Tag Archives: National Bureau of Economic Research

Why The Monetary Union Is A Failure

Over the last months it’s become quite clear that Europe‘s monetary union (EMU) is – more or less – a failure. So, what happened? And what do we do now? In this article professor Kevin O’Rourke provide a comprehensive explanation of the why’s and how’s, and put forward some suggestions for possible solutions of the greatest crisis in modern European history.

“Whether EMU can survive in the long run if the status quo persists is an open question.”

Kevin O’Rourke

“In order to understand why EMU happened, we often turn to the familiar Mundell-Fleming monetary policy trilemma. Given intra-European capital mobility, the decision by a subset of EC members to move to EMU was a logical, if radical response to the challenges posed by this trilemma. However, the institutional framework of EMU is seriously flawed,” Kevin O’Rourke writes.

Kevin O’Rourke is Professor of Economics at Trinity College Dublin, a co-organiser of the CEPR’s Economic History Initative, a Research Fellow of the National Bureau of Economic Research, and a Member of the Royal Irish Academy.

He received his PhD from Harvard in 1989, and has taught at Columbia University, UCD, Harvard, and Sciences Po (Paris).

He is currently serving as President of the European Historical Economics Society, and an Editorial Board member of World Politics.

Here is professor O’Rourke’s recent article, syndicated by www.eurointelligence.

A Tale of Two Trilemmas

For decades economists have argued that fiscal union was a desirable, and perhaps indispensable, complement to EMU.

What we now know is that a common euro zone framework for regulating financial institutions, and dealing with the consequences of their failure, is equally important.

We have a monetary union with neither of these complementary institutions, and it is clear that this architecture is not fit for purpose.

How did we end up here, and what happens now?


To answer these questions it is helpful to turn to what Dani Rodrik has labelled the “fundamental political trilemma of the world economy”. Rodrik argues that “we cannot simultaneously pursue democracy, national determination, and economic globalization.

“If we want to push globalization further, we have to give up the nation-state or democratic politics. If we want to maintain and deepen democracy, we have to choose between the nation-state and international economic integration.”

And if we want to keep the nation-state and self-determination, we have to choose between deepening democracy and deepening globalization” (Rodrik 2011, pp. xviii-xix).

The argument is that “deep globalization” involves a commitment to not just open commodity and capital markets, with the constraints that these imply, but also to a competition for mobile factors of production that makes it difficult for national governments to adopt regulatory standards or other interventionist policies, even when their populations want this.

The solutions are either to allow popular opinion to manifest itself through supra-national mechanisms, or to ignore it.


EMU solves the political trilemma by abandoning national monetary policy-making, and delegating it to a technocratic Central Bank.

The fact that this has occurred without fiscal union, or common banking policies, can be well understood within the trilemma framework.

Regarding fiscal policy, the combination of the nation-state and democracy has prevented deeper political union: German voters (among others) do not want a transfer union, while Irish voters (among others) do not want a common tax system.

When it comes to banking regulation, on the other hand, the combination of deep economic integration and national policy-making has made it very difficult to respond to the clear demands from citizens for far stricter banking regulation.


It seems that EMU is stuck between two trilemmas, one economic and the other political. Where do we go from here?

There are several features of EU politics which are relevant in thinking about this issue.

The first is the question of governance: how decisions should be made at a supranational level is a contentious issue, which can again be illustrated by means of the trilemma. For most people, ‘democracy’ involves direct elections to parliaments which legislate.

One could leave European decision-making to the European parliament, but the nation-state remains the basic focus of political identity and authority, and national governments remain centrally involved in the process.

One solution would be to prioritize national parliaments and the nation-state: one could then have intergovernmental cooperation, but this would involve national vetoes, and it is hard to see a particularly proactive EU emerging in such a scenario.

The other solution is what we have: an essentially intergovernmental mode of decision-making that gives rise to accusations of a ‘democratic deficit’. This has created a constituency in Europe that is hostile to further integration.


The second relevant feature of EU politics is the international cleavages that exist regarding EMU. In particular, German citizens were opposed to it at the time, and this has political implications today.

The third feature is the existence of sharp intra-national cleavages in opinion regarding the EU in general, and EMU in particular.

The unskilled and the poor tend to be opposed to both, while the skilled and the rich tend to be in favour. The potency of these divisions was illustrated in the 2005 and 2008 referenda in France and Ireland, where voters divided largely along class lines.

Superimposed upon these long-run political cleavages are the effects of the global crisis of 2008-9, and the present banking crisis.

In principle, the global financial crisis could have led people to view the EU as a port in the storm, and there is an element of this in the Irish referendum approving the Lisbon Treaty in 2009. On balance, however, Eurobarometer surveys indicate that attitudes towards the EU have become more negative during the crisis, while there has been a fairly dramatic deterioration in trust in the institutions of the Union.

The interaction between a sharp economic crisis in several countries, and underlying class-based or national hostility to EMU, could turn out to be a potent one.

Even more serious could be the mishandling of the banking cum debt crisis. The decision of the ECB to veto the new Irish government’s desire to impose burden sharing on private bank bondholders is extraordinary, and provides Irish eurosceptics with an extreme example of the democratic deficit in action.

Meanwhile, taxpayers in Finland and elsewhere are revolting against the notion that they should bail out their profligate partners – recognising that this is a European banking crisis that needs a European solution might help change perceptions.

So would recognise that an end to regulatory competition in the financial sector would be a more logical concession to be sought from the Irish, in return for cutting interest rates, than an increase in their corporate tax rate.

Whether EMU can survive in the long run if the status quo persists is an open question.

Governments have tended to muddle between the stark trade-offs implied by the political trilemmas, but this crisis may force them to confront those trade-offs head-on.

