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Options for Europe – Part 39

The title is my current working title for a book I am finalising over the next few months on the Eurozone. If all goes well (and it should) it will be published in both Italian and English by very well-known publishers. The publication date for the Italian edition is tentatively late April to early May 2014.

You can access the entire sequence of blogs in this series through the – Euro book Category.

I cannot guarantee the sequence of daily additions will make sense overall because at times I will go back and fill in bits (that I needed library access or whatever for). But you should be able to pick up the thread over time although the full edited version will only be available in the final book (obviously).


It promoted the Monetarist mantra about central bank independence and the need for “fixing money supply targets” (European Parliament, 1989: 334) despite the fact that central banks cannot fix such targets. This fact was evident in the 1980s, after central banks, who had become infested with the Monetarist doctrine, found it was impossible to closely target money supply growth. That failure exposed the poverty of Monetarist theory but didn’t quell the enthusiasm for it among those who had adopted it by way of ‘religious’ affiliation.

The European Parliament was just part of the Monetarist ‘cheer squad’ and supported the central bank being legislated to adopt as its sole charter an inflation-first policy with no repsonsibility for economic growth and full employment and no capacity of elected governments to influence that policy. In particular, the Resolution claimed the “European Central Bank would be federal in nature” and “based on on what are long-established national central bank structures” (p. 335) but failed to note that in these long-established federal structures, the central banks and the treasuries cooperated closely to ensure on monetary matters, which ensured that federal fiscal policy could maintain prosperity across the federated states. In the Parliament’s vision, Europe didn’t need a federal treasury. How wrong they were.

By October 1990, nuances had appeared in the European Parliament’s ‘Resolution on Economic and Monetary Union’ (European Parliament, 1990), which effectively stated the position of the Parliament in the lead up to the IGC, scheduled for December 1990 (Piodi, 2012:). This Resolution was based on a report presented by Belgian member M.Fernand Herman, who sat on the Committee on Economic and Monetary Affairs and Industrial Policy. Under Article 1, the term “autonomous European Central Bank” was used (European Parliament, 1990: 63), whereas the Resolution on the process of European monetary integration’ passed on April 14, 1989 had indicated that the European Central Bank would be part of a system of European Central Banks and that the “Central Bank of each Member State of the European Monetary Union should … be indepdendent of the corresponding political authority” (European Parliament, 1989: 334). Piodi (2012: 59-60) notes that the term ‘autonomous’ was “fully illustrated” in the Herman report and refers to the “ability to decide for itself and the freedom to act that allow the politically agreed objectives of monetary policy to be achived”. Those objectives were dominated by the exclusive focus on price stability.

The show rolls into Rome for the Intergovernmental Conference, December 15-16, 1990

The IGC in Rome began on December 15, 1990 and was tasked with producing agreed amendments to the Treaty of Rome, so that the stages two and three of the Delors Plan could be implemented. They conference had around 12 months to come up with the proposed changes. The important ‘preparatory’ documents that informed this process were the Delors Committee report, the Guigou Report from the High-Level EMU Working Party, the Christophersen Report (reflecting the Commission’s official view) and the Herman Report (and subsequent Resolution) from the European Parliament. Other contributions from the various workshops and committees were also considered as was the ‘draft statute’ from the Committee of Central Bank Governors for the new European central bank (European Commission, 1991: 34-35).

All these ‘inputs’ sang from the same hymn sheet, which meant that the die was already cast in terms of the essential design flaws that would emerge in 2008. For example, the recommendation from the Delors Report that “no new institutions” be created “in the economic sphere” (meaning no new European-level treasury fiscal function) was accepted without debate. The European Commission noted in the lead up to the IGC that there was “unanimity that certain rules (no monetary financing, no automatic bail-outs) and a principle (the avoidance of excessive budget deficits) should be enshrined in the Treaty” (European Commission, 1991: 36). However, despite this ‘unanimity’ there were still differences on matters of detail that had to be settled before there could be a change to the Treaty of Rome. Among the outstanding issues was the nature of the binding fiscal rules which would be imposed “to prevent the appearance of imbalances which might compromise monetary stability” (European Commission, 1991: 35).

The other major outstanding issue was the making concrete the rules and criteria that would govern the transition from stage two to stage three.

There were some token words relating to the need for ‘democratic responsibility’, which had become an issue because the major monetary and economic policies (through the binding rules) would be determined by unelected and largely unaccountable bodies – the new central bank and the European Council. It was proposed that these bodies would have to be “clearly and directly responsible before the Parliament” (European Commission, 1991: 35) an ambition that has never been fulfilled.

In terms of the binding rules, the EMU Working Group (under the European Commitee) had considered the formulation of an ‘Excessive Deficits rule’, which would be built into Member State legislative frameworks before the nation could receive its ‘entry ticket’ to the EMU (EMU Group, 1990: 1). The group considered that the so-called ‘golden rule’, which limited fiscal deficits to the rate of investment in productive capital would be favourably considered by Member States. The ‘golden rule’ essentially said that over some defined economic cycle (from the peak of activity to the next peak) the government should only run a deficit to cover its expenditure of capital (infrastructure) and not be used for ‘recurrent’ purposes (that is, spending which exhausts its benefits in the current year).

