The last quarter of the 19th century
witnessed a period of sustained global deflation. In the 1896 U.S. presidential
election, William Jennings Bryan famously attacked the gold standard as
the cause of deflation, declaring ''You shall not press upon the brow
of labor this crown of thorns. You shall not crucify mankind upon a cross
of gold.''
Today, Euroland is being crucified upon its own cross of gold - the institutional
arrangements behind the euro. Those arrangements have distorted the monetary-fiscal
balance, creating deflationary central bank dominance. That balance needs
correction and failure to do so could even risk the viability of the euro
in its current form.
The euro was introduced in 1999, the high-water mark of neoliberal economics.
As such, its institutional design embeds neoliberal monetary theory which
in many regards rests on the same economic principles as the gold standard.
These principles are that fiscal policy is ineffective; inflation is caused
exclusively by money supply growth; and the real economy quickly and automatically
returns to full employment in response to negative shocks.
Principles discredited
All three principles have been fundamentally discredited by the current
recession. Around the world, countries have turned to fiscal policy to
offset the collapse of private sector spending, and the recession would
have been far deeper absent that fiscal response. Money supplies have
risen dramatically almost everywhere without matching increases in inflation,
showing that the money-inflation link is highly contingent upon economic
factors such as unemployment, capacity utilization, commodity prices,
and business expectations of profits. Finally, rather than rebounding
to full employment, the global economy looks set for high unemployment
that will last years. This possibility was Keynes’ message in his 1936
General Theory.
Owing to its neoliberal monetary arrangements Euroland has run smack into
these economic realities. The European monetary union (EMU) establishes
central bank dominance through an independent central bank that is prohibited
from providing financial assistance to member country governments. Thus,
whereas the US and UK have been able to finance their fiscal and financial
market rescue plans with assistance from the Federal Reserve and Bank
of England respectively, eurozone governments have received no equivalent
assistance. Instead, they have had to fend for themselves in private capital
markets, which has raised the costs of policy and dissuaded more aggressive
action.
Not only do these monetary arrangements contribute to sub-optimal fiscal
policy, they are also aggravating fissures within Euroland. The periphery
economies of Greece, Italy, Portugal, and Spain, suffer from high public
debt, large budget deficits, high unemployment, and lack of competitiveness.
Capital markets are therefore driving up periphery country bond rates
and aggravating their financial distress. Meanwhile, these economies no
longer have their own exchange rate or interest rate to restore full employment
and financial balance. Consequently, their sole internal adjustment mechanism
is deflation, which is counter-productive in a situation of high indebtedness.
Embrace expansion
Given this, the stronger European economies must embrace expansion and
act as an economic locomotive for the periphery economies. But instead,
the European monetary system imposes a deflationary bias by restricting
fiscal space, while Germany has shown persistent recalcitrance toward
expansionary policies and exports deflationary pressures.
Part of escaping this trap requires rebalancing monetary-fiscal relations
and increasing access to money-financed fiscal policy. To this end the
European Central Bank (ECB) should establish annual country loan quotas
set according to each country’s economic size and output gap, making them
a form of automatic stabilizer. This would create a mechanism for countries
to monetize part of their budget deficits. In the current environment
it would provide a flow of low-cost deficit financing that would facilitate
periphery country rebalancing, while also providing an expansionary impulse
in Europe’s core economies.
Additionally, the ECB should establish emergency stand-by country loan
facilities that would be governed by pre-determined policy conditionality.
In effect, the ECB would act as an analogue International Monetary Fund
(IMF) for euro member countries.
This has direct relevance for Greece’s current financial crisis. Having
Greece borrow from private capital markets at exorbitant interest rates
only compounds the country’s financial burdens. Alternatively, having
the IMF bail out a euro-member country will damage the euro’s standing
as a reserve currency and it too makes no sense. Greece needs euros to
refinance its debt and the ECB is the logical source given it is the ultimate
creator of euros.
Lastly, to counter potential inflationary consequences, the ECB could
be given discretion regarding distribution of seignorage dividends resulting
from issue of currency and bank reserves.
Monetary reform alone will not bring prosperity to Euroland. That will
also require breaking with the neoliberal approach to labour markets and
macroeconomic policy. However, monetary reform is a necessary ingredient
and absent such reform Euroland faces stagnation and protracted high unemployment.
Moreover, some financially weaker member countries may be forced to exit
the euro because of financial market pressures or domestic political discontent.
Either way, this could have potentially devastating global economic consequences,
which means all countries have an interest in EMU reform.