The Italian EU Commissioner, Paolo Gentiloni, has just discovered the fatal flaw at the heart of the eurozone. Not that he’s quite understood that he has of course for facing up to reality is not a usual EU competence.
Gentiloni is saying that if the recovery from the coronavirus crisis is uneven then that’s going to be very difficult – an existential crisis – for the EU and the eurozone. Yes, entirely so. The thing being uneven, unequal, reactions to economic changes is that very problem with the eurozone itself. It is, to use the economists’ jargon, not an optimal currency area. That is, to unpick said jargon, that the reactions to economic stimuli are too different over the geography for it to be sensible for that geography to be using the same money and thus the same monetary policy.
That is, he’s just discovered the very point that people have been making about the Euro since the 1990s:
The risk of an uneven economic recovery from the coronavirus crisis poses an “existential threat” to the European Union, one of its most senior economic policymakers has said.
Paolo Gentiloni, a former Italian prime minister and now the EU’s economy commissioner, said the bloc also had a “historic opportunity” as it charts a plan to rescue Europe’s economy.
Quite so, quite so.
Gentiloni is concerned that countries do not have the same resources to recover from this economic shock. The hardest hit countries – Greece, Italy, Spain and Croatia – face falls in economic output (GDP) in excess of 9% in 2020, while Germany’s economy is set to contract by 6.5% and Austria’s by 5.5%. Meanwhile countries have varying levels of state resources to rescue ailing companies and pay workers’ wages – emergency measures that have become easier since Brussels relaxed state aid rules to deal with the crisis.
It’s not just that different places have different resources, the shock itself is different in different places.
To walk back to the beginning here. A single currency means, by definition, a single monetary policy. The larger the area this covers then the more likely it is that the heterogeneity of the economy over geography leads to monetary policy being inappropriate – perhaps to entirely wrong – for local economic conditions. Sure, it’s of benefit when everyone in the same village is using the same money and it’s sufficiently beneficial that they should all face the same base interest rate, the same exchange rate with the economy outside the village and so on.
It is not true that a village in Sicily should have the same interest and exchange rate as one in the Rhur. And the ability to use the same currency as Sicily, to be able to transact between them without FX worries etc, does not make up for this.
At some point between the village and the continent the desirability of using the same currency switches sign, from yes to no, positive to negative. There is nothing controversial about this at all, it’s the basic economics of the subject agreed upon by all.
The euro is too large that is. It is not an optimal currency area.
There is one thing that can make it more so. If a common fiscal policy applies over that same area then what is optimal becomes larger. Things like the automatic stabilisers aid. A region having a bad time gains more in public spending, pensions, unemployment pay, while also sending in less in VAT, income tax and so on. This boosts that local economy and makes up for the lack of flexibility in monetary policy to meet those local conditions.
Be in a non-optimal currency area, one that is too large, add central fiscal policy and maybe you’ll get to that optimality.
This is, again, the standard analysis of the eurozone. The only way it can be made to work is to have a central treasury, a common fiscal policy that works across the space. Without it it will fall apart. Because, as up at the top, different geographies react differently to the same economic stimuli.
Which is really what Gentiloni is saying about this opportunity. Those who designed the euro knew all of the above. They also knew that they wouldn’t be able to persuade people into that common fiscal policy. For it to be effective we’d need to have 15 to 20% of the entire economy being run through Brussels. The tax money flowing from all into there, the spending flooding out again allocated as Brussels desires. Politicians who see their career as being in Brussels think this a great idea. No one else does.
More specifically, the Germans realise that this would mean their paying Greek pensions, something they’re not going to agree to. So, build the monetary system with the flaw, then when crisis comes spring the trap – we’ve got to have fiscal policy, see, see?
That’s the federasts’ opportunity. And if it’s not taken the yes, the euro and then, inevitably, the EU, will fall apart.
As to what should really be done? Don’t have that fiscal policy, allow the falling apart. Because the EU was always a bad idea – come on now, really, who ever thought that running an entire continent through unelected bureaucrats was going to be a good idea? – and should end. If that comes from the fatal flaw in the design of the euro so be it – but come it should.
Gentiloni’s entirely correct in his basic analysis, he’s just got the answer wrong.