiveness). However, the real effective exchange rate for Greece was only 9.3 per cent lower in May 2017 than in January 2008 despite the massive austerity program it has endured.

By comparison, the real effective exchange rate for Germany fell by 11 per cent over the same period. Of these Eurozone nations, only Ireland improved its position relative to Germany over this period.

So we conclude that the massive internal devaluations that Greece, Italy, Portugal, Spain and Finland endured in this period have not restore competitiveness relative to Germany.

The only reason the external deficits in say Greece have largely disappeared is not because its exports are booming but because the Depression has been so deep that imports have collapsed. If Greece, say, was to resume strong growth, imports would rise and it would be long before it was back in rising external deficit.

And, it is legitimate to then ask what was it all for?

Please read my blog – Latest Greek bailout – a recipe designed to fail – for more discussion on this point.

Sharpf concludes that:

… the economic impact of the present euro regime is fundamentally asymmetric. It ts the structural preconditions and economic interests of Northern economies, and it con icts with the structural conditions of Southern political economies – which it condemns to long periods of economic decline, stagnation, or low growth …

… eight years after the beginning of the crisis, there is no prospect that economic stagnation and underemployment in the South will be over- come any time soon.

Which signifies a system that has failed.

We can all agree on most of that, except the neoliberal hardliners and I do not write to influence their brain-dead positions.

Two reform proposals

Sharpf offers two alternative ways in which the Eurozone can go from here:

Proposal 1: The current approach of enforcing convergence to the Northern model continues so that internal devaluation continues in the weaker economies to bolster the share of exports in national income. Of course, current account balance (or surpluses) can be achieved by suppressing domestic demand, reducing national income and imports without any substantial increase in exports.

Proposal 2: The realities of the Northern export-driven economies and the domestic-demand driven Southern economies be recognised and a “two-level European Currency Community” be established.

This would entail the Northern states remaining within the EMU and the other states (Southern and accession) operating within the so-called ERM II (a left-over from the original Exchange Rate Mechanism that most European states operated within prior to surrendering their currencies.

These states would tie their newly introduced (or current) national currencies to the euro at agreed parities with an allowable fluctuation band to meet exchange rate pressures.

There would be “mutual support” via the ECB and the system of national central banks to defend these currencies against “speculative currency fluctuations”.

Proposal 1 – Convergence to the Northern model

For the remainder of today’s blog, I consider Proposal 1.

Sharpf notes that the – Five Presidents’ Report: Completing Europe’s Economic and Monetary Union – published by the European Commission on June 22, 2015, clearly believes that further ‘convergence’ via harsh supply-side policy enforcement within strict fiscal discipline is the way to proceed.

So, more of the same.

As Sharpf notes this “must indeed be seen as an effort to impose a ‘Germanic’ socioeconomic model on ‘Latin’ societies”, which while in “purely economic terms … does not appear strictly impossible”, will “have the effect of destroying the democratic legitimacy of government in some member states and of ruling out advances toward democratic government in Europe for a long time to come.”

The costs of this strategy are “enormous” and undermine, especially in the Southern states, the political legitimacy of the Brussels-imposed plan.

The Eurozone political leaders would have to retain the power to “constrain and, if necessary, disable the democratic responsiveness of Southern governments and hence the … democratic legitimacy of Southern polities”.

This is not conjecture. Greece demonstrates the democratic deficit in action.

He notes that prior to the creation of the EMU, the Bundesbank adopted an “uncompromising commitment to price stability”, which while allowing it to gain “the pride of having a hard currency”, resulted in “significantly lower increases of income and with declining employment”.

Sharpf concludes that if the current European Commission agenda towards a “structural convergence on the Northern model”, the result would be the same as “the German performance in the 1970s and 1980s”, where the on-going internal devaluations would be “neutralized by a rising euro exchange rate” and the bias towards recession and higher unemployment embedded.

This is inevitable if the German model of the 1970s, where price stability was the major focus, was maintained.

Sharpf claims, however, that if the European Commission was prepared to relax the fiscal constraints and allow inflation to rise then the increased latitude could allow Member States to avoid this cycle of stagnation.

