Thank Carney for Meddling in Europe
Mark Carney, Governor of the Bank of England, made a notable speech last week. In an act of impressive discourtesy to euro-area governments, he explained in simple terms why their economies are stagnating and what they should do about it. Carney didn't say anything that others haven't said before, but it was out of the ordinary to hear it coming from him.
Don't expect an immediate effect. For the most part, Europe's governments continue to stare blankly at the mess they've made. The only hope for change is that a sufficient volume of authoritative protests might eventually make an impression.
Now that the European Central Bank is finally starting its long-delayed program of quantitative easing, Carney said, monetary policy is doing all it can for the euro area. But QE isn't enough. There are two key missing ingredients, he added. The first is capital-market integration. The other is a sufficient degree of fiscal union.
If overborrowing causes a state within the U.S. to suffer a crash, equity finance and fiscal policy can cushion the blow. Some of the losses are shifted to equity investors based in other states; taxes paid to the federal government decline and federal spending in the state concerned goes up.
Thus, in a well-conceived single-currency area, non-bank financial flows act as burden-sharers. The euro area relies too much on bank finance and too little on cross-border equity finance; it lacks cross-border fiscal flows almost entirely. That's a problem because the credit channel has been blocked by the recession and the equity and fiscal channels are far better at spreading risk.
The chart shows the degree of risk-sharing delivered through bank credit, equity finance and fiscal policy -- comparing the euro area with the fully integrated federal systems of the U.S., Canada and Germany. The difference is stark. The euro area is fatally under-equipped to deal with economic shocks.
As Carney says, the EU has made a start on improving the bank-credit channel by moving toward a banking union. Just last week the new European Commission launched a project to develop the equity-finance channel, a so-called capital markets union. But this is a long-term scheme and, if or when it's completed, it won't do anything to deal with the debt burdens that have already been accumulated. That leaves fiscal union -- on which euro-area governments have done, and apparently plan to do, precisely nothing.
It's important to understand that Europe doesn't lack the capacity to use fiscal policy, only the will. As Carney points out:
The euro area unemployment rate of 11½ percent is twice that in the U.K. Gross general government debt in the euro area is roughly the same as in the U.K. and below the average of advanced economies. The weighted average yield on 10-year euro area sovereign debt is around 1 percent, compared to 1½ percent in the U.K. And yet, the euro area’s fiscal deficit is half that in the U.K. It structural deficit, according to the IMF, is less than one third as large.
It is difficult to avoid the conclusion that, if the euro zone were a country, fiscal policy would be substantially more supportive. However, it is tighter than in the U.K., even though Europe still lacks other effective risk sharing mechanisms and is relatively inflexible.
What form might fiscal union take? Carney doesn't say, except to mention the possibility of a pooled unemployment-benefit program. There's a lot to be said for that: Unemployment-benefit schemes act as especially powerful stabilizers of demand; they help the principal victims of recession; they switch themselves off when economies have recovered, and so don't encourage fiscal profligacy (a perpetual concern of Germany and its fiscally conservative allies). Yet, desirable as it might be, this seems impossibly ambitious.
Another possibility, which I've discussed before, and which could be done by itself or alongside the unemployment-benefit program, is conditional eurobonds -- that is, jointly guaranteed public borrowing (with a cap, subject to conditions, and with fees based on creditworthiness). And, lawyers permitting, there's always helicopter money -- which explicitly combines monetary and fiscal stimulus.
Fewer people than ever in Europe want full political union. That isn't happening. Nonetheless, the euro area desperately needs a measure of fiscal union, and must find a way to do it. European Central Bank President Mario Draghi evidently agrees with Carney's analysis. I only wish he'd be half as forthright on the subject.
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