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Why the Eurozone is destined to fail

Last night I gave a keynote presentation in Melbourne at the – Can the Eurozone survive its Crisis? – which is hosted by the Monash University European Union Centre. The event was well attended and the chaired by the Ambassador and Head of Delegation of the European Union to Australia and New Zealand David Daly. He closed the night by saying that we shouldn’t judge the Eurozone because it is a “work in progress” and the elites are on the case. The question of-course, is – how long must the millions of unemployed and disadvantaged wait? How many more well-catered for Summits in Brussels must the citizens tolerate? The discussant for my paper was a free market self-confessed right-winger who ended up agreeing that the Eurozone is doomed. Along the way he demonstrated a lack of understanding of basic economics and eventually had to raise Weimar as his major attack on government spending. Apparently, he also thought full employment was undesirable. A picture of Von Hayek appeared at one point. The other panel member was Dr Natalie Doyle who is currently acting as the Head of the Centre and an authority on European culture and politics. I have been travelling today and so have had little time to write. But I thought I would just share a few things with you that arose from last night’s seminar.

The following video is an edited version of my presentation (taking out various ahs and ums and anecdotes) over the slides I presented. You can get a full copy of the slide show HERE (pdf formatted slides).

The volume fluctuates (as I walked around) and you may need to turn it up a bit in sections (and perhaps down in other sections). The edited presentation goes for 39 minutes.

During question time, the General Consul of Greece (in Melbourne) one Eleni Lianidou, who is a lawyer by background took exception to the whole event. She complained that the organisers had rigged the agenda and made it unbalanced because there was not a pro-Euro economist speaking. I believe the organisers tried to get a technical economist to debate the monetary issues with me but could not come up with one.

The best they could find was a political scientist from Latrobe University (one Stefan Auer) who professed his right-wing leanings and said he favoured the free market. He kept talking about command economies and stalags and made the extraordinary comment that having everyone employed is inefficient and can only be achieved via a Stalinist economy.

Clearly he didn’t grow up in Australia in the Post-World War 2 period (up to the 1970s) when there was less than 2 per cent unemployment, zero underemployment and only cyclical hidden unemployment – that is, true full employment – and we all seemed pretty free. I was youthful at that time but didn’t see too many goose-stepping authority types hunting us down each day to control our movements or ideas. It wasn’t Shangri La but, equally, it wasn’t remotely like Stalinist oppression.

I pointed out to the Greek Consul that the claims of bias could not be maintained when we considered the debate in overall terms. The view that I have (based on Modern Monetary Theory (MMT)) is hardly popular and gets swamped in the media by the mainstream macroeconomists – the deficit terrorists.

Those that claim an event is biased because it doesn’t give the mainstream a jersey rarely complain when the overwhelming majority of events do not include a non-mainstream voice.

But the Greek Consul continued to air her views in Q&A. She claimed that it would be ridiculous for us to think of kicking Queensland out of Australia just because the state suffered from very bad floods (and a cyclone) earlier in 2011. So why should the Eurozone fall apart – was her attempted analogy.

Free kick! I pointed out that when Queensland (a state of our federal system) suffered the debilitating natural disasters within 24 hours the Federal government announced a massive (billions) assistance package (not a bailout!) and funds flowed immediately. Just as they had when Victoria (another state) suffered very bad bushfires in 2009.

In other words, Australia enjoys a federal fiscal capacity which is used without delay when needed. None of the other states in Australia bemoaned the Queenslanders gaining massive federal assistance. We understood that it was part of being in a federation. We intrinsically overlay a common culture (more or less) onto the monetary union we have where the single currency – the Australian dollar – is issued under monopoly conditions by our federal government (elected by us).

The Greek Consul then claimed the attention given to Europe was unfair because the UK was also double-dipping. So if my analysis of why the Euro is failing was correct then how do I explain the UK.

Free kick Two!

Simple – the UK erroneously thinks it has the same constraints on its fiscal capacity as a member state of the EMU. While the latter are using a foreign currency and must go to the bond markets to fund their deficits, in lieu of the ECB playing a more positive “fiscal role”, the UK government is fully sovereign in its own currency and can deal the bond markets out of the equation any time its central bank desires.

