Do economists ever get it right?

There is one example when they did . . .

According to popular belief, economists rarely manage to predict correctly the consequences of important policy actions. Nevertheless, the case of the European Economic and Monetary Union (EMU) is one of those instances which economists did get it right.

Indeed, as far back as 1977, the MacDougall Report to the European Commission concluded that because the European Economic Community budget was very small, “… in present circumstances monetary union is impracticable.” Moreover, many economists on both sides of the Atlantic were cautioning against the planned single currency in the absence of a significant fiscal redistribution facility and/or the ability to run countercyclical fiscal policy.

Nevertheless, the political bandwagon prevailed, and the Delors Report threw caution to the wind and assumed that EMU could proceed without significant increases in the size of the EU budget, which was hovering around 1% of GDP (the 1977 Report was deeming it as necessary that the federal budget be as large as 10% of GDP). The only “concession” to economists’ concerns was the Maastricht Treaty rules imposing limits on government debts and deficits — as encapsulated in the Stability and Growth Pact (SGP).

However, the precedence given to moral-hazard considerations (and the defective way they were applied) over countercyclical fiscal policy — due to the fear that profligate governments would be too keen to run large budget deficits in recessions but very reluctant to run offsetting budget surpluses in booms — proved detrimental. Since the main focus of the SGP was on deficit limits, the resulting reduction (due to the euro) in real interest rates and concomitant boom experienced by some of the ‘periphery’ countries of the Eurozone made it very easy for governments to run (or to claim that they do) budget deficits below the 3% (of GDP) limit. Yet, this semblance of fiscal prudence — when in fact governments should be running budget surpluses — undermined their ability to conduct appropriately expansionary fiscal policy, when the boom ended, without running excessively large budget deficits.

To a large extent the semblance of fiscal prudence was aided by the very large current account deficits which some of the periphery countries were allowed to run during the Euro’s first decade. Although this appears to run counter to the well-known “twin deficits hypothesis” (i.e. that a larger budget deficit leads to a larger current account deficit), the experience of the periphery countries suggests that it is possible the direction of causality to be from a larger current account deficit to a smaller budget deficit.

For the periphery countries, EMU participation facilitated international borrowing at lower interest rates, allowing for a huge deterioration in the current account while the budget deficit improved. The reason is that imports, which become possible through international borrowing, need not fully displace spending on domestically produced goods (they may even increase it!). Moreover, they can create a revenue boon for the government. For example, car imports generate immediate tax revenue (VAT, registration taxes, etc.). They also allow for increases in domestic value added (e.g. services related to sales, advertising, and repairs of automobiles), thus allowing for second-round increases in income tax revenue. In the same vein, foreign loans (intermediated through the domestic banking sector) allowed for housing booms and created unsustainable increases in tax revenue.

The upshot of the above is that cynical governments may “achieve” a seemingly strict adherence to the SGP limits on budget deficits (they may even run budget surpluses as Spain and Ireland did), for some years, by running current account deficits; however, once foreign capital dries out the lack of fiscal space for countercyclical fiscal policy becomes evident. With the benefit of hindsight we know that the SGP provided the wrong signals about the exercise of countercyclical fiscal policy. It also failed to provide a replacement for the lack of market discipline. The moral is that the warnings of economists about the ability of the SGP to provide a framework for “monetary and fiscal stability” should have been heeded.

George Economides and Thomas Moutos, Guest Editors of the CESifo Economic Studies Special Issue on ‘EMU: The Way Forward’, are Professors of Economics in the Department of International and European Economic Studies, Athens University of Economics and Business, and CESifo Research Fellows.

CESifo Economic Studies publishes provocative, high-quality papers in economics, with a particular focus on policy issues. Papers by leading academics are written for a wide and global audience, including those in government, business, and academia. The journal combines theory and empirical research in a style accessible to economists across all specialisations.

This article first appeared on blog.oup.com, and is republished here with permission

A statue outside the European Commission. Photo: Getty
George Economides and Thomas Moutos, Guest Editors of the CESifo Economic Studies Special Issue on ‘EMU: The Way Forward’, are Professors of Economics in the Department of International and European Economic Studies, Athens University of Economics and Business, and CESifo Research Fellows.
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Who is the EU's chief Brexit negotiator Michel Barnier?

The former French foreign minister has shown signs that he will play hardball in negotiations.

The European Commission’s chief Brexit negotiator today set an October 2018 deadline for the terms of Britain’s divorce from the European Union to be agreed. Michel Barnier gave his first press conference since being appointed to head up what will be tough talks between the EU and UK.

