The systemic crisis of the euro-zone: A result of internal contradictions Robert Guttmann (Hofstra; UP13-CEPN) Joint Seminar–EPOG (04/11/2015)

The European Union : a logic of continuous integration for 60 years European Coal and Steel Community (1950). European Economic Community (1957) => customs union with common trade policy. Single European Market (1987) -> common market, free movement of L and K. Maastricht Treaty (1992) => Economic & Monetary Union => intro of euro in Lisbon Constitutional Treaty (2009) => new governance for the European Union.

Systemic contradictions within the European integration process Contradiction between the simultaneous deepening of the EU (=> United States of Europe) and its widening (consecutive steps from 6 to 28 country members). Conflicting views about the nature of Europe’s federalism : market-oriented approach vs a strong policy role for governments.

Two major biases at the center of the EU’s modus operandi (I) I/ The monetarist bias (& anti-Keynesian philosophy) « Political independence » of the ECB. Inflation = the primary evil to be avoided. « Hard money » policy by the ECB. Balanced government budgets & « no bail out » clause => no help for countries with large deficits. Preference for overvalued currency. Prohibition against central bank’s monetization of government debt.

Two major biases at the center of the EU’s modus operandi (II) II/ The mercantilist bias Market-oriented view has been gaining ground. Export-led growth strategy by dominant countries : Germany & neighbors (Austria, Netherlands, Denmark) => high-saving rates, large trading surpluses, fiscal discipline => non cooperative tax & social policies based on competition

The €-zone is facing a dramatic challenge of adjustment among its members 1) The €-zone does not meet Mundell’s criteria for an optimal currency area which becomes a problem when a heterogenous « union » is hit with a shock. 2) Need for alternative adjustment mechanism when ER and IR no longer available. Mundell specified following: A high degree of labor mobility Wage and price flexibility Fiscal transfers from stronger to weaker states Synchronized business cycles among OCA members 3) In absence of those, only alternative is painful « internal devaluation » (i.e. depression of deficit countries) made worse when surplus countries refuse their share of adjusting.

Divergent evolution of EMU countries following the launch of the euro Two groups of countries : « mercantilist countries » (Germany & neighbors) : low inflation, undervalued currency, export-led growth, trade surpluses « southern countries » (PIGS) : higher inflation, low real interest rates, overvalued currency, higher debt, consumption-led growth, large macroeconomic and external imbalances

GDP growth rate Domestic demand growth rate Inflation rate (GDP deflator) Real interest rate (long term) Wage share in GDP Change in perc. point Public balance % GDP Net public debt % GDP Current account balance % GDP France Germany Netherlands Austria Ireland Italy Spain Greece Eurozone UK United States Table 1 : Major macroeconomic indicators Source : H. Mathieu & H. Sterdyniak (2010)

EU government debt crisis ( ) = Stage II of global systemic crisis Contrary to expectations, the euro-zone has been hit harder by the financial crisis than the US : the Greek crisis was first stage of a crisis-contagion process to hit the most fragile €-zone countries Two major causes : – The subprime crisis = an asymmetric shock due to strong heterogeneity among countries in €-zone -> widening gap between both groups of countries. – There has been inadequate crisis management: Lack of solidarity, strong political divergencies. European institutions not adapted to tackle the crisis.

Bail-Out and Adjustment Programs 1) Greece -> three bail-out packages and one extension. Second bail-out imposed losses on creditors -> triggered banking crisis. 2) Ireland -> has made a lot of post-bailout adjustment progress. 3) Portugal -> adjustment progress, but slow growth and lack of competitiveness. 4) Spain -> just banking bailout, but worked due to macro-econ. adjustment -> rebalance success. 5) Cyprus -> bank bail-out + public-sector debt.

EU Crisis Management Tools and Structural Reform Initiatives 1) ECB programs: LTRO, OMT, huge bond-purchase program 2) 750bn€ EFSF (2010) + 500bn€ ESM (2013): bail-out funds 3) Pact for euro (2011): strengthen fiscal-policy SGP (“fiscal pact”), structural labor-market reforms. 4) Banking Union: single banking supervisor (ECB), unified deposit insurance, EU-wide resolution regime. 5) Further reforms: EIB-issued project bonds bought by ECB for infrastructure investment; capital-market union. 6) More ambitious reform ideas: bigger EU budget (with mutualized Eurobonds and ECB monetization) for transfer union; debt restructuring (with Eurobonds);

Is the crisis of €-zone behind us? The answer is yes and no. => YES, because: sovereign-bond yields have fallen across board to low levels and are stable (even amidst Greece crisis of ‘15); euro is at much more competitive level; bailout countries have succeeded with difficult adjustments. => NO, because: necessary reforms, even though already gone half-way, are not enough to allow for more coherent and growth-oriented EU; macro-economic policy mix keeps EU in managed depression; political sentiments are shifting in the wrong direction; EU is only one shock away from a dangerous debt-deflation spiral.

Conclusion The crisis raises the question of the long-term viability of €, even EU (amidst other divisions, like crisis of migrants undoing Schengen). €-zone crisis revealed incomplete institutional architecture of the euro’s construction. Political biases and institutional constraints continue to feed slow growth and unsustainable imbalances in EU. While worst has been averted so far, it is not clear that the current calm will prevail.