The common element between the UK and the EMU and their respective appalling economic performance is that both regions have embraced the fiscal contraction expansion myth. By imposing fiscal austerity, the governments in these regions are undermining aggregate demand at a time when their private sectors are unwilling to increasetheir spending to drive growth and overall austerity is killing export markets.

By refusing – for ideological reasons – to use the most powerful policy instrument they have – deficit spending – to drive growth and stimulate private sector confidence and revive export markets – all these governments are damaging their economies.

The difference is that the UK can simply stop the nonsense and act responsibly. Within the ambit of its monetary system, the national government has all the capacity it needs to restore prosperity.

However, for the EMU states, they need to change to change the monetary system itself – abandon the common currency and float the restored sovereign currencies – to really embrace a positive direction. The ECB can serve the role of deficit funder but it is better to devolve monetary policy to national boundaries and integrate it with fiscal policy at that level.

My discussant, who said he represented the free market view from the right and was held out as an expert on European matters, at one stage said that I was wrong to claim that austerity was being imposed. He said it was wrong because the member states were still running deficits – that is, there were no budget surpluses being generated.

A first-year macroeconomics student could have answered the question correctly. First, you cannot deduce a shift in the discretionary fiscal stance by considering the budget outcome.

A shift in deficit from 10 per cent of GDP, say to 6 per cent of GDP may indicate a discretionary tightening in fiscal policy but then it might also indicate a strengthening economy and cyclical impacts (via the automatic stabilisers).

In other words, you cannot tell from the information provided anything about the discretionary fiscal stance adopted by the government

But in outright terms, a budget deficit that is equivalent to 10 per cent of GDP is more expansionary (overall) than one that is 6 per cent of GDP.

To see the difference between these statements we have to explore the issue of decomposing the observed budget balance into the discretionary (now called structural) and cyclical components. The latter component is driven by the automatic stabilisers that are in-built into the budget process.

The federal (or national) government budget balance is the difference between total federal revenue and total federal outlays. So if total revenue is greater than outlays, the budget is in surplus and vice versa. It is a simple matter of accounting with no theory involved.

But the reason we cannot conclude that changes in the fiscal impact reflect discretionary policy changes relates to the operation of the automatic stabilisers. To see this, the most simple model of the budget balance we might think of can be written as:

Budget Balance = Revenue – Spending.

Budget Balance = (Tax Revenue + Other Revenue) – (Welfare Payments + Other Spending)

We know that Tax Revenue and Welfare Payments move inversely with respect to each other, with the latter rising when GDP growth falls and the former rises with GDP growth. These components of the budget balance are the so-called automatic stabilisers.

In other words, without any discretionary policy changes, the budget balance will vary over the course of the business cycle. When the economy is weak – tax revenue falls and welfare payments rise and so the budget balance moves towards deficit (or an increasing deficit).

When the economy is stronger – tax revenue rises and welfare payments fall and the budget balance becomes increasingly positive. Automatic stabilisers attenuate the amplitude in the business cycle by expanding the budget in a recession and contracting it in a boom.

So just because the budget goes into deficit or the deficit increases as a proportion of GDP doesn’t allow us to conclude that the Government has suddenly become of an expansionary mind.

Nor does a rising deficit tell us that the government is not pursuing fiscal austerity. In fact, it is likely that when a government does attempt to cut its discretionary net spending at a time when non-government spending is weak, that the impact on aggregate activity will be so negative that the cyclical budget effects will drive the overall outcome towards a higher deficit.

To overcome this uncertainty, economists devised what used to be called the Full Employment or High Employment Budget. In more recent times, this concept is now called the Structural Balance. The Full Employment Budget Balance was a hypothetical construct of the budget balance that would be realised if the economy was operating at potential or full employment. In other words, calibrating the budget position (and the underlying budget parameters) against some fixed point (full capacity) eliminated the cyclical component – the swings in activity around full employment.

So a full employment budget would be balanced if total outlays and total revenue were equal when the economy was operating at total capacity. If the budget was in surplus at full capacity, then we would conclude that the discretionary structure of the budget was contractionary and vice versa if the budget was in deficit at full capacity.

It is clear that austerity is being imposed in Europe once you look more deeply into the data and see what is happening to the cyclical and structural components.

But it also remains true that the total deficit outcome (the sum of the structural and cyclical components) tells us the public sector impact on aggregate demand and the higher that is as a proportion of GDP the more expansionary is the impact of the government sector.

