Konferenz im Offenen Kanal Berlin (Sonderkanal 8 im Berliner Kabelnetz):
5. November 2001, ab 10:00 Uhr (Teil 1)
16. November 2001, ab 10:00 Uhr (Teil 2)
eine Wiederholung wird gesendet am
13. Dezember 2001, ab 21:00 Uhr (Teil 1)
14. Dezember 2001, ab 21:00 Uhr (Teil 2)
Die Europäische Zentralbank - Macht außer Kontrolle?
Presentation to the European Parliament
When asking the question how to create an appropriate policy mix in Europe, we will first have to define appropriateness and the targets and objectives for the policy mix and then look at the methodology required to achieve it.
1. The definition of an optimal policy mix
I will first deal with the concept of an optimal policy mix and then quickly look at where we presently stand in Europe.
1.1 Definition of an optimal policy mix
Traditionally, the concept of policy mix is related to the idea of the so-called magic quartet whereby economic policy should simultaneously try to achieve price stability, full employment, sustainable growth and external balance. Tinbergen had developed a framework for this analysis in the 1950s where one policy instrument corresponded to each target. Monetary policy was aimed at price stability, wage policies at employment, fiscal policy at growth and the exchange rate at external equilibrium. This analysis implicitly assumes that there are no interdependencies or spillovers between these different policies. However, reality is not that easy. Interest rates also affect fiscal policy through the debt service and economic growth and both have impact on unemployment. The early theories about policy regimes were also unaware of the Lucas-critique whereby private actors respond to policy regime changes and therefore change the structure of the economy within which policy actions are supposed to have their intended effects.
A modern way of looking at an optimal policy mix would still try to achieve simultaneously internal and external balance but would have to take the interdependencies between the different policy areas and their reactions by rational private actors into consideration. Internal balance requires price stability and full employment, while external balance should reflect a current account position that is in line with sustainable foreign debt and domestic growth considerations. Although price stability is ultimately the objective for monetary policy, it needs to be supported by stable unit labour cost and therefore wage bargaining that focuses on the distribution of productivity gains. If unit labour costs are kept stable, monetary policy can be more accommodative for economic growth, lowering interest rates and thereby supporting the creation of employment. Modern economic theory also emphasizes that fiscal policy in the long run should aim at keeping public debt sustainable. This does not mean zero deficits or balance budgets but the stability of the debt GDP ratio. It implies that the debt service is covered by an adequate primary service. This means that in the medium and long run Ricardian equivalence holds whereby savers are aware that government borrowing will be repaid by future tax levies. However, in the short run automatic stabilizers can play an important role in stabilizing effective demand in case of temporary demand shocks.
1.2 Where do we stand?
During the first two years after the introduction of the single currency, Euroland has been lucky. Inflation remained below 2 %, interest rates were rather low and economic growth and employment started to increase. Fiscal deficits were falling. These positive developments clearly reflect some of the structural advantages from creating a single currency. Those who fought for European Monetary Union had always expected them.
However, more recently Euroland has been affected by two supply shocks: the increase in the oil price and food prices. These supply shocks have lowered potential output and therefore would require a lowering of effective demand in order to avoid inflationary pressures similar to the 1970s. From that point of view, a tightening in effective demand in the short term would be justified and this could be achieved by tighter monetary policies i.e. higher interest rates or fiscal policy. But higher interest rates would also lower incentives to invest and therefore reduce the growth of potential output. On the other hand, if fiscal policy were not tightened under these circumstances, the public sector would crowd out the private sector. Therefore, from a point of view of creating growth and employment it might be preferable to tighten fiscal policy so that monetary policy can remain more accommodative.
It could be argued that the negative supply shock from oil and food prices could be compensated by a positive supply shock of lowering wages. However, if unit labour costs are to remain stable and a negative supply shock has lowered productivity, this would imply that nominal wages would have to fall and this is hardly in the interest of the wage earning population in Europe. Alternatively, it could be argued that by keeping wages nominally stable, but allowing prices to rise due to higher oil and food prices, real wages would fall and this would compensate for the negative supply shock. Yet, this is dangerous and puts additional strain on the credibility of the European Central Bank, as can be observed nearly every day. There is a danger that these price increases will ultimately be recuperated by wage earners wishing to compensate for the loss of purchasing power. It therefore seems to me that the appropriate response to these negative supply shocks is a modest tightening in fiscal policy, although one has to be careful not to inhibit the working of automatic stabilizers. It has also been argued that in addition to the two negative supply shocks, there has been a demand shock from the slowdown of the US economy. If this is true, it is extremely difficult to disentangle the impact of supply and demand shocks on the European economy. Fiscal policy should then be careful not to increase the cyclically adjusted structural budget position in Euroland, but it should let the automatic stabilizers work in order to compensate the slowdown in foreign demand.