Speaking in Brussels, he warned that UK-EU relations had entered “uncharted waters”. He used the conference to effectively shorten the time period for negotiations under Article 50 of the Lisbon Treaty, the legal process to take Britain out of the EU. The article sets out a two year period for a country to leave the bloc.

But Barnier, 65, warned that the period of actual negotiations would be shorter than two years and there would be less than 18 months to agree Brexit.  If the terms were set in October 2018, there would be five months for the European Parliament, European Council and UK Parliament to approve the deal before a March 2019 Brexit.

But who is the urbane Frenchman who was handpicked by Commission President Jean-Claude Juncker to steer the talks?

A centre-right career politician, Barnier is a member of the pan-EU European People’s Party, like Juncker and German Chancellor Angela Merkel.

A committed European and architect of closer eurozone banking integration, Barnier rose to prominence after being elected aged just 27 to the French National Assembly.  He is notorious in Brussels for his repeated references to the 1992 Winter Olympics he organised in Albertville with triple Olympic ski champion Jean-Claude Killy.

He first joined the French cabinet in 1993 as minister of the environment. In 1995, Jacques Chirac made him Secretary of State for European Affairs, teeing up a long and close relationship with Brussels.

Barnier has twice served as France’s European Commissioner, under the administrations of Romano Prodi and José Manuel BarrosoMost recently he was serving as an unpaid special advisor on European Defence Policy to Juncker until the former prime minister of Luxembourg made him Brexit boss.“I wanted an experienced politician for this difficult job,” Juncker said at the time of Barnier, who has supported moves towards an EU army.

 

Barnier and the Brits

Barnier’s appointment was controversial. Under Barroso, he was Internal Market commissioner. Responsible for financial services legislation at the height of the crisis, he clashed with the City of London.

During this period he was memorably described as a man who, in a hall of mirrors, would stop and check his reflection in every one.

Although his battles with London’s bankers were often exaggerated, the choice of Barnier was described as an “act of war” by some British journalists and was greeted with undisguised glee by Brussels europhiles.

Barnier moved to calm those fears today. At the press conference, he said, “I was 20 years old, a very long time ago, when I voted for the first time and it was in the French referendum on the accession of the UK to the EU.

“That time I campaigned for a yes vote. And I still think today that I made right choice.”

But Barnier, seen by some as aloof and arrogant, also showed a mischievous side.  It was reported during Theresa May’s first visit to Brussels as prime minister that he was demanding that all the Brexit talks be conducted in French.

While Barnier does speak English, he is far more comfortable talking in his native French. But the story, since denied, was seen as a snub to the notoriously monolingual Brits.

The long lens photo of a British Brexit strategy note that warned the EU team was “very French” may also have been on his mind as he took the podium in Brussels today.

Barnier asked, “In French or in English?” to laughter from the press.

He switched between English and French in his opening remarks but only answered questions in French, using translation to ensure he understood the questions.

Since his appointment Barnier has posted a series of tweets which could be seen as poking fun at Brexit. On a tour of Croatia to discuss the negotiations, he posed outside Zagreb’s Museum of Broken Relationships asking, “Guess where we are today?”

 

 

He also tweeted a picture of himself drinking prosecco after Boris Johnson sparked ridicule by telling an Italian economics minister his country would have to offer the UK tariff-free trade to sell the drink in Britain.

But Barnier can also be tough. He forced through laws to regulate every financial sector, 40 pieces of legislation in four years, when he was internal market commissioner, in the face of sustained opposition from industry and some governments.

He warned today, "Being a member of the EU comes with rights and benefits. Third countries [the UK] can never have the same rights and benefits since they are not subject to same obligations.”

On the possibility of Britain curbing free movement of EU citizens and keeping access to the single market, he was unequivocal.

“The single market and four freedoms are indivisible. Cherry-picking is not an option,” he said.

He stressed that his priority in the Brexit negotiations would be the interests of the remaining 27 member states of the European Union, not Britain.

“Unity is the strength of the EU and President Juncker and I are determined to preserve the unity and interest of the EU-27 in the Brexit negotiations.”

In a thinly veiled swipe at the British, again greeted with laughter in the press room, he told reporters, “It is much better to show solidarity than stand alone. I repeat, it is much better to show solidarity than stand alone”.

Referring to the iconic British poster that urged Brits to "Keep Calm and Carry On” during World War Two, he today told reporters, “We are ready. Keep calm and negotiate.”

But Barnier’s calm in the face of the unprecedented challenge to the EU posed by Brexit masks a cold determination to defend the European project at any cost.

James Crisp is the news editor at EurActiv, an online EU news service.