Seven theses on the eurozone
A summary of heretical arguments on current accounts and fiscal
Free Lunch has long taken somewhat out-of-the-mainstream positions on international macroeconomic policy and especially as it applies in the eurozone. For your weekend musings, here are seven theses about current accounts and fiscal union.
The first three are about external surpluses and deficits of national economies, or current account asymmetries, as I insist on calling them. That is a better term than the more common “imbalances”, which builds into the terminology a sense of something that cannot be sustained (after all, being out of balance is to be ripe for a fall). But as the theses below suggest, asymmetric current accounts can be both sustainable and desirable.
1. The cyclical growth impulse from an economy’s trade and capital flows with the rest of the world is a function of the change in the current account (as a share of gross domestic product), not its level (as a share of GDP).
That is not to deny that a country’s external balance can affect short-term demand growth in its trading partners — so-called aggregate demand externalities. But it is to insist that it is a change in the external balance that imposes such an externality. An increase in an external surplus, and indeed a reduction of an external deficit, is a drag on growth elsewhere, but a constant surplus is not.
2. For aggregate demand externalities in the eurozone, what matters are changes in intra-eurozone current account asymmetries.
It is mistaken, therefore, to blame Germany for reducing growth in the eurozone after the financial crisis. Its surplus with the rest of the monetary union shrank in 2011-13 and has remained constant since. That means it cushioned the recession in the periphery. What is true is that its growing surplus with the rest of the world passed the eurozone’s aggregate demand contraction in that period on to other parts of the global economy.
3. Current account levels asymmetries can matter for financial stability (as opposed to aggregate demand externalities). That is because they add up over time to excessive stocks of cross-border liabilities. But that is only so if they are out of proportion to economic growth in the recipient economies, and if they take the form of hard-to-restructure claims such as debt.
Some implications of these theses are that Europe’s monetary union should want asymmetric current accounts, not try to avoid them. Part of the promise of the euro is to make it easier for capital to flow to the economies that have the least of it and where it should therefore be the most productive. But the eurozone should also push capital flows away from shorter-term debt instruments towards very long-term debt or ideally equity-type investments. That is both less destabilising and more likely to be well invested.
As for fiscal union, the term is used to mean many things — common borrowing; or a eurozone budget; or compensation mechanisms for countries in economic trouble. Here are four theses that apply to “fiscal union” in the basic sense of “insurance against shocks”, that is to say temporary transfers based on unpredictable events so that nobody can expect to be a net recipient or loser ahead of time (actuarially fair insurance, in the jargon).
Fiscal union is proposed as a solution to a whole list of challenges; in fact it may not be the best solution to any of them.
4. Fiscal union (in this sense) is neither necessary nor sufficient for national fiscal countercyclical stabilisation.
It is not necessary so long as one allows national-level fiscal policy to be sufficiently countercyclical, and so long as there is market access (on which see the next point). It is not sufficient because the scale will be too small (the US fiscal union cushions only about 20 per cent of idiosyncratic shocks to state economies). It is also not sufficient because if any transfers are truly temporary and will later have to be paid back, then markets will take this into account when assessing the creditworthiness of a country in crisis. That takes away from the overall ability to stabilise a national economy if it makes government borrowing from markets more expensive than it would otherwise be.
5. Fiscal union is neither necessary nor sufficient for sovereign “safe liabilities” — that is to say, for governments to have market access.
Note that market access is not a binary matter; the question is what price a government has to pay to borrow. With a sufficiently long-term debt structure, temporarily high interest rates are affordable. Fiscal union is also not necessary because further alternatives exist: central bank support such as the European Central Bank’s programme to intervene against speculation that a country may leave the euro; or in extremis, various forms of debt restructuring starting with the subordination of the outstanding debt stock to new bonds.
Fiscal union is not sufficient for the same reason as above: since risk-sharing is essentially a form of borrowing, limited transfers can have counterproductive effects on the cost of normal government financing.
6. Fiscal union is neither necessary nor sufficient for “safe assets” often thought to be needed as benchmarks for a stable private financial system.
It is not necessary because there are alternatives, such as the proposed European Safe Bonds. Besides the ECB can always issue its own liabilities for this purpose. It is not sufficient because not all forms of fiscal union would create a common bond; and none would realistically create it in sufficient quantities.
7. Fiscal union is neither necessary nor sufficient for eurozone-level fiscal countercyclical stabilisation.
It is not necessary because the European Commission can use its power over national budget policy to pursue a common fiscal stance for the eurozone. It is not sufficient because any fiscal union mechanism to insure against national shocks may have no ability to stabilise economic fluctuations that affect all countries at the same time.
None of this makes a fiscal union undesirable. But to the extent that it is politically resisted, it is wise to realise that there are alternatives. A combination of smarter structuring of cross-border financial claims, better use of the eurozone’s fiscal rules (which the treaty does not just allow but arguably requires) and a greater acceptance of debt restructuring — together these go a long way to restoring national fiscal policy to its rightful place.
When, in addition, efforts on private financial markets — the banking union and capital markets union — eventually secure risk-sharing through private channels, there is little left for a fiscal union to do.