I set out yesterday the main economic test for would-be reformers of the European monetary union. The only essential reforms are those that help prevent self-reinforcing downward spirals in the economy of a eurozone member, and above all the sort of instability that could make the euro itself fall apart. Bastardising slightly the argument made by Mario Draghi, eurozone countries must be able to engage in Keynesian macroeconomic demand management. That means safeguarding the economy’s ability to cushion spending as much as possible from repercussions from shocks to income — whether that stabilisation happens through private or public channels.
The fears of such “death spirals” are not unreasonable: they did enormous damage to the European (and indeed global) economy in the years 2010-12. But to assess the merit of prospective new reforms, we must first take stock of the big steps that have already been taken since then. How far does the completed work take us in preventing a future crisis from developing like the last one?
The answer is: quite far, both institutionally and in terms of policy experience.
For fiscal stabilisation, the European Stability Mechanism has half a trillion euros worth of financing for cash-strapped sovereigns. What is more, the writedown of Greek public debt in 2012, without the sky falling, taught policymakers that sovereign defaults can be restructured within the euro, and illustrated good legal techniques for doing them.
For macroeconomic stabilisation via private markets, a game-changing decision in the summer of 2012 was to launch a European banking union. It was endowed with two significant components. One was the Europeanisation of banking rules, regulation and supervision, with the creation of supranational bodies (the single supervisory mechanism and the single resolution board) to ensure a consistent application of uniform rules. The other was the decision to require “bail-in” — a writedown of banks’ debt — before taxpayers could foot any losses.
Both components go a long way towards removing hindrances to cross-border banking and, in time, to boost cross-border ownership as failing banks are taken over by others. It also lessens the bank-sovereign “doom loop”. Bail-in means public finances need no longer be dragged down by a sick banking sector; and since writing down bank debt is a form of recapitalisation, it should boost banks’ ability to sustain credit flows, lifting growth and with it public finances.
There is another set of changes that is not acknowledged often enough. There have been huge improvements in policy choices. The universal switch to fiscal tightening in 2010, coupled with interest rate rises in 2011, are primarily to blame for the fact that the eurozone had a second recession while the US kept growing. Since then fiscal policy has been put in neutral (and the European Commission made a timid attempt at advocating eurozone-wide fiscal expansion), and monetary policy has been much more stimulative. What is more, policymakers went from treating sovereign and bank debt restructuring as anathema to deploying both. Finally, the European Central Bank has explicitly assumed the duty of countering perceived “redenomination risk” in financial market bets on a country leaving the euro.
We should recognise how much difference all this makes. In a future crisis, a hard-hit country could: seek an ESM emergency loan (or in extremis, restructure its debt); let investors take the hit for bank problems and quickly recapitalise them through creditor bail-in; and expect a less counterproductive macroeconomic policy at the eurozone level and ideally at home.
What, if anything, is missing? Banking union could do with a more committed implementation, and some further tightening of the rules could help. If bail-in is fully adopted, there is less pressing reason for common eurozone fiscal backing for either bank resolution or deposit insurance; these are not so much must-haves than nice-to-haves.
The change of heart in favoured policy choices, too, needs to be more firm — macroeconomic policies by governments and the ECB have remained too timid — and must be translated into the conditions set for any future ESM programme. The procyclical policy demands attached to previous emergency loans caused huge damage; if the ESM is to help again, it must accept policies that sustain domestic demand rather than make any downturn worse. More broadly, the fiscal rules must be understood in a more growth-friendly way — as they should be since their purpose is to ensure sustainable debt burdens. That is only possible through solid growth.
This is the crux of the matter. If, in a future severe downturn, eurozone policymakers revert to the policies that make things worse (as a condition for emergency lending, or otherwise), they will reproduce a similar balance-of-payments crisis with the risk for euro membership it entails. This is the prospect feared by those who say further, more powerful stabilisation tools are needed. Proposals vary — and we survey them tomorrow — but they largely come in two forms. One is some automatic fiscal insurance mechanism, where taxpayer money from all eurozone countries is used to buttress spending in crisis-hit states. The other is some form of joint government security to ensure that sovereign borrowers always have access to financing for countercyclical budget policy.
This is the trade-off that needs to be resolved. Either existing tools and policies are clearly dedicated to allowing proper countercyclical policy, or new tools and institutions that can do this automatically, are needed.
- Gabriel Zucman and his colleagues have posted the latest instalment of their path-breaking work on profit shifting and tax avoidance. They “estimate that close to 40 per cent of [global] multinational profits are shifted to low-tax countries each year” and show “that the global rise of the corporate capital share is significantly underestimated”.