Please read my blogs – Structural deficits and automatic stabilisers and Structural deficits – the great con job! – for more discussion on this point.

Finally, the summing up by the Chair (David Daly) was interesting because it was so official line that in the context of the evening it appeared to be almost surreal.

He said that we should not consider the Euro a failure because it was a “work in progress”. He said that the EU leaders have realised that the design problems were in need of correction and had taken a number of steps – bailout fund (Mark 1 and 2) and the fiscal compact.

He also said that the process of introducing the Euro was essentially democratic according to the individual processes of each of the member states (in ratifying treaties) and that the people had wanted the Euro.

He considered that as a work in progress we had to give it time.

But we are now 5 years into the crisis (nearly). More than 50 per cent of willing youth workers in Spain and Greece are unemployed. Many more underemployed. In some nations overall unemployment is rising to 25 per cent and will continue to rise as austerity deepens.

The bond markets are no nearer being appeased than they were 2 years ago. The focus has just shifted from Greece for a while to Spain and soon Italy and on it will go.

With a whole generation of Europeans (the youth) imperiled by the policy folly how much longer can Europe wait to “give it time”?


A more normal blog will appear sometime tomorrow.

That is enough for today!

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    This Post Has 17 Comments
    1. “My discussant, who said he represented the free market view from the right and was held out as an expert on European matters, at one stage said that I was wrong to claim that austerity was being imposed. He said it was wrong because the member states were still running deficits – that is, there were no budget surpluses being generated.”

      You can hear this almost every day on the broadcast news – assertions that “there are no cuts” because “government spending” is still rising.

      The imbecile John Redwood was also to be seen incanting his mantra about the state still “crowding out” the private sector.

      You have to wonder which planet they live on.

    2. Bill, will you be speaking publicly in Sydney some time soon? Your work is truly brilliant and I’d love to hear a speech in person

    3. “Hence, the enormous quantity of excess reserves can create an even greater expansion in the money supply. While discussions of the money supply are nearly nonexistent in modern monetary theory and policy, both economic theory and historical experience suggest that a significant and persistent expansion in the money supply will be associated with a significant increase in the longer-run inflation rate.” . … discuss.

    4. Bill,
      Thanks for publishing your talk and your notes on what happened at the conference.

      Off topic a little – On BBC Radio 4 tonight there is a talk by Sir Mervyn King, Governor of the Bank of England. It starts at 21.00 British Summer Time and lasts 45 minutes.

      Happy listening.

    5. I would bet my house that he will be able to present himself as the genial “safe pair of hands” in “difficult circumstances” and that he will not be asked why mainstream economic predictions were, and continue to be, impressively incorrect.

    6. “My discussant, who said he represented the free market view from the right and was held out as an expert on European matters, at one stage said that I was wrong to claim that austerity was being imposed. He said it was wrong because the member states were still running deficits – that is, there were no budget surpluses being generated.”

      “We distinguish between the “pure fiscal expenditure” and the published total expenditure. The “pure fiscal expenditure” or simply, fiscal expenditure of the textbook variety is defined as the sum of government consumption and government gross investment whereas the published total expenditure equals this pure fiscal expenditure plus transfers. Excluding transfer payments (i.e. transfers to financial sector and automatic stabilisers like higher unemployment benefits that were a consequence of the higher unemployment levels) allows us to consider the impact of the discretionary fiscal stimulus. That is, “pure fiscal expenditure” is the government expenditure relevant for computing the Keynesian fiscal multiplier. While a large literature defines countercyclical fiscal policy as one with positive correlation between fiscal surplus and output, we focus on actual government spending. We agree with Kaminsky, Reinhart and Vegh (2004) that one needs to focus on government instruments to smooth business cycles, not on outcomes like fiscal deficit, that are endogenous. For example, the government may be raising tax rates in the recession and cutting expenditure, yet running a fiscal deficit because the tax base is smaller.”

    7. acorn,
      I read the document you linked to. As far as the quote you picked up on, they seem to make an assertion about “both economic theory and historical experience”, without going into any detail – perhaps someone should ask them to explain further. They have also clearly indicated with the big blue writing on page one, that they believe that banks lend reserves, which of course they do not.

