Ever since the recent Greek “tragedy” in 2011, the nominal debt problem that swallowed up not just Greece but other EZ peripheral countries in Southern Europe, there have been mounds of speculation as to root cause of the complex set of problems involved.
Some of the explanations have revolved around supply side problems in certain EZ member nations including heavy government involvement in the economy with national enterprises, corruption and lax tax enforcement. Others are more simplistic suggesting that the governments made too many promises and have too many liabilities for what their economies produce. There are likely some grains of truth in all of these. You can’t spend more than you’re worth. And because government enterprises are generally less economically efficient, there is a certain amount of financial counterproductivity in maintaining the basic tenants of an economy tipped toward socialist.
Then there is line of thought that the Eurozone isn’t an “optimal” currency zone; monetary policy is good for some countries in the EZ but not for others. David Beckworth has posted a more detailed example of this line of thinking that is supported by an overlay of the level of Taylor Rule guidance on top of the actual ECB policy rate to show that ECB policy rates tracked the Taylor Rule guidance rather closely. The overlay is then compared to economic data for the “core” and “periphery” to show some adverse impact to the peripheral countries to conclude that the EZ isn’t an optimal currency union.
I agree with some aspects of all of these explanations. I agree the problem with the EZ is mostly a political problem inside each member country. I agree that the Taylor Rule, and most of its hybrids, is a bad rule. It is biased toward tight which, in my opinion, isn’t particularly beneficial for most economies and is especially incompatible with economies that are tipped toward socialist. But I also think that as a condition of EZ membership certain economic reforms were required with the intent that undertaking these reforms were for the benefit of the ascendants, not for the whole. In other words, Europe said, “We’re doing X with monetary policy, and if you want to join us you have to do A, B, and C – otherwise it will hurt,” and it did.
My general opinion is that despite the political problems in the EZ, if I were to peel back the layers of onion, the Taylor rule, and probably the price stability mandate is at the core for all of the EZ members. Germany, supposedly the crowned jewel of economic liberalism in Europe, currently has historically low unemployment at 5.6% but is growing at the pace of a turtle; hardly the sign that EZ monetary policy is good for even Germany. Just because a certain policy regime can be weathered under certain conditions, doesn’t make it optimal or even rational.
It all comes down to questions about why something like the Taylor Rule is the policy. If you’re the crowned jewel of economic liberalism and/or or flexible supply-side, then what is the worry about inflation? The rhetoric of Jens Weidmann, tells us everything we need to know about how important it really is (quotes and content from this Bloomberg March 12, 2015 article:
I remain unconvinced that the macroeconomic situation really warrants” quantitative easing, Weidmann, who heads Germany’s Bundesbank, said at the release of the institution’s annual report in Frankfurt on Thursday. “One especially problematic aspect is that the massive government-bond purchases will make the Eurosystem central banks the biggest creditors of the euro-area member countries. Fiscal policy and monetary policy will become even more closely entwined.”
The report said the German economy should grow “beyond its normal capacity utilization” this year and “perhaps even more strongly in 2016.”
If capacity utilization grows in response to QE, then all of the fretting about inflation under the current circumstance is rather unwarranted. And so the benefit of strict adherence to price stability and a Taylor rule in all circumstances (or any at all, really) in the EZ seems questionable at best.
To put it another way, suppose we’re designing a currency regime for decentralized supply side governance. Would it make sense, just considering the basic political structure, to adopt price stability as a mandate and a Taylor Rule for monetary policy? I think it would not because out of 18 or 19 members, there are 18 or 19 different variations on supply side policy, some more radical than others. One would hope that the monetary regime would be designed to minimize the effects of supply shocks emanating from individual member nations, and a price stability mandate aggregates them instead. And this, I think, is what the argument in the EZ is all about: why should Germany have to suffer for Greek inefficiencies or why should Greece have to suffer for Germany’s conservatism – and so on – the basis of which comes directly from the price stability mandate and inflation targeting that are not optimal for decentralized supply side governance. The good news is that there are alternatives to providing a nominal anchor that do not single-mindedly focus on price changes.
I am not saying it’s an easy to problem to solve. My assertion is that it is possibly solvable and I see the people who have endured the utmost of hardship to keep their European dream alive. If the dream is worth that much pain, it is worth solving.