marco - the economics of the monetary union and the eurozone crisis (2014)

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marco - the economics of the monetary union and the eurozone crisis (2014)

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SPRINGER BRIEFS IN ECONOMICS Manuel Sanchis i Marco The Economics of the Monetary Union and the Eurozone Crisis SpringerBriefs in Economics For further volumes: http://www.springer.com/series/8876 Manuel Sanchis i Marco 1 3 The Economics of the Monetary Union and the Eurozone Crisis Manuel Sanchis i Marco Faculty of Economics University of Valencia Valencia Spain © The Author(s) 2014 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. Exempted from this legal reservation are brief excerpts in connection with reviews or scholarly analysis or material supplied specifically for the purpose of being entered and executed on a computer system, for exclusive use by the purchaser of the work. Duplication of this publication or parts thereof is permitted only under the provisions of the Copyright Law of the Publisher’s location, in its current version, and permission for use must always be obtained from Springer. Permissions for use may be obtained through RightsLink at the Copyright Clearance Center. Violations are liable to prosecution under the respective Copyright Law. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. While the advice and information in this book are believed to be true and accurate at the date of publication, neither the authors nor the editors nor the publisher can accept any legal responsibility for any errors or omissions that may be made. The publisher makes no warranty, express or implied, with respect to the material contained herein. Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com) ISSN 2191-5504 ISSN 2191-5512 (electronic) ISBN 978-3-319-00019-0 ISBN 978-3-319-00020-6 (eBook) DOI 10.1007/978-3-319-00020-6 Springer Cham Heidelberg New York Dordrecht London Library of Congress Control Number: 2013934987 For Yvonne, my beloved wife vii The ECB decided in September 2012 to act as a lender of last resort in the government bond markets of the Eurozone. In doing so, it prevented panic from undermining the stability of the Eurozone. It was a necessary move to eliminate the existential fear that was destroying the Eurozone. While necessary, the ECB decision is insufficient to save the euro in the longer run. The greatest threat for the Eurozone today does not come from financial instability, but from the potential social and political instability resulting from the economic depression Southern European countries have been pushed into and that has led to increases in unemployment not seen since the Great Depression. This state of affairs is the result of a dramatic failure of macroeconomic management in the Eurozone. Under the leadership of the European Commission and the ECB, tight austerity was imposed on the debtor countries while the creditor countries continued to follow policies aimed at balancing the budget. This has led to an asymmetric adjustment process where most of the adjustment has been done by the debtor nations. The lat- ter countries have been forced to reduce wages and prices relative to the creditor countries (an “internal devaluation”) without compensating wage and price increases in the creditor countries (“internal revaluations”). These internal devaluations have come at a great cost in terms of lost output and employment in the debtor countries. As these internal devaluations are not yet completed (except possibly in Ireland), more losses in output and employment are to be expected. Thus, the burden of the adjustments to the imbalances in the Eurozone between the surplus and the deficit countries is borne almost exclusively by the deficit countries in the periphery. This creates a deflationary bias that explains why 5 years after the start of the financial crisis the Eurozone still has not recovered and threatens to return into a recession. The risk is real that citizens in Southern European countries that are subjected to prolonged deep economic downturns revolt and reject a system that was prom- ised to them to be economic heaven. In order to understand these dramatic economic developments that grip the Eurozone, the book of Manuel Sanchis i Marco is the right one coming at the right Foreword Foreword viii time. The theory of optimal currency areas remains the essential framework to understand the design failures of the Eurozone. Professor Sanchis i Marco does a superb job in explaining this theory and in making it relevant for our understand- ing of the problems faced by the Eurozone. The last two chapters of the book turn towards an analysis of the crisis of the euro and how to get out of this crisis. Spain is used as the prototype country to explain how the crisis unfolded. This is the country that in the beginning of the Eurozone seemed to do everything right. Few saw how the imbalances were build- ing up; even fewer predicted that this would lead to disaster. This book produces the best analysis I have seen of why things have gone wrong so badly in Spain. By suggesting a path out of the crisis, Professor Sanchis i Marco leaves us with some hope for the future for Spain and other Eurozone countries. Paul De Grauwe London School of Economics January 2013 ix Early in July 2012, Professors Esther Versluis, Director of Studies of the MA in European Public Affairs of the University of Maastricht, and Christine Arnold from the Department of Political Science of that University, invited me to partici- pate in the MA programme on European Studies as a Guest Speaker. They pro- posed that in autumn I give a set of six Guest Lectures on The Economics of the Monetary Union and the Eurozone Crisis. Over the summer, I was very engaged with the preparation of the teaching material for this set of six lectures, now transformed into the six chapters of this book. It was a great honour to participate in the University of Maastricht‘s MA program on European Studies, and I would like to thank both professors for giv- ing me the opportunity to do so. I also wish to thank Professor Vicent Almenar who assisted me in the