It is probably the opportune time now to make a preliminary analysis of the subject, “Euro in Crisis”.
To be honest, I thought that I was the first to use the phrase, “Euro in Crisis”. However, during my research, I came across an article, “Eurozone in Crisis“, published in April 2012 on the website, Counterpunch.org, that was written by Tom McNamara. With superb insight, Tom could already read the writing on the wall at that time and it was not a happy story.
There now exists an unending stream of books, videos, articles and blog posts on this subject. Mostly, the experts and amateurs alike are all in agreement that there are some serious problems, although there is no consensus on the best remedies. The way I see it is that, whilst there exists differing opinions on the actual causes of the problems, the best course of action to address the problems cannot yet be determined.
As an enthusiastic amateur and an interested follower of these events, I am going to add my opinion onto the growing pile.
At the outset, I must clearly state that my opinions and conclusions are derived from purely informal study and research that I have conducted over the past year or so. I have no formal education in economics or politics and I claim no special expertise. However, I have an inquisitive mind that never tires with the task of forever questioning the status quo.
My primary goal is to use this blogging platform as a formalized record of the evolution of my thinking and logic.
My secondary goal is to stimulate debate and criticism of my point of view.
The one aspect of this whole subject that concerns me the most is that the “Euro in Crisis” lobby do not seem to be able to persuade the majority of the EU citizens that:
- A crisis actually exists in the Eurozone; and that
- Every EU citizen needs to understand what the problems are and how these are affecting the people; and that
- Every EU citizen needs to make an informed choice of what remedy they will support; and that
- Every EU citizen needs to understand the full consequences of their decision.
Euro in Crisis:
The formation of the Economic and Monetary Union (EMU) was enshrined in the Treaty on the European Union (the Maastricht Treaty) in 1992. The objectives of the EMU were:
- Coordination of economic policy-making between Member States
- Coordination of fiscal policies, notably through limits on government debt and deficit
- An independent monetary policy run by the European Central Bank (ECB)
- Single rules and supervision of financial Institutions within the euro area
- Adoption of the single currency and the creation of the euro area
The common currency, the Euro, came into official use in 1999.
All EU countries are members of the EMU. However, the process of finally adopting the Euro as a country’s national currency is effectively a 3 stage process. Two countries, Denmark and the United Kingdom, have ‘opt-out’ clauses in the Treaty exempting them from adoption of the Euro (ie. continuing on to the third stage). The other 9 non-Euro countries are “en-route” to adopting the Euro, although with differing amounts of enthusiasm.
The term “Euro” refers to the common currency in use and the countries that use it are often referred to be in the Eurozone.
Economic governance within the EMU
Within the EMU there is no single institution responsible for economic policy. Instead, the responsibility is divided between the Member States and the EU institutions. The main responsibilities of the EMU are divided as follows:
- The European Council – sets the main policy orientations
- The Council of the EU (the ‘Council’) – coordinates EU economic policy-making and decides whether a Member State may adopt the euro
- The ‘Eurogroup’ – coordinates policies of common interest for the euro area Member States
- The Member States – set their national budgets within agreed limits for deficit and debt, and determine their own structural policies involving labour, pensions and capital markets
- The European Commission – monitors performance and compliance
- The European Central Bank (ECB) – sets monetary policy, with price stability as the primary objective and act as central supervisor of financial Institutions in the euro area
- The European Parliament – shares the job of formulating legislation with the Council, and subjects economic governance to democratic scrutiny in particular through the new Economic Dialogue
Problems start to appear:
As the effects of the 2007/2008 Global Financial Crisis spread across to Europe, the problems peaked towards the end of 2012 with the European debt crisis. The inability of the mechanisms of the EMU to cope effectively with the problems were acknowledged by many senior EU politicians. In December 2012, the four presidents of the European Council, European Commission, ECB and Eurogroup issued a report entitled “Towards a genuine Economic and Monetary Union”. The report outlined the details of the first reform plan for implementing actions that were required to ensure the on-going stability and integrity of the EMU.
Stage 1: Ensuring fiscal sustainability and breaking the costly link between banks and sovereigns (2012-13)
Stage 2: Completing the integrated financial framework (banking union) and promoting sound structural policies (2013-14)
Stage 3: Improving the resilience of EMU through the creation of a shock-absorption function at the central level (2015 and later)
To be fair to the EMU, it must be acknowledged that much of what they set out to achieve in the Stage 1 round, was done. However, critics of the substance of the actions completed point out that none of these actions have achieved much real benefit.
Stages 2 & 3 did not really get going before it was realised that a different approach was going to be needed.
