Huge external accounts imbalances between the member states are to blamed partly for the eurozone crisis. Now we need intelligent and coordinated economic policies which will foster sustainable external accounts and thereby contribute to economic stability, writes Paulo Casaca.
Paulo Casaca is director of ARCHumankind and founding member of Euroreform 2014.
2008 marked the beginning of a world downturn which has left Europe facing the worst economic recession in the post-war era. Now, more than five years on, most economies are showing signs of recovery, but despite leaders' feverish efforts the eurozone’s economies remain ailing. The cause of this continued economic hardship lies in making the wrong diagnosis and applying the wrong medication to get our economies back on track.
In order to understand the current situation we need to go back to the foundations of the construction of the euro curerncy: the Maastricht Treaty. The indicators set by Maastricht focused on public budgetary discipline for maintaining stability (max 3% deficit and 60% debt of GDP).
Over the years, compliance with the Maastricht criteria obtained an almost mythical status and, ironically enough, the European Parliament and other European institutions as well as member states drastically reinforced its logic through the recent six pack, two pack, fiscal compact and so forth, exactly when evidence was showing how erroneous this approach was.
The misplaced obsession with these criteria quickly became apparent when the markets attacked many of the eurozone’s periphery economies. Agreed, the public accounts of Greece and to some extent Portugal had poor budgetary credentials. However, this does not support the proposition that there is a causal relationship between economic downfall and inadequate budgetary discipline of the public accounts. In fact, among the countries that were hit most by the economic crisis were some of the Euro area’s best budgetary performers. These are, for example, Spain and Ireland but also the Baltic States which had their respective currencies directly pegged to the Euro.
The real cause for the crisis stems from the huge external accounts imbalances that emerged among the members of the Eurozone. External accounts are the sum of the public and private accounts. Thus, while Maastricht provided for close scrutiny of the public accounts, private accounts remained off the radar. Consequently, private accounts imbalances could grow unabatedly to the point that the economy had to give.
Public accounts can be used as an instrument to equalize private accounts, and thereby to rebalance external accounts. Self-evidently, this requires public budgetary decision making. By imposing strict rules on the public accounts, the Maastricht Treaty prevented eurozone governments of the ability to stabilise their external accounts.
In addition, Maastricht only recognises deficits as problems, while surpluses aren’t considered at all. However, elementary economic logic has it that the surplus of one economy necessarily equals the deficit of another. And so, the persistence of vast and systematic and external imbalances within a monetary union, meaning the chronic persistence of deficits in some member states and surpluses in others, forms a highly explosive cocktail.
Efforts to repair the damage have been surprisingly inaccurate. The “Fiscal Stability Treaty” is a botch-up that is not much more than a reiteration of the Treaty of Maastricht. It continues to consider the current crisis as a public debt crisis and imposes even harsher fiscal and budgetary limitations and stricter control on the public accounts. This new treaty does more harm than good to the European economies as it negatively affects employment figures and consumer price stability.
Another factor contributing to much of today’s economic hardship relates to the lack of a proper regulatory framework in the Euro construction for banking activities. Indeed, a monetary union cannot be built without regulating its banking activities for the performance of the former is closely interconnected with to the activities of the latter. Plans for the development of a banking union are on the table, but so far only watered down versions of such a union have been proposed.
As for the ECB, Maastricht provided all safeguards for maintaining the ECB’s independence from the political playfield. But surprisingly enough, no concern was raised with the most obvious risk: the ECB’s lacking independence from their professional associates – the banking sector.
In dealing with the eurocrisis, the ECB was also limited. As per the Maastricht Treaty, the ECB is prohibited from acting as a ‘lender of last resorts’. Therefore, it had to make to with makeshift policies to deal with the crisis. Because of this the Eurozone performs remarkably poorly when compared to monetary systems that do have the disposal of fully-fledged central banks such as the UK, US and Japan The monetary policies in these countries – although debatable and far from perfect – have brought improvements in growth and unemployment rates, while the opposite is true for the EU.
If no fundamental changes are made to the legal and institutional fundaments of the Euro, an endless slump scenario similar to the Japanese of the last decades will become a permanent phenomenon. The inability to get to the roots of the problem and solve the Euro-crisis has seen its expression in a wave of euroscepticism that has reached unprecedented proportions.
Member states must acknowledge that the stability of the euro and thereby sustainable growth and favourable employment figures should be central in the monetary union. In order to achieve that, a dynamic system of economic policy coordination has to be adopted, allowing public accounts to be used as an external accounts stabiliser, and ensuring restrictive budgetary policies for those members with external deficits and vice versa. With these measures a smarter euro would be created, a euro that applies intelligent and coordinated economic policies which will foster sustainable external accounts and thereby contribute to economic stability.
More on the study 'EuroReform 2014' written by Paulo Casaca and Nerea Artamendi can be found at www.eureform.org