In The Eurozone, If Wages Can’t Be Cut Payrolls Will – O’Rourke And Taylor In The Latest JEP

Before the Euro was introduced, each member country had its own central bank that managed monetary policy. After the Euro was introduced, the European Central Bank took responsibility for monetary policy in the Eurozone.

This article by Kevin O’Rourke and Alan Taylor in the latest Journal of Economic Perspectives looks at the internal adjustments needed within the Eurozone in order to get out of the rut where some countries are definitely hurting because they have no independent monetary policy.

They discuss how the United States is a “true” monetary union in the way that Robert Mundell discussed. High internal labour mobility, a common language and the fact that if a state goes bankrupt the Federal government is unlikely to bail it out are key factors that distinguish the United States from the European Union.

Because monetary policy needs to respond to adverse shocks, having a monetary union denies a member state the ability to respond appropriately if there is a shock that affects it alone. Shocks can be distributed asymmetrically across a monetary union – and that means that within that monetary union there can be substantial adjustment problems.

There is an argument that adjustment to macroeconomic shocks in these circumstances should take place by way of internal devaluation. However O’Rourke and Taylor highlight nominal wage rigidity and sticky prices with this brilliant illustration of how hard it can be to adjust wages downwards:



What this shows is the human cost of adjustments after adverse shocks. Look at how many people in Greece are completely screwed – but also look at how when wages can’t be cut because of either refusal to accept pay cuts or labour market rigidities that make it impossible, the number of people employed will plummet in response to the shock anyway.

This paper goes on to discuss how the core European countries are essentially on a different planet in terms of productivity and public service performance relative to the periphery countries like Greece and Spain.

But I do not agree with their argument for a stronger banking union across the European Union. The Euro was always doomed from the start. If you’ve read any French economic history, you’d realise that the politics of the European Union are essentially a cold war between French and German interests.

Whilst Germany has been able to exercise strong influence over monetary policy, France has been a key driver of the vast expansion of the European Union’s bureaucracy and legalistic interference in member countries.

France will eventually go through the reforms that Germany went through in the 1990’s but that may not happen as fast as some people think it will. The idea that completely different cultures could come together to have a single political entity was only successful for the Austro-Hungarian empire which had obedience to the Hapsburgs over silly things like voting in leaders democratically.

Anyway, this is an interest piece that explores the pitfalls of having a monetary union if all of your institutions and financial sector entities aren’t on the same page. It also highlights how money is everything and there are no guarantees of political stability when creditor countries start to force wage cuts on debtor countries. This won’t end well.

More European Union Powers Won’t Work

The theory of Optimal Currency Area first written about by Robert Mundell had several key requirements in order for a currency union to work.

They were labour mobility, capital mobility, flexible prices and wages, similar business cycles and risk sharing that enables struggling members to get bailed out.

There is no doubt that labour is highly mobile within the EU. But there are enormous cultural and language barriers that haven’t gone away and never will. Capital is mobile, but the moral hazard involved with risk sharing has played out into “Northern” member countries having their wealth squandered bailing out “Southern” member countries.

The difference in attitudes between a German and a Spaniard with respect to work are completely different. The likelihood of an Irishman learning Polish to take advantage of work opportunities in one of the EU’s better performing member countries is trivial.

Over the past few years Germany successfully reduced its labour costs and continued to have a workforce that leaves school with very little “skills mismatch” nonsense we have in New Zealand

Most Euro zone countries have hardly budged on flexible prices and wages. Struggling countries can’t take advantage of cheaper national exchange rates because their economies are stuffed to spur any form of recovery.

Instead of earning their way out of recession, German officials are dictating to governments what they should do in order that predominantly German banks and bondholders get repaid at 100 cents on the dollar.

All the other bondholders – pension funds, retirement schemes, unit trusts and the like – are being forced to eat substantial losses on their bonds. Their losses are privatised, unlike those of “Too Big To Fail” EU banks who have cynically taken billions in additional liquidity from the ECB and parked it on their balance sheets.

Putting all examination of whether currency unions are a bad idea or not, the EU has proven beyond all doubt that they are incapable of managing a common currency and thus a common monetary policy.

Thus arguments for giving more power to EU officials and even standardising fiscal policy across member countries are so insane it is clear that EU officials are living on another planet.

Let’s recall : before the Euro there were several attempts at a “common currency”. All of them failed because no one played by the rules. The UK was one of the worst offenders at this. They paid for their sins on Black Wednesday.

The “unicorns and rainbows” theory that all member countries can sort out their mess by simply handing over the reigns of their fiscal policy and monetary policy to the unelected bureaucrats of Brussels, overseen by an incompetent and gridlocked European Parliament, needs to be examined far more closely by the media.

I regularly read opinion pieces and articles in the media that are clearly closer to European Central Bank press releases than any decent analysis of what’s at the root of all of this nonsense : the idiotic notion that an organisation that produces such varied Euro Vision contest entries could somehow co-operate on fiscal and monetary policy without making itself a laughing stock.