It’s been over a month since my initial post about Greece and I’ve finally managed a follow up. Slack blogging I know. In the interim I’ve had some deliberations about who this blog is for and how I should go about writing it. I’ve also questioned some of the key assumptions and framework for my initial analysis: specifically, the relationship between monetary and fiscal policy – are the two inextricably linked? In this post I discuss some of the points of contention and give a brief update on the Greek bailout and its impact on the Eurozone. More generally, for more about this blog and what I intend to do with it, check out the updated About page.
Since I last wrote, Grexit has been avoided after a third bailout package was agreed. Greek banks and the Athens stock exchange have re-opened. Somewhat shockingly, after calling a referendum (on the proposed bailout terms) and receiving an overwhelming No, Mr Tsipras later accepted a set of more stringent terms in order to borrow more money. The Prime Minister obviously concluded that doing a U-turn and going against the wishes of the Greek public was better than a Grexit.
I’m not opining as to whether this was a good or bad deal for Greece but, given the circumstances, this was the best possible outcome for the Eurozone. That said, a fundamental flaw remains: the Eurozone has a single monetary policy and 17 separate fiscal policies. It is my belief that monetary policy does not work effectively without an appropriate fiscal policy: interest rates can only remain low if fiscal policy is credible (and by this I mean that people who lend money to a country are convinced that they will get it back). I will not explain why low interest rates are important to stimulate growth, but to the non-economists, take my word for it, they are. And having low interest rates is even more important when inflation is low, as is the case in many Eurozone today. That is one problem.
Perhaps an even more pressing problem – resulting from this incongruous monetary/fiscal policy relationship – is that the Eurozone and Euro will pass from crisis to crisis. In fact, every time there is an election in one of the 17 Eurozone countries, the threat of the Euro breaking up will be a risk. This sounds like a radical statement. But, if you think about it and unpick the facts, it really isn’t. Every time there is an election, politicians fight about how much money the state should spend. This is even an issue in the UK, where the unemployment rate is 5.4%; it was an issue at the last election (which Labour lost) and is shaping up to be an even bigger problem now that Jeremy Corbyn has a good chance of becoming the next Labour leader.
The issues of austerity, social welfare, and the debate how much a state should spend, is far greater in most European countries where the unemployment rate is much higher – think Belgium (8.5%), France (10.5%), Italy (12.4%), Portugal (13.0%), Spain (22.7%), Greece (25.6%). If any of these countries elect a leader similar to Syriza that wants to spend more and renegotiate the terms of its debt, then a familiar chain of events are likely to take place. Investors will be the first to go, pushing borrowing costs up and the stock market down. This would result in less investment, lower growth and higher unemployment. And this could all happen even before the new government takes office (in anticipation of what the new government will do). Savers (including ordinary citizens) will get scared and withdraw their money. Banks may close. The ECB may be force to provide emergency funds. Or not. And the threat of leaving the Euro arises once again. And so the cycle goes…
Even the less ‘radical’ parties in these countries may decide that the state needs to spend more money. This brings up the question of debt sustainability and whether the ECB should be buying that governments’ bonds (which it is currently doing for many countries under its QE programme). There is a good chance that borrowing costs would rise and markets would be rocked.
The point is that unless national governments give up sovereignty over their fiscal policy, there is always going to be a huge degree of uncertainty. Businesses create jobs by investing and businesses hate uncertainty. Until a proper solution is found (to remove this uncertainty in the Eurozone), investment, job creation and economic growth are likely to remain sluggish.
Now, I’m running out of time and this blog post is starting to sprawl. I haven’t really addressed the issue of whether monetary and fiscal policy are inextricably linked although I did state my opinion in relation to this above (second paragraph in bold italics). There are some counter arguments that people could throw to say that they are not – Japan has low interest rates but a debt / GDP ratio of above 200% and the UK has lower borrowing costs than most of Europe but a higher budget deficit. These are legitimate points although I could throw some counter arguments to the counter-arguments. I don’t claim to have the definitive truth. And I have just scratched the surface of this important topic. Ultimately this comes down to bigger picture questions like: what is money and how is it created? And the traditional theories on this topic are all up in the air with things like QE and forward guidance. To be continued….
Note: these views are mine, and mine alone. They do not reflect those of my employer (past, present or future) or anybody that has or will pay me money. They are also subject to change, at the drop of a hat.