What this discussion shows is how difficult it is and how careful one has to be in order to assess the right policy stance in the short run in order to optimise the policy mix. These difficulties are greatly increased by the uncoordinated nature of fiscal policy in Europe. I will come back to this point below. In the long run, however, the appropriate response to these supply shocks are structural reforms that are aimed at increasing potential output in Europe. Focus must be on completing the single market, especially for goods, services and capital markets and to rapidly implement the reforms decided at Lisbon. Creating a competitive European knowledge society and placing it in the context of sustainability as in Stockholm reflects the European approach to overcome our structural impediments and increase our output and growth potential. However, all these measures ultimately need public and private investment and this requires a monetary environment of stability and low interest rates.
2. Measures to reach an optimal policy mix
An optimal policy mix always refers to the framework of a monetary economy. The reason is that money is the hard budget constraint for economic decision makers. This of course implies that an optimal policy mix needs to be determined for the whole of the euro area and not only in the national context - except for those countries that have kept their own currency. Therefore, the degree of policy co-ordination between different jurisdictions within the unified Euroland economy must be significantly higher then between countries that are linked by exchange rates.
2.1 What kind of policy co-ordination?
Is economic policy co-ordination needed? Economic theory in the 1980s has discussed this question mainly from a point of view of exchange rate regimes. In the context of European Monetary Union, these theoretical approaches are no longer adequate and increasingly economists are using the theory of clubs and public goods as their reference model. These models start with the premise that in a monetary union there are certain goods, which are shared by all. Examples are the price level, the exchange rate, interest rates, the current account balance etc. These variables are called club goods. The existence of EMU club goods implies a new channel of externalities between national economic policies. Policies of individual member states that affect policy relevant European area aggregates have economic implications for other member states because the ECB will react to them and this reaction is felt by all member states. Consequently, it is not enough to look at the direct transmission of policy impulses between countries, as the traditional literature on economic co-ordination has done, to identify the need for co-operative policies in the euro area .
The economic literature on collective goods or club goods has clearly established that the uncoordinated provision of such goods can lead to sub-optimal supply. This is called co-ordination failure. The theory of co-ordination failure allows us to clearly distinguish between different forms of co-ordination. We can distinguish three cases.
1. No policy co-ordination is required if the externalities can be privatised. In this case, markets can price the impact of the externality and this will provide the optimal supply of these goods. A typical example in Europe is the no-bail-out clause for public debt, where private capital markets are supposed to price the risk of default when public authorities over-indebt.
2. Inter-governmental co-operation is appropriate when club-goods are inclusive. This means there are strategic complementarities between the objectives of different policy makers. These complementarities arise when the objectives of all other players induce a change in the same direction by any national government because any national government benefits from the fact that the aggregate supply of this club good is higher. Such club goods are called inclusive because the benefit for some members, but not necessarily for all, is sufficient to ensure the provision of the good - although supply is not necessarily optimal. Typical examples for such inclusive goods are the policy objectives established in Lisbon. For example, the development of a knowledge society does not necessarily require the participation by all, provided that a sufficiently large number of governments and agents participates and thereby create a dynamic that might lead others to follow this example. But clearly, if all countries implemented the necessary reforms, welfare would be optimised. Similarly, wage bargaining can be seen as an inclusive club good where the wage developments in Germany are setting a bench mark that other wage bargainers seem to consider for their own bargains. However individual bargains may deviate and lead to regional unemployment. The theory of co-ordination failure shows that inclusive public goods create strong co-ordination failure meaning that a lack of ex ante co-ordination may prevent the necessary investment to provide these public goods. Hence, there are multiple equilibria possible which are not necessarily optimal. This failure can be overcome by improved communication, which would help actors to understand the motives of the other club members and therefore improve the provision of such goods. European policy co-ordination typically has used these devices by setting common standards in the single market or also by establishing the macroeconomic dialogue. The underlying logic of the macroeconomic dialogue is derived from the assumption that wage rigidities in the labour market lead to sub-optimal employment equilibria, which can be improved by communication between wage bargainers and policy makers.
3. If club goods are exclusive, all members of the club are required to participate in their provision. This means - contrary to inclusive public goods - no free riding is admissible. Exclusive club goods are subject to weak co-ordination failure which is much more serious to remedy because it requires binding constraints and community institutions for rule setting and policy-making. A typical example is monetary policy: the binding budget constraint for a monetary economy requires that all member states have the same interest rate and this could only be provided by establishing a European Central Bank as the sole policy maker. Most club goods resulting from EMU are effectively exclusive. The argument also applies to the definition of an aggregate fiscal policy stance. For example assume, starting from macroeconomic equilibrium, that an EMU member state adopts a tax policy that leads to a slowdown in economic growth and an increase in prices in this country. As a result, the euro area price level moves upwards. The ECB would react to this change with an increase in interest rates, thereby affecting the macroeconomic equilibria in all other EMU states. Thus preserving the quality of the EMU club good called "price stability" in the presence of uncoordinated national policy actions by member states creates economic costs for all other members. This problem can only be overcome by the definition of an aggregate fiscal policy stance that is relevant for monetary policy of the ECB. Such an aggregate fiscal policy stance is an exclusive club good because every member state has to contribute. As a consequence, an institution is needed to define such a policy stance.
