ECB bashing is the favorite sport of the economically uneducated. They should pause and think: where would Europe stand in today’s financial turmoil without the euro? The DM would shoot up to levels devastating German industry; excessively high interest rates would push up French unemployment and the Italian lira would fall through the floor, distorting relative prices in the single market. In the weak currencies in new member states would accelerate inflation. In short, European integration would fall apart. There would be little hope for economic growth.
The euro is protecting the EU economy. But is it also sufficient to invigorate it? After the 75 base point rate cut by the Fed last week, should the ECB follow? Or should Europeans copy the American fiscal stimulus?
The answer is a double No! US monetary policy is part of the problem, not a solution. For years the Fed has flooded the world with cheap liquidity, feeding the asset price bubble which is now imploding. By contrast, Europe’s financial conservatism has kept debt levels for businesses and households down and this is now protecting jobs and economic growth.
As for fiscal policy, public debt levels are higher in Europe than elsewhere – partly a leftover from the great inflation of the 1970s and the subsequent disinflation. Adding more debt to it would be the wrong signal. It could destabilize the bond markets. Moreover, Europe does not have the appropriate institutional framework for implementing a fiscal stimulus. The US fiscal package amounts to 1% of GDP – approximately the equivalent of the EU-budget. Who should decide on such magnitudes of public spending in Europe?
Few people seem to understand that in European monetary union only an aggregate fiscal policy could interact successfully with the unified monetary policy. If individual governments decided to go ahead on their own, they might stimulate their own economy marginally but also their neighbours, because in the single market most of the effect would dissipate into other member states. But the country that undertakes the fiscal expansion would bear the burden of public debt alone. No wonder that national governments are reluctant to embark on this road. The only feasible solution would be a comprehensive package agreed and implemented by the Euro-group or allowing the European Union budget to go into deficit by issuing Union Bonds. None of this is likely to happen, although one should not discard the option.
If neither monetary nor fiscal policy can provide an economic stimulus for Europe, the only alternative is private consumption. This is the Euro area’s weakest spot. Real wages have been lagging behind productivity and the wage share has been falling. But falling real wages are no stimulus for consumption. Thus, higher wages are needed.
But would the end of wage restraint not cause inflation? Not necessarily. Provided nominal wages do not increase by more than productivity plus the ECB’s inflation target, price stability will be preserved from the cost side. In 2007, productivity per person employed increased by 0.9% in the Euro area. Given the ECB target of 2% inflation, this would have allowed nominal wages to increase by 2.9%. But in reality they only rose by 2%. Thus, there is room for higher wages in Europe.
However, national divergences need to be considered. In Portugal, Spain and Italy, wages have increased too much, in Germany and some smaller countries not enough. On average unit labour costs in the Euro area have increased since 1999 by 1.5%, but in the three Mediterranean countries by respectively by 2.9, 2.6 and 2.4 percent. By contrast, in Germany they have increased by only 0.2%, thereby building up an enormous competitive advantage relative to the rest of Euroland. Europe needs a mechanism to correct these developments.
The Macroeconomic policy dialogue between social partners, national governments and the ECB was meant to do this job; it has failed. This reason may well reside in the confidential nature of this Dialogue. Little of it becomes publicly known and even less of it gets taken into account when social partners bargain over wages. While monetary policy is highly transparent, with the ECB President appearing regularly before the Economic and Monetary Committee of the European Parliament, income policy continues as if the decisions taken in each member state had no consequences on the rest of Euroland. As a first step for redressing this situation, it may be a good idea to transfer the Macroeconomic Policy Dialogue to the European Parliament, which should consult with the social partners prior to the audition of the ECB President.