THE EUROPEAN UNION AND THE EUROCRISIS

Why did it happen (2002)?

• Why have multiple currencies in a single market?

• Similar beliefs: monetarism, market liberalism

• Geopolitics: to anchor Germany in Europe after

unification

Why was the currency union

flawed?

• No optimal currency area: economy works differently in

different parts of the European Union

• Insufficient labor mobility

• No federal budget to offset depression in one area

Eurocrisis 2008+

Key events

Lehman Brothers is allowed to go bankrupt (US)

German Chancellor Angela Merkel declares no European

guarantee for failing banks – it’s a national responsibility

National governments pay bank bailouts through DEBT

(2009-2010)

Speculation against Spanish and Italian government debt

(summer 2011)

Why no warning?

• Delusions of market rationality and deregulation

• Economic boom: top 1% in heaven.

• Lenders (north) and borrowers (south) benefit

• Governments, banks, rating agencies buy in.

• Wrong diagnosis: real threat was imbalances in the

economy (real estate bubble, financial deregulation)

— not government budgets

• Wrong medicine: focus on government debts

It’s not government debt

It’s the housing bubble (. . . and other bubbles)

Government debt = result of bailing out banks

. . . and speculation !

Why delayed problem solving?

National identity

No federal budget

Difficult to reform the rules

So: technocratic solutions

• Solution one: ad hoc intergovernmental loans (2009+)

• Solution two: the European Central Bank creates

liquidity (from 2012) and regulates big banks (from

2016)

• Solution three: tighter supranational surveillance of government deficits (from 2015)

Should Europe have a Fiscal Union?

Fiscal union is the integration of the fiscal policy of nations or

states. Under fiscal union decisions about the collection and

expenditure of taxes are taken by common institutions, shared by

the participating governments.

EU is no fiscal union, but:

• Sets framework rules on consumption taxes and sets trade tariffs

• Spends an annual budget of appr. €140 billion (=$154 billion) [vs.

$3.8 trillion US federal budget)

• Since 2013 (not for Britain, Czech Republic, Croatia)

• Ceilings on spending & debt + automatic correction (fines if non-

compliance)

• Coordination of economic policy (not binding)

Political problems

• Austerity (government cuts) is unpopular and unfair:

low growth, rising inequality

• North vs. South conflict

• Declining trust in European institutions

• Rise of populism

Austerity and Growth (2009-2013)More austere countries have a lower rate of growth

Gro

wth

ra

te

Austerity = the average annual change in the cyclically adjusted primary surplus

Source:

Paul

Krugman

(2015)

Economic fall-out: rising unemployment

Social fall-out: rising inequalitySocial fall-out: rising inequality

Systemic fall-out: declining trust

Southern Europe: declining trust in democracy

R=0.67

anti-EU pro EU | Total

-------------+----------------------+----------

non-populist | 22 140 | 162

|

-------------+----------------------+----------

populist | 46 13 | 59

|

-------------+----------------------+----------

Total | 68 153 | 221

|

Political fall-out: rise in populism

Anti-Europe populism: vote strength in 2014-15

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gr

esp

fr

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nl

uk

port

aus

fin

svbul

cz

hun

lat

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pol

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10

20

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40

50

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0 10 20 30 40left populist and anti-EU

DIAGNOSIS

• Populist parties thrive on anti-austerity, anti-

immigration, anti-solidarity, anti-trade, anti-EU

• Polarization

• But . . .

• Mainstream pro-EU parties still

control governments

• Strong supranational institutions

• 2009-10: Purchase of sovereign bonds (relax criteria for

collateral)

• Dec 2011: Long Term Refinancing Operation (LTRO) which

provides cheap money to commercial banks

• Sept 2012: unlimited sovereign bond-purchasing provided that

country enters into Commission-monitored austerity pact

• 2014: banking union (single supervisor = ECB)

• 2015: further increase in liquidity

• Jan 2016: banking union in effect: stress tests for largest banks

+ insurance fund (8% bail-in required)

Solution one: the European Central Bank steps

in

• Tighter surveillance (2011+)

beyond budget deficit into competitiveness indicators (unit labor costs, labor productivity, hiring/firing, pension schemes, labor

force participation rates)

• Crisis management: European Stability Mechanism (2013) to

provide bridging loans and debt restructuring

Solution two: monitoring among states