How can this be achieved? Today, the Stability and Growth Pact gives a clear policy rule: all national budgets should be balanced over the business cycle and excessive debt GDP ratios require additional surpluses in order to bring them down below the 60% margin. This rule gives the clear indication what fiscal policy stance is to be achieved. It leaves it to the European Central Bank to set interest rates at a level that would ensure aggregate demand to be in balance with potential output.
However, this rule is not really consistent with the statement by the European Commission whereby "economic policy co-ordination within the euro area is based on consensus. It does not aim to impose decisions on a particular member state". For the question arises whether the simple policy rule of the Stability and Growth Pact is always optimal. This pact does not provide any flexibility in changing policy priorities. Yet, there can be cases when the balanced budget rule is not appropriate, either because an optimal policy mix would require further lowering of interest rates and therefore higher budget surpluses or because the authorities wish to follow a golden rule where public investment is financed by debt. In fact, the aggregate fiscal policy stance is a matter of collective preferences. It must reflect the time preferences for intergenerational tax burdens. Ultimately, an optimal policy mix depends on what preferences people in Europe have and how these preferences are formed.
2.2. Policy preference formation in the EU
We will consider the European policy mix as a public good. The definition of an optimal European policy mix will then require the formation of European public preferences. Today fiscal policy preferences are determined exclusively within a national framework. Budgets are set by national parliaments and this is the ground rule of democracy ("no taxation without representation"). National parliaments reflect national preferences and these preferences are formed through democratic debates in these countries, often during parliamentary debates or electoral campaigns. Therefore, the definition of an aggregate policy stance, either as in the Stability and Growth Pact or in any other form, cannot be superimposed at the European level without seriously undermining the legitimacy of policy decisions. The Irish referendum is a clear indication for the growing democratic deficit that follows from intergovernmental policy co-ordination for providing exclusive club goods in Euroland. Therefore, although the Stability and Growth Pact may be a short-term solution for defining an optimal policy mix, it will not be sustainable in face of the growing democratic deficit in Europe. What is needed in the long run is a fully democratically legitimated policy mechanism for the definition of policies with respect to exclusive public goods. In the field of fiscal policy this means, first, that the aggregate fiscal policy stance needs to be defined for the entire Euro-area taking into account the general economic environment. Secondly, such aggregate fiscal policy stance needs to be legitimated at the European level. Thirdly, it should be implemented nationally.
One could envisage a future institutional set-up whereby the Commission would determine the appropriate fiscal policy stance, reflecting European-wide public preferences, which would yield the optimal policy mix, because it is the only institution that has the required know-how, services and information. In order to do so, it would set an envelope for the aggregate public expenditure and income and therefore define also the aggregate deficit. The aggregate fiscal policy stance proposed by the Commission would then have to be approved in a second step jointly by the European Parliament and the Council, reflecting the democratic choices of the people in Europe. In the final stage national governments would set their national budget priorities within the framework of the overall envelope. This guarantees that national priorities remain fully coherent with the requirements of a properly functioning monetary economy in Euroland. In order to strengthen the commitment by national governments to stick to the overall agreed and established budget envelope it may be necessary to think about the setting up of a stabilization fund or a system of limited regional national transfers.
An arrangement along these lines would mean that the economic governance in Euroland needs to be contained in the constitutional arrangements that have become a subject of discussion since the German Foreign Minister Fischer gave his speech in May last year and in view of the agenda set after the Nice summit. In fact what is necessary is not only to redefine the tasks vertically in terms of responsibilities between different jurisdictional authorities, but also horizontally in terms of the disentanglement between the executive functions and the legitimising and legislating functions of government. The concept of collective club goods and their inclusive and exclusive nature provides a criterion for the vertical redefinition of tasks. However, it should be clear that a properly functioning European level of policy making also requires greater democratic legitimacy than is provided by national governments and institutions in the formation of collective preferences. We, the people of Europe, request a greater say about policy preferences in Europe. You, our MEPs should help us to get it. This does not mean the creation of a European super-state but it means that Europe's public goods have effectively become a res publica europea. Unless policy makers address this issue over the next few years, Europe will disintegrate again and the policy mix will be far from being optimal.
26. June 2001
Stefan Collignon is Professor of European Political Economy at the London School of Economics and Political Science. He was previously for ten years Director of Research at the Association for the Monetary Union of Europe in Paris and from 1999-2000 Deputy Director General for Europe at the German Ministry of Finance.