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Re: [gang8] Re: [A-List] EU stability & growth pact: Stiglitz critique

I wrote the following in Asia Times on January 18, 2003 (months before
Stiglitz May 9 piece in The Guardian)as part of my series on central
banking:

http://www.atimes.com/atimes/Asian_Economy/EA18Dk02.html

During the past decade, central banks worldwide have achieved
unprecedented heights of policy dominance through their function as
chief guardians of strong national currencies in globalized, unregulated
financial markets. Simultaneously, monetary authorities the world over
have been promoting the doctrine of central-bank independence from duly
constituted national governments and their national economic policies,
as if populist government and people-oriented policies are financial
evils that must be resisted. Poverty and unemployment are hailed as the
foundation of sound money that should not be jeopardized by political
pressure. This elitist doctrine is fundamentally incompatible with a
political world order of independent nation states and the principle of
consent of the governed. Any nation that forfeits its monetary
prerogative also forfeits its political independence.

The ECB's institutional structure represents the ultimate real-world
application of this doctrine on a regional scale. In the name of
central-bank autonomy, the Maastricht Treaty explicitly prohibits the
ECB from seeking or taking instruction from constituent national
governments, or European Community institutions such as the European
Parliament, or "any other body", and bars constituent national
governments from attempting to influence the decisions of the ECB.
Critics have pointed out that those same rules place no reciprocal
restrictions on the ECB's policy advocacy. ECB president Wim Duisenberg
has unreservedly pushed euro zone economies to refashion their labor,
product, services, capital and credit markets along neo-liberal
market-fundamentalist lines, even in economies under social democratic
governments. This has contributed to the EU's slow growth and high
unemployment. Germany, the dominant economy in the EU, has persistently
suffered high unemployment, which hit 9.7 percent in November, rising
above the politically sensitive 4 million level; in eastern Germany, the
unemployment rate was 17.6 percent.

Article 105 of the Maastricht Treaty states clearly: "The primary
objective of the European System of Central Banks shall be to maintain
price stability." The wording of the Maastricht Treaty was not so much
influenced by economic insights as it was written in a very specific
political context: to persuade an inflation-averse Germany to exchange
the deutschmark for the euro, by guaranteeing the stability of the new
currency. This explains the focus on price stability and the fact that
other objectives were mentioned separately and secondarily. The statutes
of other central banks, such as the Fed, can be changed by action of a
single legislature. The ECB would require all 15 member states and their
parliaments to change the treaty that defines the structure and
institutional mandate of the ECB. This makes the ECB one of the most
independent central banks in the world. The treaty did not define "price
stability", leaving a vacuum quickly filled by the new and independent
ECB by defining price stability as "an inflation rate that does not
exceed 2 percent over the medium term", a very tight definition by any
standard. Interest-rate policy alone is an inadequate tool because a
single instrument cannot hit multiple targets. Furthermore, using
interest rates to control asset markets risks inflicting significant
collateral damage on the rest of the economy, which was exactly what
happened in the past few years.

The BIS harbors latent ambitions to turn itself into a de facto World
Central Bank (WCB) with the ECB as a model, while the argument for the
need for a WCB is floated around in the upper reaches of
internationalist monetary circles.


Henry C.K. Liu wrote: 
I have dealt with the issue of the undesirability of an "independent"
central bank in my series on central banking in Asia Times.  It is good
to see Stiglitz sing the same tune with the credibility of a Nobel prize.

As for inflation, everybody is now talking about the need for inflation
targeting, while many of us have been arguing for it for a number of
years on PKT.  Akerlof's research has the same problem as all economic
research: it needs past data to substantiate what common sense deems
obvious in order to be taken seriously by the profession.  This type of
research serves only to cover ones professional behind. It tends to have
nothing to do with creativeness by its very nature. Macroeconomics is a
game of setting rules of the game which all participants try their best
to bypass, break, or ignore without being disqualified and expelled.
There are a number of ways through which rules are enforced in any game.
  On way is self termination where violation end the game itself.  Since
life does not end, even under great unnecessary pain of economic
collapse, this type of self termination enforcement does not work in
macroeconomics.  Another way is through state policing, called
government regulations.  This has been attacked as antithetical to
freedom, the alleged prerequisite for  economic prosperity.  Self
regulation is preferred to government regulation on the ground that
participants know best.  The result is an exclusive game of musical
chairs where the number of chairs is always larger than the number of
participants.  This is achieved by making membership to the club open
only to the selected few.  The financial sector, for example, really
operates as a cartel, one of the remaining guilds in the modern economy.
  Another enforcement regime is to punish only the low and mid level
soldiers who were merely carrying out implicit orders of maximizing
profit by all means, while the specific responsibility of illegality is
always confined to the lower levels.  The top level is always protected
and only indictable if the prosecutor makes a deal with the lower level
guilty to finger the higher-ups. The Bank of New York's illegal role in
money laundry for Russian gangster capitalism was confined to a vice
president based in Moscow, despite that profit from such activities had
been visibly celebrated in its annual reports for years.

