THE full political consequences of yesterday’s voting in the French referendum may take months to unravel, but its economic significance is already clear. Democratic support for European integration has become the latest victim of the Continent’s miserable economic performance. This is entirely appropriate, since Europe’s economic failure can be blamed largely on the mismanagement of the euro project and the incompetence of the European Central Bank (ECB).
After the votes in Germany, France and the Netherlands (to come on Wednesday), European governments would be wise to respond to the anger of their citizens by reviving economic growth and reducing unemployment.
But supposing that a “dash for growth” becomes the main political imperative across Europe, how can this be achieved? Can politicians hope to pull their economies out of a period of almost uninterrupted stagnation and joblessness that has now lasted more than a decade? The answer essentially comes down to a simple choice.
Will Europe stick to the do-nothing monetarist dogmatism of the ECB, which has not made a monetary move since June 2003; a period when the Bank of England has moved six times — and in both directions — while the Fed has changed interest rates nine times? Or will they learn from the examples of America, Britain, Australia, Canada and, recently, even Japan — which have proved that an active policy of monetary and fiscal demand management is indispensable for full employment, steady economic growth and successful economic reform?
To any rational economist this is a “no-brainer” choice. The importance of an active policy of demand management to sustain growth and full employment has always been evident to anyone who studied Keynesian economics. But until ten years ago monetarist academics and politicians were able to dismiss the Keynesian view as a theoretical “curiosum”, which applied only to economies with uncompetitive markets and rigid wages.
In the past decade, however, the intellectual foundations of macroeconomic management have been transformed. The dispute between activist Keynesian economics and laissez faire monetarism used to be a theoretical issue, but now the world’s economies have conducted a controlled experiment of the kind long familiar in the hard sciences but almost unknown in macroeconomics.
Since the early 1990s all but one of the major capitalist economies have actively and aggressively used macroeconomic policy to manage demand. The eurozone, meanwhile, has consciously and publicly refrained from using either monetary or fiscal policy to boost growth.
The ECB has publicly committed itself to the ultra-monetarist Bundesbank slogans that “a central bank must not be a counter-cyclical institution” and that monetary policy must be conducted with a “steady hand”. The European Commission, meanwhile, has used the Growth and Stability Pact to prevent, or at least discourage, national governments from using tax cuts and public spending to stimulate demand.
The results of this controlled experiment have been clear. The countries that have used both monetary and fiscal policy most actively — the US, Britain and Australia — have done best, especially in terms of unemployment. The ones that adopted demand management more reluctantly — Canada and Japan — initially did badly but have caught up as their demand management became more aggressive.
Meanwhile, the “control” economy, whose monetary and fiscal policy were disabled by the single currency and the stability pact, has performed disastrously by almost every criterion and especially in terms of unemployment. The ECB’s annual predictions of recovery being “just around the corner” have been refuted with clockwork regularity, while other central banks and governments have come quite close to achieving their growth targets. What more evidence does a scientific mind require?
Even in terms of stability, which the ECB has elevated to the ultimate standard of economic performance, the eurozone has failed miserably.
Since the euro experiment began (effectively in 1997, when France, Italy and Spain began to implement their convergence programmes in preparation for joining), the world economy has been subjected to a series of shocks — the Asian financial crisis, the Russian default, the internet boom and bust, the 9/11 attacks, the corporate scandals on Wall Street, the Iraq war, the rise of China and the doubling of oil prices.
All of these shocks originated outside Europe and the ECB repeatedly predicted that the single currency would create an “oasis of stability” in the eurozone. Yet in every case Europe has suffered far more economic and financial disruption than America or Britain. Even Japan has begun to perform much better recently, after replacing the governor of the Bank of Japan.
Which brings us to what Europe’s politicians could, and should, do to avoid further humiliations from voters. They must revive economic growth and the only way to do that is to combine the supply-side reforms that many have undertaken with very aggressive macroeconomic stimulus.
Supply-side reforms that reduce wages, pensions and job security are necessary for Europe’s economic competitiveness in the long run but in the short term they are bound to reduce consumer demand and have to be compensated with low interest rates. The historical benchmark for eurozone interest rates should not be the policy of the Bundesbank in the 1960s but the 1 per cent rates implemented by the US Federal Reserve Board after September 11, 2001, or even the zero-interest rate policy of the Bank of Japan.
To produce the powerful monetary stimulus that the eurozone needs for political survival, the governments of Europe must insist on a drastic change in the policies of the ECB. The ECB must be made to follow last week’s advice from the OECD and cut its key interest rate immediately to 1.5 per cent. US experience suggests that it should go further, to 1 per cent or below.
But what if the ECB refuses to do this? European governments should remind the ECB that exchange-rate policy is still a matter for governments — and instruct the ECB to start selling euros aggressively for dollars and yen. The next recourse should be to call for the resignation of the ECB management, since they should be held accountable for the public rejection of the European project. Finally, the leaders of Europe must make it clear that the ECB’s independence and its legal mandate will be the top priority for renegotiation in the next European treaty.