The ‘golden rule’ reflects the mainstream economics view that governments have to ‘fund’ their spending just like a household. There is no recognition of the fact that most national governments issue the currency in which they spend. Further, a household uses the currency that the government issues and so must work out ways of getting it before they can spend, whereas the government can spend first and ultimately does not have to worry about financing such expenditure. We will consider the fallacies of the mainstream view in later chapters because they impinge on the way we view the future options for Europe.

But within the flawed mainstream framework, any excess in government spending over taxation receipts has to be ‘financed’ in two ways: (a) by borrowing from the private sector; and/or (b) by ‘printing money’ (borrowing from the central bank). The latter funding source – the so-called ‘monetary financing of deficits by central banks’ – is now eschewed because it is claimed that the extra spending will cause accelerating inflation because there will be ‘too much money chasing too few goods for sale’. This view was adopted as a religious doctrine in the lead up to the introduction of the EMU.

The proposition is generally preposterous because economies that are constrained by deficient spending (defined as spending that is insufficient to generate full employment of available productive resources including labour) respond to increases in spending by expanding the production of goods and services rather than increasing prices (which could lead to inflation). There is an extensive literature pointing to this result. So when governments are expanding their own spending (and increasing the fisal deficit) to offset a decline in private sector spending, there is typically plenty of spare capacity available to ensure output rather than inflation increases.

Given the mainstream fear of inflation from the ‘printing money’ option, economists of this persuasion argue that a better (but still poor) solution is for governments to issue debt (bonds) to the private bond investors to ‘finance’ their deficits. These economists claim there are costs associated with this option, which is why they advocate governments should run fiscal surpluses whenever they can. These costs include alleged increases in short-term interest rates and higher future tax rates because the debt has to be ‘paid back’. At this stage, we will just note that these propositions do no bear scrutiny and we will reflect on them in more detail in later chapters.

For the present discussion, we note that the golden rule is based on these myths. What we will learn is that the golden rule logic my be legitimately applied to governments which do not issue their own currency, such as state governments in a federal system. In the context of the proposed EMU, the Member States were to cede their currency issuing capacities to the European Central Bank and as such start spending in a foreign currency (one they did not have the capacity to issue). In that regard, the Member States of the EMU would have the same status as a state in the US or Australia.

In that context, the ‘golden rule’ was considered equitable across generations because the current ‘taxpayers’ would ‘pay’ for the public benefits they received while the future generations would participate in footing the bill for the infrastructure that would deliver them benefits in the years to come. Thus, day-to-day spending that benefits the current taxpaying public should be covered by taxation revenue and capital infrastructure should be funded through debt. It means that the fiscal balance would be always in balance (or better be in surplus) once public investment spending was taken out.

The EMU Working Group also noted (in June 1990) that other rules might be adopted by the Member States themselves which might include the requirement that a 2/3 majority of the parliament is required to pass a fiscal deficit “beyond a certain level” (EMU Group, 1990: 2). The subsequent Christophersen Report (August 1990) concluded that (1990: 24):

Despite its definitional shortcomings, the golden rule of public finance, i.e. that public borrowing shall not exceed investment expenditure, appears the most satisfactory from an analytical point of view and is the only one widely applied in existing federations. Complementary to this rule, other objective criteria, such as the deficit and debt to GDP ratios might prove helpful in this context. These rules and criteria will have to be laid down in the Council regulation covering multilateral surveillance.

As it turned out, it was not the Germans who led the way in defining the tough binding rules that emerged out of the IGC.


Its a man’s world – the Rome Intergovernmental Conference delegates, December 14-15, 1990

Credit: The Council of the European Union


Additional references

This list will be progressively compiled.

Abeille, G. (2010) ‘A l’origine du déficit à 3% du PIB, une invention 100% … française’, La Tribune, October 1, 2010.

EMU Group (1990) ‘Minutes EMU Group Meeting, Tuesday 19th June’, European Commission.

European Commission (1991) ‘Intergovernmental Conferences: Contributions by the Commission’, Bulletin of the European Communities, Supplement 2/91.

European Parliament (1989) ‘Minutes of the sitting of Friday, April 14, 1989’, Official Journal of the European Communities, 17.4.89, No C 95/1.

European Parliament (1990) ‘Minutes of the sitting of Wednesday, October 10, 1990’, Official Journal of the European Communities, 12.11.90, No C 284/01.

Le Parisien (2012) ‘L’incroyable histoire de la naissance des 3% de déficit’, September 28, 2012.

Sachs, J. and Wyplosz, C.. Buiter, W., Fels, G. and de Menil, G. (1986) ‘The economic consequences of President Mitterand’, Economic Policy, 1(2), 261-322.

That is enough for today!

(c) Copyright 2014 Bill Mitchell. All Rights Reserved.

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