The euro and the euro-crisis

The 1992 Treaty on European Union (TEU) launched the Economic and Monetary Union, where Member States agreed to form a single currency area, coordinate their economic policies, respect some budgetary constraints (limit public deficit to 3% and public debt to 60% to GDP), and get trade and price stability gains. The TEU established that “the primary objective of the European System of Central Banks (ESCB) […] shall be to maintain price stability”. Given the proven link between independence and monetary stability, as shown by the Bundesbank example, the EU created a super independent central bank with little transparency and political accountability.

18 Member States today form the Eurozone and during the first 10 years, the area enjoyed stable growth and low inflation thanks to a dual economic model based on export-led growth in central countries (Germany, Finland, Austria) and debt-led growth in peripheral ones (Ireland, Italy, Greece, Spain, Portugal, Cyprus). The low interest rate policy of the ECB fueled this model[1].

The deregulation of the financial markets globally and the failure of the threat of the “non-bail-out clause” created an illusion of the single currency. Banks took enormous risks and entered into the global speculation casino. The financial institutions became too big to fail and of systemic importance for the economy, with one major problem: in the Eurozone, contrary to the United States, the central bank was not able to bail them out and recapitalize them without creating huge consequences for the rest of the economy[2].

This is because the ECB has not the ability of act as lender of last resort, which is a huge contradiction given that central banks exist mainly because they can act as lenders in the last resort: they can bail out a bank that is of systemic importance in order to prevent a credit crunch or contagion and create stability because the final goal of central banks is financial stability.

The 2007 global crisis made this contradiction tangible. The European Council had to come out with different strategies and policies to save countries that were forced to bail out their own national financial systems or that were victim of the instability in the public debt market. Greece, Ireland, Portugal, and Cyprus asked the EU for a total bailout and in exchange implemented macroeconomic adjustment programs. Spain was indirectly rescued with a loan of 100bn euros to recapitalise its banks. Italian banks, among others, frequently asked the ECB for access to its cheap loans.

To do that, the EU created the European Financial Stabilisation Mechanism, the European Financial Stability Facility and finally the European Stability Mechanism, an intergovernmental treaty to provide financial assistance. In parallel, Member States launched the “Fiscal Compact” to introduce the golden rule of fiscal consolidation in their constitutions, thus signalling what was already in to force: solidarity was at the expense of conditionality on macroeconomic policies.

At the same time, the EU decided to create a complex cooperation scheme to act in certain countries: the Troika (European Commission, ECB, and the International Monetary Fund). In the middle of the turbulence, the EU reinforced the Stability and Growth Pact, incorporating the so-called 6-pack and 2-pack to strengthen the fiscal consolidation approach, activate alarm mechanisms to detect some macroeconomic imbalances, and apply corrective sanctions whenever is necessary.

On top of that, the promise of a banking union and the Commission’s Blue Print, as well as the four presidents communication, gave the impression that structural measures were going to be taken to eliminate legal loopholes in the Eurozone and allow the ECB to act as a central bank with all its instruments and competences.

In all those policies, the ECB played a key role, particularly in the design and implementation of the macroeconomic adjustment program (via the Troika) and some country-specific recommendations.[3] However, those policies proved to be ineffective to the financial markets, obliging the president of the ECB, Mario Draghi, to declared that the “ECB is ready to do whatever it takes to preserve the euro” and approved the no-less controversial mechanism to buy bond in the secondary market of weak Member States, OMT. The ECB was promising to act as lender of last resort in extreme cases. The European Court of Justice is currently analysing the OMT, known as the ECB bazooka, because the German Constitutional Court suspects that it exceed the competences of the central bank.

The ECB policy recommendation

ECB policy recommendations can indicate the ECB role as controller of the macroeconomic conditionality of the bailout countries. Even if the conditionality is an initial agreement within the Eurogroup, the ECB seems to exercise the pressure, and interpret ex-post the conditionality in a particular manner. National governments by accepting those recommendations actually reinforce the power of the ECB. It is questionable whether this goes beyond the original responsibility of the ECB and whether affects its legitimacy or not.

