We cannot understand the limits of the euro if we do not consider the macroeconomic theory on which it was built. According to this theory, the economy is, yes, subject to continuous fluctuations, but it always rights itself again with self-regulation: small policy doses are enough to return it to its “natural” balance of full employment (Blanchard, 2014) .
Before the Great Recession, the possibility that a shock of a modest entity could degenerate in a large-scale crisis was seen as unlikely by economists.
The governance of European Monetary Union was modelled on this theory. The two pillars that supported it (fiscal and monetary) were built by imposing stringent limits on the use of demand-side economic policies.
The two “pillars”
On the fiscal front, the main pillar was that Member States were responsible for a budgetary policy that, in a system of constraints monitored from the outside, aimed to achieve a balance or surplus, and left room for automatic stabilizers only when they became necessary to offset cyclical effects.
This pillar is based on the belief that public (unproductive) spending crowds out private (productive) spending; that budget deficits have no expansive effects; and tax conservatism, even during crises, is good for growth because it reduces sovereign risk, strengthens market confidence and attracts capital.
Such beliefs do not provide for tax redistribution mechanisms and symmetrical adjustment between countries of a monetary union, which are indispensable to ensure its stable growth. Consequently, this belief system says that when a country's economy is hit by a crisis of demand, the only answer is to consolidate the public budget, cut prices and wages, and reduce the internal absorption of goods and services. This vision has forgotten the Keynesian lesson that one person's spending is another person's income, replacing it with belief in austerity as the only virtuous path to palingenesis.
As regards the monetary pillar, the Treaty stipulated that “the main objective (...) is to maintain price stability” (Article 127) and gave the European Central Bank (Ecb) full independence in the operational definition of its goals and how to achieve them. This is a far different choice from the one adopted by the United States at the end of the 1970s, which imposed on the Federal Reserve the goal of not pursuing price stability only, but also full employment.
The goal set for the ECB is rooted in neoclassical economic theory, according to which markets populated by rational actors and with flexible prices and wages ensure efficient allocation of resources and full employment (Fitoussi and Saraceno 2013).
In this context, it is the supply that determines demand, and thus the only recognized role of economic policy is to increase the productive capacity of the economy, considering any intervention on aggregate demand useless or damaging.
In addition, money is “neutral”: it only acts affects prices and has no impact on the real economy, except in the short term due to rigidities that slow down the price adjustment and the formation of expectations.
As a consequence, the central bank's task is to stick to a moderate price growth target, so as to anchor the expectations of market players and reduce uncertainty about relative price dynamics, increasing their signalling value. This conclusion -- implicit in the Ecb's Statute -- negates the role monetary policy can play, especially if it is co-ordinated with fiscal policy, to revitalize an economy in recession (Turner 2015).
Euro yes or no euro?
The Great Recession revealed the serious inadequacies of the Eurosystem. The latter does not have the tools to prevent or stem financial crises and therefore deprives the Union of that powerful self-propelled mechanism that can be such an advantage to a big economy: active demand management. Even before the euro was born, Franco Modigliani (1998) and other well-known economists had warned - ignored - of the dangers of “the pernicious orthodoxy that has trapped European policy makers.”
Although the events have confirmed the perniciousness of that orthodoxy, the underpinnings for different assumptions are no where in sight.
Is this enough, then, to conclude that Italy would do better to abandon the euro? No. The risks would be very high, except for under very special conditions that are quite unlikely to materialize (Bossone 2017). As the 25 Nobel Prizes recently wrote on Le Monde, commenting on Marine Le Pen's anti-European program: “There's a big difference between never having joined the euro and getting out of it after having adopted it.”
We need to be realistic: Italy doesn't have other choice but stay in the euro. But we must also think out of the box: the country can not be condemned to stagnation, relying on a magical effect of immaginary structural reform while the economy is strangled by an unbearably high level of taxation, devitalized by the absence of growth prospects, weakened by shortage of jobs and low purchasing power, and blocked from using any sort of tools to get back on its feet.
We need to think about how to recoup margins of manoeuver in the fiscal sphere, reverse the collapse of demand, and lift the expectations of businesses accustomed to depression. “Fiscal money” is the only tool that can achieve this objective without putting the euro in question and, indeed, avoiding the possibility that any future unraveling has its origins in Italy (Cattaneo et al 2017, Zezza et al., 2017). The topic should be the subject of subsequent contributions to this important debate.
Amato, M., L. Fantacci, e G. Zezza (2017), «E se la moneta fiscale desse nuovo slancio?» Il Sole 24 Ore, 6 maggio.
Blanchard O. (2014) «Where danger lurks», VoxEu, 3 ottobre.
Bossone, B. «Italy's Predicament is Europe's Predicament», EconoMonitor, March 8.
Bossone B., M. Cattaneo, M. Costa e S. Sylos Labini (2017) «Uscire dalla crisi con la Moneta Fiscale», Economia & Politica, 20 aprile.
Fitoussi, J. P. e F. Saraceno (2013) «European Economic Governance: The Berlin-Washington Consensus», Cambridge Journal of Economics 37 (3): 479–496.
Modigliani, F, J-P Fitoussi, B Moro, D Snower, R Solow, A Steinherr, and P Sylos Labini (1998), «An Economists' Manifesto on Unemployment in the European Union», BNL Quarterly Review 206, pp. 327-61.
Turner A. (2015) «The Case for Monetary Finance – An Essentially Political Issue», 16th The Jacques Polak Annual Research Conference, International Monetary Fund, Washington, DC, November 5–6.
Amato, M., L. Fantacci e G. Zezza (2017) «E se la moneta fiscale desse nuovo slancio?», Il Sole 24 Ore, 6 maggio.
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