Eurozone Watch

The Greek case is moving markets – and minds. Over the last few weeks, for instance the German government including Angela Merkel has become a strong proponent of economic policy coordination in the Eurozone. Not only financial markets are nervous these days. Politicians and high officials in particular in the Eurozone are stressed, not only because they wish for nothing less than bailing out Greece, but because they fear contagion to other Euro states such as Spain or Ireland if markets get even more nervous.

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Yesterday’s decision by the Ecofin to water down the Commission’s proposal on the reform of the European Financial Market supervision to make it little more than a teethless tiger is deplorable. But the last word is not spoken – the European Parliament seems set to give the Ecofin a hard time.

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In our new contribution for Project Syndicate, we argue that the European Monetary Union needs a new stability pact which limits not government budgets, but imbalances in the current accounts of the member states. In such a pact, both deficit and surplus countries would be required to use their fiscal and general economic policies to strive for a rebalancing. If countries are uncooperative, they would be fined. In this way, dangerous trends of external indebtness for single countries can be limited as well as excessive beggar-thy-neighbor policies through revaluation limited.

Read the full column at the Project Syndicate Website here.

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Regarding the SPE’s performance in the European elections, a recurrent question was why the Socialists/Social Democrats did not reach better scores: Why hasn’t the left been able to capitalise on the shift in public attitudes against conservative economic liberalism and right wing individualism in the current crisis? The SPE’s election manifesto does start with the observation that "this crisis marks the end of a conservative era of badly regulated markets". The voters in last week-end’s European election however do not seem to have noticed.

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The German Foreign Secretary and social democratic candidate for the Chancellors office in the next general elections in September 2009 has finally formulated some ideas on the future of Eurozone governance. Unexpected by many who had given up hope that the SPD candidate would pronounce himself on this matter before the European and German elections, he devoted 10 lines of yesterday’s speech in Budapest to EMU – and has departed in at least six aspects from the position on EMU the grand coalition has been holding before and during the current crisis.

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Last Monday, French President Nicolas Sarkozy once again pushed for an old French idea, the "gouvernement économique" for the Eurozone. In his speech in front of the European Parliament, the acting EU Council President reinterated the French quest that the governance structures of the European Monetary Union should be strengthened in order to allow for more politics in the management of the Eurozone economy.

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Two important political developments in the EMU surfaced on the ECB's tenth anniversary celebrations. Firstly, the EMU's fiscal policy coordination mechanisms are more in flux and under pressure than the EMU institutions would like to have the public believe since the reform of the Stability and Growth Pact. And secondly, the issue of lower than expected economic convergence within the Eurozone is receiving more and more attention: pro-longued business cyclces and cyclical divergence are now longer issues reserved for the macro-economic academic debate but are increasingly picked up by policy makers.

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Last Friday, Ulrich Fritsche and I presented the results from our analysis of unit labour costs in EMU compared to regional unit labour cost developments at a workshop in Cambridge (see paper here). When we remarked that Portugal had lost roughly 17 percent competitiveness between the start of EMU and 2006, more than has been ever observed in any German Land or US state within any 8-year-period, one discussant remarked that Portugal has actually improved competitiveness in 2007 and is set to do so again in 2008. So, is Portugal actually turning the corner after years in the doldrum?

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Next Wednesday, May 7th, the European Commission will put forward a long-awaited report on the Eurozone. A few months ahead of the Euro's 10th anniversary, this report is unlikely to trigger a debate the EMU should go through, given recent developments, such as the increasingly observed cyclical divergence and prolonged business cycles that EMU is experiencing, and the economic tensions that are coming up e.g. for Spain. There is a (very) slight chance that the report is somewhat more ambitious regarding external issues, such as the international representation of the Euro, but it is again improbable that it will tackle the issue of what to do with the external value of the euro (i.e. how to manage relationships with the EMU’s major economic partners, the US, China, the UK, …). But let’s concentrate on the question what there is to expect for the internal aspects of EMU governance for the moment.

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Last weeks' news about the Eurogroup meeting and the ECB Board meeting revealed a clear rift between the political leaderships in the eurozone and the European Central Bank. For the first time since the euro started its race for ever new historical heights, all Finance Ministers of the Eurozone agreed to voice unanimous and strong concern about this development. Previously, at least the German Finance Minister, Peer Steinbrück, had notoriously taken some distance to the others' concerns and had claimed that a strong exchange rate was no problem. Obviously with the euro quickly approaching 1.55 $, the pain is also starting to be felt in Germany. Both the European Industrial Federation and the European Trade Unions voiced similar concerns recently.

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