Monday, 22 September 2008

Eurozone problems

Following on from Tim Congdon yesterday we get Ambrose Evans Pritchard today.

Europe has embedded paralysis in its treaty law. Maastricht prohibits a Keynesian blitz. Budget deficits above 3pc of GDP are not allowed until an EU country is already in dire straits, and even then approval requires a committee vote by 27 states. So Ireland, Italy and France must now tighten fiscal policy into the downturn. There is no EU Treasury to back the euro, and therefore no Euro-Paulson with the powers and legitimacy to take sweeping steps in an emergency. By extension, there is no clear-cut lender of last resort either. Each country is on its own, yet none have the instruments of monetary policy to carry out a Paulson-type rescue with credible punch.

The European Central Bank stands aloof with Teutonic severity, as hawkish as the old Bundesbank - or the Reichsbank in 1931. It too is a prisoner of a rigid treaty mandate. There was a mad Wagnerian feel to its July rate rise. We now know that Euroland was already slipping into recession when it acted. Do the hawks mean to unleash Götterdämmerung on the peoples of Spain, Ireland, Italy, Portugal, and Greece, with all the dangers that must accompany a disintegration of EMU?

These are three of the problems that I fret over with the ECB, indeed the entire eurozone system.

The first is that by definition, with a single currency there has to be a single interest rate. So economies which are falling into recession have no ability to lower interest rates in order to minimise or even forestall problems.

The second, that the ECB itself seems to have not worked out what actually caused the Great Depression: it was the tightening of interest rates and the subsequent contraction of credit. So with a financial crisis like the one we have interest rates should indeed be going down.

The third is that there is in fact no lender of last resort in this system. There's no "there" there.

All of these three individually and even more strongly all of them together mean that while we and the Americans might have a financial jolt and a downturn, we at least have the tools to deal with them while the eurozone simply doesn't. Which doesn't bode well for the severity of the downturn when it comes to that very eurozone.

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