In principle, following the treaties[5], the ECB shall support the general economic policies in the EU, without prejudice to the objective of price stability. This means that the ECB should cooperate with Member States to achieve a sustainable development of Europe based on balanced economic growth and price stability, and a highly competitive social market economy, aiming at full employment and social progress.

However, the ECB made policy recommendations aiming first and foremost to calm the financial markets and not necessary follow the general economic interest of the EU. Spain received a letter from the ECB asking for modification of its constitution, and in the financial market reports there are policy recommendations beyond its scope, such as VAT increments, pension reform, or labour market reform. Italy received a secret letter signed by both Mario Draghi and Jean-Claude Trichet asking for full liberalisation of local public services among others. Greece and Portugal even received recommendations from the Troika to privatize its water services.

Nevertheless, Member States have taken ECB recommendations as compulsory, due to the real power the central bank has or who is behind the ECB decision, like Germany, or due to their desire to take advantage of implementing unpopular measures without having any political responsibility. While the peripheral countries say there is no alternative to macroeconomic adjustment, the central countries prefer to hide themselves behind the ECB. Even Germany seems to prefer the ECB to develop flexible monetary policies which to indirectly recapitalize some banks than to go through a formal bailout process. It seems that the political vacuum in the EU might explain the strong activity of the ECB in front of the euro crisis.[6]

ECB’s recommendations are advocating for fiscal consolidation, privatisation and austerity measures in south Europe. This position has been accepted by all national governments, either conservators or social democrats.  So, there are two crucial questions: Why does the ECB play the role of controller of macroeconomic conditionality? And why do national governments accept and comply with those recommendations?

For the first question, we can argue that the ECB is just doing what it has to do in order to save the euro. Structural reforms and recommendations in taxation, the labour market, or other areas are just to ensure the stability of the euro and the transfer mechanism of the monetary policy. In any case, as they have argued, they are just making recommendations.

Alternately, it might be that the Eurogroup and the Council lack authority and power so they delegate to the ECB the control on macroeconomic conditionality. The policy vacuum in the EU and the ECB power of printing money, gives the bank credibility to threaten financial markets, so both national governments and the markets perceive it as more credible than the Council and the Eurogroup. It seems even more efficient to let the ECB take over that role.

However, it might be that the Council does not have an agreement on how to express who is deciding and has rationally (to maximize its policy impact) made the ECB responsible in front of the citizens. The Council and the Eurogroup knows that the real power remains in their hands. Concretely, we can see that despite the recommendations, central countries are reluctant to concede sovereignty to the ECB for the banking union.

For the second question, an answer is that national governments, by accepting the ECB recommendations, institutionalize the idea of “there is no alternative.” Hence, they kill any possible political contest and reduce the electoral cost to the party in office of applying unpopular measures, taking advantage of the fact that the ECB is not a directly elected institution.

Alternately, we can assume a bargaining process between the Eurogroup, the ECB and the bailout country where policies can be anything between total austerity or full stimulus. If we consider the ECB as a more conservative agent (because Germany is stronger within the ECB) with strong power in the negotiation, it might be that the equilibrium shift towards austerity when the ECB enters in the bargain. Thus, the Eurogroup is willing to give power to the ECB, to get more pro-austerity adjustment programs and avoid responsibilities.

Conclusion

I think the reality is a mix of the different answers I stated: governments of southern countries are willing to accept the imposition of macroeconomic conditionality to gain some solidarity and not assume any political responsibility. Merkel is willing to accept an ECB who exceed its competence if it stabilize the Eurozone and avoid major debates in Germany. The ECB actually is willing to stabilize the euro, but it also has a hidden neoliberal agenda, shared with the IMF and the Commission, and does not hesitate to develop it, as long as financial markets keep calm.

However, it is important to figure out the strategic game at the EU level to institutionalise macroeconomic adjustment programs and austerity. The ECB is an important player, but we cannot forget about the role played by the Council, the Eurogroup, the Commission and the European Parliament, as well as some key national governments like Germany. In the end, it is not entirely clear: who really has the power.

 

Notes