However, there would be “enormous economic, social, and moral transition costs” incurred in the transition, which would be politically difficult to sustain.

The Northern states would be under less transition pressure because they already define the export-led goal. However, for the Southern states, would face major hurdles in achieving “structural convergence” (continued mass unemployment, undermining of opportunities for youth, etc).

Sharpf doesn’t believe that the European Commission will be able to maintain, indefinitely, the narrative that things are heading in the right direction under the current convergence policies and that the costs of “exit” would be astronomical.

People are understanding that the costs of the current approach are massive and will eventually realise that the scaremongering about “the presumed catastrophe of exit” are neoliberal lies.

The problem is that a vast proportion of the progressive Left have been seduced into believing that exit would be the end of the world.

I provide a very different view in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale.

Sharpf also acknowledges that the damage to the Southern states would extend to “the purposeful destruction of cultural and institutional traditions and practices considered part of the collective identity of ‘Latin’ societies”, which makes it a fraught strategy.

This is why it is clear that the European Commission has to trample on the democratic processes in the troubled Member States to ensure the convergence process, damaging though it is to the prosperity of the nations in question, continues.

We have to be clear that the convergence is to similar unit labour costs (wage costs per unit of output) rather than unemployment or wage levels etc.

It is obvious that this strategy is a race-to-the-bottom and will result in many nations (Spain, Italy, Greece, even France) decimating the material prosperity of their citizens just to ensure the export share rises.

As Sharpf notes “the glaring inequality of the regime’s impact on Northern and Southern economies” would undermine the European Commission’s agenda.

The only way that the system has endured is that:

… a coalition between Northern and Southern governments, technocratic European authorities, and a pro-European Parliament that is decoupled from its constituents has so far prevented the politicization of conflicts over the asymmetric euro regime.

In other words, the system is maintained by suppressing the voice of the people.

For if they really understood what was going on and the options that are available (say through the creation of a “Europe-wide mass media, accessible in the languages of all member states”) the elites could no longer maintain this suppression.

I would add that hiding behind all the rhetoric of rules and processes is a European Commission that has corrupted its own rule of law. It is obvious that the ECB has defied the no bail-out clauses to use its currency-issuing capacity to fund fiscal deficits in most of the Member States.

If it hadn’t broken the laws, the euro would have been abandoned in 2010 or perhaps 2012 when Italy was nearing insolvency.

Eventually, the continued push to make all the Member States like Germany will fail and the political backlash that will occur (and is occurring) will undermine the EMU.

Sharpf, concludes that it is better to adopt more pragmatic reforms to ensure the entire monetary system is maintained but the weaker-currency nations are allowed more flexibility.


Tomorrow, I will consider his second, more reform-like proposal to save the euro and provide some national policy space for the weaker nations within Europe, which is currently denied under the harsh structural convergence approach being pursued by the European Commission.

That is enough for today!

(c) Copyright 2017 William Mitchell. All Rights Reserved.

This Post Has 4 Comments

  1. “Eventually, the continued push to make all the Member States like Germany will fail and the political backlash that will occur (and is occurring) will undermine the EMU.”

    If only… I’m afraid, and nearly certain, that the built-up pressure will undermine not only the EMU (good riddance), but the Union itself as well as democracy and European peace, since only misguided or autocratic extremists can get a word out about the stupidity.

  2. …”the degree of integration of markets will be high for capital”

    Well, this line says it all, doesn’t it? Also, I’ve read Eurozone Dystopia and your blog today gives me again this weary feeling of being trapped in some kind of horror and not knowing yet what kind of horror. Like it hasn’t yet revealed itself in its full scope. Shock, a commotion underway or “Something doing” as William James would say.

    But maybe also, what is even worse and more disturbing is that nature and human life seem of no importance in the whole Eurozone narratives, they only fret about inflation and price stability while in the meantime life on this planet is reaching it’s limits in that it’s resources are finite.

    Well, Colonel Sanders said it wise; There’s no reason to be the richest man in the cemetery. You can’t do any business from there. In which you can add, even if your dead or alive!

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