Wednesday, January 12, 2011

The German Dilemma

From Otmar Issing, former chief economist of the ECB, in the Financial Times (January 11, 2011):

“My conclusion at the start of 2011 is a somber one. We have not yet reached the moment of truth for Emu. It has merely been postponed.”

Although proposals that Emu should be expanded into a “transfer union” are “wrong”, he said, the current loose system for policing fiscal rules call into question its very survival. But on the other hand “trying to create political union through the back door of the common currency … would be setting up a system under which bad policies would be subsidized on a quasi-automatic basis.”

My comment: the euro itself provides incentives for national governments to run large deficits. Both because the common monetary policy cannot fit adequately diverse national stabilization needs (thus pushing governments toward the use of fiscal policy), and because the suppression of intra European exchanges rates eliminates exchange risk premiums and thus reduces the cost of borrowing.

It is thus quite unlikely that these governments would consent to eliminate the only macroeconomic policy instrument still at their disposal by adopting a strict new version of the defunct stability pact.

On the other hand Germany is both reluctant to become a “transfer state” taxing its citizens in order to subsidize other Europeans (and thus to reduce the need for their governments to borrow more) and to the perspective of returning to flexible intra European exchanges rates that would strengthen the Deutsche Mark and jeopardize the current German export competitiveness in Southern Europe.

But the German policy makers can’t have it both ways. They are caught on the horns of a dilemma. That's why they procrastinate.

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