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Review by Mason misconstrues role of the euro in Eurozone crisis

An interesting and helpful new book review in the Boston Review by the up-and-coming John Jay College of Law economist and blogger J. W. “Josh” Mason of Yanis Varoufakis’s book Adults in the Room makes a key mistake, misunderstanding the role of the post-1999 single currency in the fiscal crisis in Greece and other countries in the “periphery” of the Eurozone, especially Greece, Ireland, Portugal, and Spain.

Toward the beginning of the argument in question, Mason states

Under the gold standard, as under the dollar standard that most of the world operates on today, central banks are subject to the same constraints as national governments. The Bank of Mexico cannot print dollars, it can only acquire them in the same ways as anyone else in Mexico. The European case is different.

Mason misunderstands the differences between a gold standard and the Euro system and between the latter and a system of national fiat currencies. It is certainly true that national central banks are able to perform clearing operations, allowing imbalances between member countries. If country 1 buys 100 euros worth of goods from country 2, while country 2 buys 50 euros worth of goods from country 1 during a day, and each exporter uses a bank within its own country, euro can be sent through the ECB in its role as a clearing bank.

Next, however, Mason incorrectly claims that

But from the point of view of creating a disciplining mechanism on states, it is a fatal flaw. With a cooperative central bank, it is impossible for a euro area government to ever run out of euros.

Hence, Mason concludes, that countries in the eurozone are not institutionally constrained. Rather, it is only with noncooperative national central banks that their national governments can be fiscally constrained. Hence, Mason argues, the currency union itself does not in principle pose an obstacle to fiscal expansion and policy autonomy. To the contrary, national central banks’ clearing functions do not permit a second standard central bank function: that of a banker to the national government. National central banks do not offer a checking account permitting national governments to make payments, as in, for example, the case of the Fed’s role as banker for the U.S. national government. Hence, to obtain Euro to pay its bills, the Greek government is subject to constraints posed by limited depression-level tax revenues and limited transfers from other governments.

This structural characteristic has been a key institutional constraint presented by membership in the European currency union, preventing Greece from adopting fiscal stimulus policies as its unemployment rate skyrocketed. Countries such as the Norway, U.S., Canada, and Japan do not face such a constraint and hence can never be forced to default on debts denominated in the currencies used by their governments. Hence, they cannot face “fiscal crises” of the type that countries in the eurozone experienced following the first phase of the global financial crisis, which was related to mortgages and mortgage-backed securities.

Work by my colleague Stephanie Kelton of Stony Brook University, along with other chartalists (now known as adherents of Modern Monetary Theory), helped to clarify for economists the role of the new euro institutions around the time of their inception. Notable is a work by Kelton (then Stephanie Bell) and Edward Nell on the new system as a “metallist” system—essentially equivalent in most regards to standard in which the value of the currency is tied to that of a precious metal. The theory of currency unions holds that it is appropriate to have a currency union under some essentially “microeconomic” conditions that imply a single-currency system has lower transactions costs. In fact, there are probably no such conditions. The single currency experiment has been a key factor leading to the crisis; the unwillingness of international creditors to grant reductions in government debt (so-called “haircuts” in the jargon of finance) has only added to the problems posed by unworkable fiscal and monetary institutions.

Mason notes that in the days before the single currency, Greece often ran large current account deficits despite having the ability to devalue its currency. That is true. However, current account deficits are not abnormal and do not always pose a threat to growth or sustainability. However, in countries with their own currencies, sufficiently flexible exchange rates, and no debt denominated in foreign currency, governments need never default on their debts—even leaving aside capital controls. Moreover, predecessors to the single-currency system sometimes imposed fixed exchange rates, rather than granting national autonomy. These systems stabilized exchange rates but their strictures on exchange rates played a role in current account deficits that existed prior to 1999.

It must be said that transfers to poorer European countries were always among the benefits of being a part of Europe in the post-war system, helping to make it a good deal for Greece and other countries in the continent’s economic “periphery” and benefiting all members. These transfers (including transfers to newer members that are transitional economies) could be part of a set of European institutions with distinct national fiat currencies and the ability to deficit-spend without the risk of involuntary default, as in the U.S. case. Another conceivable option would be to imagine a governmental system in Europe that approximated that of a single nation, with each country in the position of, say, a U.S. state, and with European-style social programs at the federal level.

Many readers of this blog have shared my enthusiasm for Josh’s blog (to be found on my “Assorted Links” page) and his academic and policy work for the Roosevelt Institute.

Note: (February 15) For a few hours today, an incorrect edit changed Stephanie Kelton’s affiliation. She appears indeed to be at the Stony Brook campus of the State University of New York, known as Stony Brook University. Here is a bio page for her in this new position.

Leanne Ussher
February 16th, 2018 at 3:05 pm

But isn’t this also Mason’s point — the imposition that national central banks do not offer a checking account permitting national governments to make payments, is a political rather than economic constraint?

February 16th, 2018 at 4:56 pm

Yes. I think my version of problems in Europe, based on Modern Monetary Theory (MMT), shares that characteristic. The constraints in the MMT story are perhaps more institutional, but euro institutions themselves are the product of political decisions and the forces that make them what they are. In some countries, voters have rejected membership in these institutions by referenda. I agree with Josh’s argument that once the fiscal crisis began, a greater degree of fiscal austerity was imposed by fiscally conservative Eurozone authorities than was in any way necessary or warranted. Economic stagnation and high unemployment rates throughout Europe also created a political environment elsewhere in Europe that was conducive to the imposition of a counterproductive austerity in heavily indebted countries. An alternative approach with more political viability might have used grants in “new” euro to forgive portions of the debt and to create jobs programs in countries with double-digit unemployment.

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