There is a joke about the annual May Day military parade in Moscow
during Gorbachev time when a group of unruly civilians marched in lose
formation behind the latest ICBM battalion.  The nervous aides were busy
telling the chief they did not arrange for the poor show where as
Gorbachev told them to relax, that he personally approved the
participation of this contingent of civilians.  "They are economists and
they are more deadly to capitalism than ICBMs," explained Gorbi.

Henry C.K. Liu

Michael Keaney wrote:

Don't trust the bankers' homilies

The EU stability pact destabilises by cutting spending in a downturn

Joseph Stiglitz
Friday May 9, 2003
The Guardian

France, Portugal and Germany are all flagrantly flouting the stability pact,
the agreement among eurozone members to keep their deficits below a critical
threshold (3% of GDP today, but lower, supposedly, in the future). France's
prime minister, Pierre Raffarin, defends his government's position by saying
that France was not prepared to impose austerity on its own people. If
France will not, other European leaders must wonder, why should they?

Mr Raffarin was right to say that austerity would result if France obeyed
the pact's strictures, but in debates over economic policy, the truth is
seldom appreciated. There is a long list of central bankers' homilies that
are not supposed to be questioned. Do so and you are exiled from the circle
of those who supposedly know how the world "really" works. Here are three:

An independent central bank is necessary for sound macroeconomic policy. The
truth: countries that do not have an independent central bank, such as
India, manage to contain inflation as effectively as those with independent
central banks. In Russia, an independent central banker, Viktor Gerashencko,
could not be removed for years, though he tolerated both inflation and
corruption. Generally, there is little evidence that countries with
independent central banks grow faster, have higher wages, or generate higher
incomes - indeed, that they perform better in any real sense than those that
do not.

Once inflation starts, it increases at a faster and faster rate, and the
costs of reversing it are high. The truth: there is no evidence of an
inflation precipice, or that the costs of reversing inflation (in terms,
say, of pushing unemployment to high levels) are any greater than the
benefits from inflation (in terms, say, of allowing unemployment to fall to
low levels).

Inflation is bad for growth and productivity. The truth: below a critical th
reshold - a threshold far beyond the levels of inflation that now prevail in
Europe and North America - there is no evidence of significant adverse
effects from inflation. On the contrary, recent research by Nobel laureate
economist George Akerlof and his colleagues suggests that pushing inflation
too low may impede growth, and that the critical threshold is higher for
countries, such as the post-communist transition economies, engaged in large
structural changes.

When an economy faces a downturn, one should engage in expansionary fiscal
policies. But in a downturn tax revenues fall. Thus, debt must increase. But
the EU's stability pact, as commonly interpreted, requires either that tax
rates be raised (always difficult, especially in a recession) or that
expenditures be cut. Either way, such policies will exacerbate the downturn.

The stability pact put into place an automatic economic destabiliser. But
the EU - indeed, every country - should seek stabilisers, policies that
automatically boost the economy in a downturn. The US is facing, albeit in a
weaker form, a similar problem.

Most of America's 50 states have constitutional amendments that effectively
impose a balanced budget. As tax revenues drop due to the economic downturn,
the states are cutting back on expenditures, exacerbating America's slump -
and the world's. I warned of this problem more than a year ago, and I
suggested that the federal government pick up the tab for the shortfall in
state tax revenue, because the states did not cause the country's slowdown.

At the time, there was some disagreement about how long the downturn would
last (I was a pessimist, and unfortunately I have been proved right). But I
argued that this was irrelevant: making up the states' shortfall would cost
the government nothing if the optimists turned out to be right, but it would
be just the right medicine if pessimists like me were correct. Instead, the
Bush administration pushed ahead with tax cuts for the rich, tax cuts that
were not designed to stimulate the economy and that, no surprise, have
failed to stimulate the economy.

The lesson for Europe is clear: the EU should redefine its stability pact in
terms of the structural or full employment deficit - what the fiscal deficit
would be if the economy were performing at full employment. To do otherwise
is irresponsible.

There does need to be a commitment to fiscal responsibility. In the long
run, governments should run balanced budgets, with surpluses in good years
making up for deficits in bad years. But to insist on an arbitrary budgetary
position in an economic downturn is to ignore everything we have learned
about economics in the past 70 years, risking the well-being of millions who
are thrown out of employment.









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