In June 2015, a follow-up report entitled “Completing Europe’s Economic and Monetary Union” was issued by the five presidents of the European Commission, the Euro Summit, the European Parliament, the European Central Bank and the European Council. The report outlined the second EMU reform plan (2015-25) that would implement further EMU-deepening actions, that were required to ensure a smooth functioning of the currency union and to allow the member states to be better prepared for adjusting to global challenges:
- Stage 1 – “Deepening by Doing” (1 July 2015 – 30 June 2017): using existing instruments and the current Treaties to boost competitiveness and structural convergence, achieving responsible fiscal policies at national and euro area level, completing the Financial Union and enhancing democratic accountability.
- Stage 2 – “Completing EMU” (by 2025): more far-reaching actions will be launched to make the convergence process more binding, through for example a set of commonly agreed benchmarks for convergence which would be of legal nature, as well as a euro area treasury.
Enhancements and changes required in four policy areas have been identified:
- Economic Union
- Financial Union
- Fiscal Union
- Political Union
In October 2015, the Commission began work on implementing the recommendations contained in the “Five Presidents’ Report”. More details, including the full report are available on the 10 priorities website of the Commission: A Deeper and Fairer Economic and Monetary Union.
So that is the official story, up to where we are today. Whether any of these proposals are good enough and far reaching enough, is being currently debated by supporters and critics alike. Here is an expert’s analysis of the trouble that the Euro is in.
In an article on his blog titled “Doomed from the start“, posted on 10 February 2010, this is what Bill Mitchell had to say regarding the formation of the EMU:
When I step back and think about all this in a longer context, the only conclusion I can consistently reach is that there is a madness present.
First, the nations’ leaders agree to surrender their currency sovereignty – they didn’t have to but chose to. They largely mislead their citizens with spurious arguments about optimal currency areas and the rest of the sophistry that the neo-liberal economists happily fed them.
In doing so, they give up their monetary policy independence and so differential circumstances cannot be dealt with by variations in interest rates.
Second, they then invented ridiculous fiscal constraints which have no basis in anything that relates to the way the real economy and the monetary system interacts. Mostly these constraints were a reflection of long-standing suspicions (racism, etc) – that is, they were ideological and political.
Third, Germany then introduces harsh labour market reforms to not only screw their own workers but also to ensure that the other EMU partners are behind the 8-ball.
Fourth, the EMU bosses refuse to introduce any fiscal redistribution capacity to ensure the member states achieve similar growth in real living standards.
Fifth, when the whole thing melts down due to its design and the German strategy, the nations which are now in extreme crisis are told they have to introduce harsh pro-cyclical fiscal policies to savage living standards of their citizens.
a) I think that it is now abundantly clear that the system of the EMU contains fundamental flaws that are adversely affecting the countries that use the Euro as their unit of currency. These adverse effects exist, to a greater or lesser degree, in most if not all of the Eurozone countries (19 countries).
b) The problems of the EMU have, in turn, placed undue pressure on the political framework of the European Union (EU). And this is even more the case concerning the countries in the actual Eurozone. Of course, the problems with the Euro, as an integral part of the EU system, cannot be looked at in isolation from some of the political problems that exist in the EU. Whereas the shortcomings in the EU have scope for adjustments, changes and even minor transformation, the serious problems that have been exposed in the design of the EMU do not seem to have straight forward or simple remedies. So far, despite all their best efforts, the EU bureaucrats are struggling to gain some headway.
c) Most EU policies can be changed or adjusted, without too much difficulty I think, to better satisfy the requirements of a modern and evolving Europe. I am sure that the EU is a “work in progress” and will likely look and operate differently in the future compared to the way it looks and works today. I believe that there is the desire and motivation to do this. The EMU, on the other hand, is a much harder nut to crack. However, whatever changes are made in the EU framework are unlikely to have too much effect on the fundamental problems of the EMU, unless of course the ultimate step is taken…..the dissolution of national sovereign states and the formation of a federation, “The United States of Europe”. But that is maybe getting a bit too far ahead of ourselves.
d) Perhaps the biggest problem in the EMU, that underpins all of the other problems, is the disparity in the economic, monetary and fiscal conditions that existed, and still exist, between each EMU country. This problem was supposed to have been overcome by the requirement that each Member State would attain the convergence criteria before it would be admitted into the Eurozone. In theory, this was a sound and necessary principle and it was understandable and seemed to made perfect sense. Then, once a country was within the criteria, it would be expected that it would be able to remain so or, in the unlikely event that a country strayed outside the limits, pressure would be applied to force the transgressor to get back into line. However, reality proved to be very different.
In 2006, a study/analysis was done by Professor Sławomir I. Bukowski, Ph.D., Head of the Department of International Business & Finance, University of Technology and Humanities in Radom, Poland. His specialty is economics. He published a paper titled “The Maastricht Convergence Criteria and Economic Growth in the EMU“. Although the professor appears to be highly educated in his subject, I cannot pass any judgement as to his knowledge or expertise. The reason why I have drawn your attention to his study is to highlight the difference between reality and theory. Since this is the basis of the EMU, the study is so steeped in theoretical assumptions in order to arrive at its positive conclusions that it is frightening. Read the complete study and decide for yourself.