      Kind Regards

    8. An excellent presentation but virtually nobody will listen until it is too late for the poor Euro-lemmings. Humans are not rational and they generally make moral judgements based on intuition. I’m currently reading “The Righteous Mind: Why Good People are Divided by Politics and Religion” by Jonathan Haidt. It offers an in-depth explanation why we are generally immune to evidence making moral judgements.

      I believe it goes like this:
      “To print money – what a disgusting thing! It will lead to hyperinflation and whatever. I hate that. But all the money is “printed”. So what? But it is still disgusting and bad. I hate that and I am wiling to allow anyone to suffer but I’ll not print.”

      Anyway – they have in Europe prof Kazimierz Laski in Vienna who has been saying similar things for years. They listen to him as much as First Secretary of the Communist Party Wladyslaw Gomulka listened to Michal Kalecki. It all ended in a social disaster just a few months after Kalecki died (December 1970).

    9. acorn, please Bill’s blogs on the money multiplier such as … or, or

      because that is essentially what you’re talking about. You may also like to read this –

      “Simple textbook treatments of the money multiplier give the quantity of bank reserves a causal role in
      determining the quantity of money and bank lending and thus the transmission mechanism of
      monetary policy. This role results from the assumptions that reserve requirements generate a
      direct and tight linkage between money and reserves and that the central bank controls the
      money supply by adjusting the quantity of reserves through open market operations. Using data
      from recent decades, we have demonstrated that this simple textbook link is implausible in the
      United States for a number of reasons” ….

    10. Dear Bill,

      I thoroughly enjoyed our discussion. Even though we had different views on possible solution, I think our positions were closer to each other in terms of identifying the severity of the current situation. I thought your readers might be interested in my perspectives:

      The most recent article I published in the Australian on Monday, 30/4:

      A longer study arguing that the single currency is at the heart of Europe’s current problems:

      and a study that argues that German strategy is bound to fail:

      All the best,
      Stefan Auer

    11. According to your own theoretical framework, a federal europe doing deficit spending at the federal level is an equally good solution as the principalities each introducing local currencies and doing the same at principality-level. Economically the choice is neutral, or if anything biased towards the federal solution due to economies of scale, so why are you pushing for the divisive version rather than federalism? As it cannot be for economic reasons, one can only conclude your bias is purely political, that is your politics are aligned with that of the European far right who also support principalities going alone (for arguably other reasons). For someone who pretends to be left wing and a progressist, this is a bit puzzling…

    12. Cig, it is the powers that be that divide in order to rule Europe. The mad Euro design managed by the ECB tyrants impose austerity on nations like Greece, create self-fulfilling prophecies of their debts’ unsustainability, wreck their economies, and unemploy & impoverish millions. If the European far right don’t want to have their nations enslaved, then more power to them. By that token, in that very important regard, they are far to the left of, far more progressive than the fake left – which is sadly most of the left in Europe.

      The choice is go along with ECB austerity & oppression, in this oh-so-wonderful federal Europe or go alone, because that’s the choice that the powers that be present them. Of course the individual states should make their case to the Eurocrats with sane MMT economics – if they could deprogram themselves. The most potent weapon in the hands of the oppressor is the mind of the oppressed. They haven’t even deprogammed themselves to the extent of issuing Mosler bonds.

      But even if they did – look at what happened to Papandreou when he tentatively suggested that democracy means people voting, rather than marching to orders from ones’ betters. A firestorm of abuse, betrayal & criticism from his own government & party, and quick unceremonious replacement by an apparatchik appointed from on high. The Czar is not Good. The Eurocrats & the Euro governments, and worst of all, too many of the electorate have been brainwashed by the innumerable innumeracies of modern mainstream “economics”.

      Abba Lerner criticized this trend of thought about monetary union long ago, as “sentimental internationalism”, saying that real union cannot come in this rigid top-down way. Thoughts that are more timely than when he wrote them, for the major object of his critique, the Bretton Woods institutions & exchange rate rigidity were far more flexibly & wisely designed, with far better will, than the absurd Euro & ECB. The Eurozone is a forced, imposed unity, an inflexible tyranny. The Euro is a racket, run by fanatical, ultimately mindless, gangsters. A lasting, strong, real unity is unlikely to arise from such utter lack of influence from the bottom up, such corruption, such utter contempt for democracy & the genuine, urgent needs of the citizens of Europe.

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