What happens then is anyone’s guess.

By Kevin O’Rourke

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European Investors Secure Profits

European investors seems to secure their profits Monday morning, as most stock markets slide. According to Saxo Bank, the cancelation of the merger between BHP Billiton and Rio Tinto is one of the reasons why investors are taking a little break. However, focus is still on earnings.

“Apple will the first major company that is reporting on how the state of the consumer globally is holding up and look especially for Apple’s assessment on how 2011 looks from a consumer perspective.”

Christian Tegllund Blaabjerg


Lately we’ve had a very strong surge in risk taking, supported various times by Federal Reserve chairman Bernanke stating that more stimuli may be needed to help the economy gain traction again. In addition,  earnings so far has been pretty strong across the board pushing investor confidence quite high. But the cancellation of the deal between BHP Billiton and Rio Tinto in creating the world’s largest iron ore producer seems to be the trigger that made market participants take home some of their profit, analyst Christian T. Blaabjerg points out.

However, it’s still about earnings, Blaabjerg underline.

“So, look out for earnings from Apple, Citigroup and IBM today,” he writes adding that the major macro release today is the US Industrial Production.

Consumer confidence continues to languish in recessionary territory, but retail sales continue to power ahead (0.6% MoM).

“Industrial production is a major release today and we expect the report to show that production stagnated in September after a weak increase of 0.1% MoM in August. We expect production to remain unchanged (0%), and question how much of the recent increases in production have been due to inventory rebuilding? Likewise, capacity utilization is expected to remain unchanged,” Saxo Bank says.

The NAHB (National Association of Home Builders) housing market index will also be released today. This is usually a good indicator of the developments in that market though it does not garner too much attention from the markets.

“The confidence report continues to draw a weak picture of the state of the American consumer, which suggests that the recession never ended.”

The University of Michigan Confidence survey declined to 67.9 in September from 68.2 (preliminary) as job concerns and high debt levels continue to weigh on consumer sentiment.

We note that Saxo Bank now has reached the same conclutions as several other prominent economists and commentators:

“The confidence report continues to draw a weak picture of the state of the American consumer, which suggests that the recession never ended (it did officially in June 2009),” Blaabjerg notes.

The average reading in recessions since 1975 is in fact 68.9, so the last two reports are in recessionary territory (and August was spot on the recession average).

“Expansions – which we supposedly are in now – are averaging around 89.2, so the surveyed better listen to the National Bureau of Economic Research and not care about their balance sheet problems: this is a recovery!”

“We do not expect any material increase in the consumer indexes in the coming months as Americans are figuring out that the recovery was mostly fuelled by stimulus spending and a general bounce back in global trade.”

Business inventories makes another strong display, rising by 0.6% in August following the 1.1% increase in July.

“This is quite positive for third quarter growth (inventory additions positively affect GDP growth), but the question remains: are companies restocking too fast? Will it simply mean much weaker net additions in September and Q4? We think the inventory readjustment cycle has mostly run its course and any net inventory addition going forward will simply drag GDP growth forward, but will not be sustained in the quarters ahead,” the Danish analyst writes.

All About Earnings

Last week we had solid earnings reports from the majors – Intel, JPMorgan, Google and GE.

“This week and next week are the major trend settings weeks in terms of getting direction on how you should expect the remains of the earnings season to play out; so look very carefully,” Saxo Bank advises.

“Apple will the first major company that is reporting on how the state of the consumer globally is holding up.”

 

Christian Blaabjerg

 

“As we have stated before we expect an above average earnings season with at 70% beat, less growth in margins and sales still sluggish. Today’s companies to look for is clearly Apple (global consumer exposure), Citigroup (financial), Halliburton (oil services) and to IBM (technology services). Apple will the first major company that is reporting on how the state of the consumer globally is holding up and look especially for Apple’s assessment on how 2011 looks from a consumer perspective. So far the private consumption is sluggish in some parts of the world, but has not dropped as much as e.g. investments.”

“Citigroup is interesting after we had the class leader, JPMorgan out last week. Especially look for their comments on the development in their credit portfolio and how they expect the housing issue to affect their balance sheet. Halliburton will tell us something on the demand for oil because oil services are very short term sensitive to the development in the oil price and finally IBM will provide us with an insight as to how the outsourcing in companies are progressing, market strategist Christian Blaabjerg concludes.

Today’s Calendar

GMT Event Saxo Bank Consensus Previous
13:00 US Total Net TIC Flows (AUG) $63.7B
13:00 US Industrial Production (SEP) 0.2% 0.2%
13:15 US Capacity Utilization (SEP) 74.8% 74.7%
14:00 US NAHB Housing Market Index 14 13
16:55 US FED’s Lockhart gives speech on Economy in Savannah

Economic data highlights Saxo Bank Consensus Actual Previous Revised
EC CPI MoM (SEP) 0.2% 0.2% 0.2%
EC CPI MoM (SEP) 1.8% 1.8% 1.8%
EC Trade Balance (AUG) 0.0B -4.3B 6.7B 6.2B
CA Manufacturing Sales MoM (AUG) 0.5% 2.0% -0.9% -1.1%
CA New Motor Vehicle Sales MoM (AUG) -5.0% -4.8% 2.4% 2.2%
US CPI MoM (SEP) 0.2% 0.1% 0.3%
US CPI YoY (SEP) 1.2% 1.1% 1.1%
US Advance Retail Sales (SEP) 0.4% 0.6% 0.4% 0.7%
US Empire Manufacturing (OCT) 6.00 15.73 4.10 4.14
US University of Michigan Confidence (OCT) 68.9 67.9 68.2
US Business Inventories (AUG) 0.5% 0.6% 1.0% 1.1%

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