Convergence criteria are, to some extent, a consequence of adopting theories of optimum currency areas and cost and benefit analysis of creating a single-currency area as the foundation of the monetary union of the European Community. Fulfillment of convergence criteria should be of durable character and this requires a certain degree of real convergence among the monetary union countries. The analysis of the significance of convergence criteria which has been carried out in this paper indicates that despite numerous extra-economic premises for adopting them in the Maastricht Treaty, their implementation is an important factor enforcing macroeconomic stabilization in the EMU countries and the countries which aspire to the EMU accession.
From the point of view of the theory of economics as well as from the point of view of empirical studies it cannot be declared unambiguously that the convergence criteria pose a barrier to economic growth. This matter is controversial, yet it may be concluded that implementation of these criteria by the EMU member countries and the countries which are waiting for joining the Union is an important factor of the long-run macroeconomic stabilization and balanced economic growth in the EU. Naturally, [there] are other factors apart from this one.
Low economic growth rate and relatively high unemployment in the EU countries result, first of all, from such factors as: overregulating of economies (including labour market), rigid wages and prices, excessively developed social policy, high taxation burden for population and enterprises, too big budgets which should be reduced while reducing taxes and expenditures at the same time. Therefore, economic reforms aiming at creating institutional and structural conditions for efficient functioning of market mechanisms are indispensable. These reforms should aim at increased flexibility of markets, prices and wages, lower taxation and reduced role of the state in economy.”
So, what are the convergence criteria?
The convergence criteria are formally defined as a set of macroeconomic indicators which measure:
- Price stability, to show inflation is under control [The Consumer Price Inflation rate must not to be more than 1.5 percentage points above the rate of the three lowest inflation Member States].
- Soundness and sustainability of public finances, demonstrated by having limits on government borrowing and national debt to avoid excessive deficit [Government deficit must not exceed 3% of GDP and government debt must not exceed 60% of GDP].
- Exchange-rate stability, through participation in the Exchange Rate Mechanism (ERM II) for at least two years without strong deviations from the ERM II central rate.
- Long-term interest rates, to assess the durability of the convergence achieved by fulfilling the other criteria [The nominal long-term interest rate must not be more than 2 percentage points above the rate of the three lowest inflation Member States].
Once a country became a member of the EU, it undertook to abide by the Stability and Growth Pact (SGP). The purpose of the pact was to ensure that fiscal discipline would be maintained and enforced in the EMU. The fiscal discipline of the SGP required each Member State to implement a fiscal policy that ensured that the country stayed within the convergence criteria. All EU member states are obliged, each year, to submit a SGP compliance report for the scrutiny and evaluation by the European Commission and the Council of Ministers. The report presents a country’s expected fiscal development for the current year and the subsequent three years.
These reports are called “stability programmes” for Eurozone Member States and “convergence programmes” for non-Eurozone Member States, but despite having different titles they are identical in regards of the content. If a Member State breaches the SGP’s outlined maximum limit for government deficit and debt, the surveillance and request for corrective action will intensify through the declaration of an Excessive Deficit Procedure (EDP); and if these corrective actions continue to remain absent after multiple warnings, the Member State can ultimately be issued with economic sanctions (See here and here for examples of how this is done [or not done]…..is this a joke?)
Just to see how well the SGP is working and to see how close the EU countries have been sticking to the rules, have a look at these:
- Price stability (CPI) – this graph.
- Government deficit – this graph.
- Government debt – this graph.
- Long term interest rates – this graph.
Conclusions regarding the Preliminary Analysis:
- The disparity in the economic, monetary and fiscal conditions that exist between each EMU country make it nearly impossible for a one-size-fits-all policy to be able to satisfactorily meet the requirements of each country. Therefore the EMU framework, in its current form, cannot and will not, ever, properly satisfy the requirement of having all countries being prosperous within a prosperous and harmonious EU.
- Realistically, it is improbable to expect that greater economic, monetary and fiscal convergence is likely to happen in the near future. The EMU project has been under way for 25 years and, on the whole, things are now worse than when the project started.
- Currently, the system is stumbling along, neither providing the basis for economic improvement but neither collapsing entirely. A sort of equilibrium has been reached whereby the richer, more prosperous, low unemployment countries will remain much as they are while the poorer, less prosperous, high unemployment countries experience very little or no improvement in their current situations. This assumes that there will be no external shocks experienced to push things over the edge.
- The politicians have realised that there are problems and have made proposals for changes. However, the EMU is still pursuing the one-size-fits-all policy. For all the reasons stated above, I deem this policy to be fundamentally flawed.
In a follow up post, I will attempt to look in greater detail at the issues and challenges facing us and the possible solutions.