preparation of the graphs and tables. Thanks are also due to Sallie Russell, responsible for the final version of the text in English. Finally, I would like to express my gratitude to my beloved wife, Yvonne, who as always, showed exceptional patience and indulgence with me during the long summer days when I was typing the manuscript. La Canyada, January 2013 Manuel Sanchis i Marco Preface Disclaimer: The author asserts that the views expressed in this book are his own and do not represent the official position of the European Commission or any of the European Institutions. xi 1 The Economics of Monetary Union: The Theory of Optimum Currency Areas 1 1.1 Introduction to the Analytical Framework 2 1.2 The Theory of OCAs: The Costs of Having a Common Currency 3 1.2.1 Mundell: Factor Mobility 3 1.2.2 McKinnon: Openness of the Economy 5 1.2.3 Kenen: Product Diversification 6 1.2.4 Magnifico: “National Propensity to Inflation” 7 1.2.5 Ingram: Degree of Financial Integration 7 1.2.6 Vaubel: Real Exchange-Rate Changes 8 1.3 The Benefits and Costs of a Common Currency 9 1.3.1 Benefits 9 1.3.2 Costs 11 References 11 2 The Economic Rationale of Fiscal Rules in OCAs: The Stability and Growth Pact and the Excessive Deficit Procedure 13 2.1 Why Don’t Regions Leave Currency Areas When they Experience Asymmetric Shocks? 13 2.2 The Economic Rationale of Fiscal Rules in a Monetary Union 18 2.3 The Stability and Growth Pact 20 2.3.1 The Preventive Arm 20 2.3.2 The Dissuasive Arm: The Excessive Deficit Procedure 20 2.3.3 The Long-Term Sustainability of Public Finances 23 2.4 An Assessment of the Revised Stability and Growth Pact 25 2.5 The Six Pack: Scoreboard for the Surveillance of Macroeconomic Imbalance Procedure 27 References 28 Contents Contents xii 3 Coping with Asymmetric Shocks in the EMU: The Role of Labour Market Flexibility 29 3.1 Conditions for Success 30 3.2 Nominal and Real Wage Growth: The Experience from the 1970–1997 Period 31 3.3 Coping with Asymmetric Trans-European Shocks 33 3.4 Adjustment to Shocks 35 3.5 Behavioural Changes of Economic Agents and Institutions 36 3.6 Wage Negotiations Within Member States from a European Perspective 37 3.7 Price Setting and Wage Bargaining Behaviour 38 References 40 4 The Concept of Labour Market Flexicurity in the Eurozone 41 4.1 A Tentative Proposal for the Concept of Flexicurity 41 4.2 The Concept of Labour Market Flexibility 43 4.3 The EU Policy Approach to the Flexibility-Security Nexus 43 4.4 Definition of Labour Market Adaptability 44 4.5 How the European Commission Understands Flexicurity 46 4.6 Wilthagen’s Definition of Flexicurity: The Dutch Approach 47 4.7 Madsen’s Definition of Flexicurity: The Danish Approach 48 4.8 The Flexicurity Approach in Austria 50 4.9 The Flexicurity Approach in Spain 50 4.9.1 Elements of Flexicurity in the Spanish Labour Market Reforms (1984–1997). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51 4.9.2 New Reforms During the 1997–06 Period 51 4.9.3 Latest Reforms During the 2010–12 Period 52 References 53 5 The Spanish Case: The Housing Market Bubble and External Disequilibria. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 5.1 Gliding Economics Did Not Solve the Spanish Meltdown 56 5.2 Spain’s Major Macroeconomic Imbalances and Weaknesses 60 5.3 A Huge Current Account Deficit, Though Now Close to Balance 61 5.4 Over-Dimensioned Sectors and Structural Reforms 62 5.4.1 The Housing Market 62 5.4.2 The Financial Sector 69 5.4.3 Labour Market Reforms 70 5.4.4 Changes in the Fiscal and Budgetary Scenarios 71 5.5 Is Spain a Heavily Indebted Economy? 71 References 74 [...]... advantageous to be part of a wider country with a common currency M Sanchis i Marco, The Economics of the Monetary Union and the Eurozone Crisis, SpringerBriefs in Economics, DOI: 10.1007/97 8-3 -3 1 9-0 002 0-6 _2, © The Author(s) 2014 13 14 2  The Economic Rationale of Fiscal Rules in OCAs Consider, for instance, the effect that the oil crisis of 1973–75 had on Spain At the time, the Spanish economy had... countries, less of it in others.” (Magnifico 1971, p 12) 1.2.5  Ingram: Degree of Financial Integration The above four criteria focus on the real side of the economies, and leave little room for the analysis of financial and monetary issues Indeed, the models proposed by Mundell, McKinnon, Kenen and Magnifico put the stress on real 8 1  The Economics of Monetary Union: The Theory of Optimum Currency... The EU at the Crossroads 100 References 102 Appendix: Ideology and Economics in the Failure of Lehman Brothers 105 Chapter 1 The Economics of Monetary Union: The Theory of Optimum Currency Areas Abstract  In the 1960s, the theory of Optimum Currency Areas (OCAs) emerged as a by-product of the theoretical debate between fixed and flexible... inflation-unemployment relationships, and worsening regional disequilibrium Keywords  Optimum  currency  area  •  OCAs  •  Monetary union •  Monetary integration  •  Cost-benefit approach  •  One money, one market  •  Exchange rate fixity  • Exchange rate flexibility M Sanchis i Marco, The Economics of the Monetary Union and the Eurozone Crisis, SpringerBriefs in Economics, DOI: 10.1007/97 8-3 -3 1 9-0 002 0-6 _1,... change in the terms -of- trade—because B cannot lower money wages and prices in the short run, while A cannot raise prices because of credit restrictions—then the reduction of country B’s real income will take place through output forgone and job losses The latter would imply higher unemployment levels 4 1  The Economics of Monetary Union: The Theory of Optimum Currency Areas in order to reduce the demand... 10.1007/97 8-3 -3 1 9-0 002 0-6 _1, © The Author(s) 2014 1 2 1  The Economics of Monetary Union: The Theory of Optimum Currency Areas 1.1  Introduction to the Analytical Framework The theory of optimum currency areas1 (OCAs) emerged in the early 1960s, as a by-product of the theoretical debate between those who favoured fixed and those who favoured flexible exchange rates According to this theory, we understand a currency... rationale of setting fiscal rules for a common currency area and the resulting EU institutional frame for the Stability and Growth Pact (SGP) and the Excessive Deficit Procedure (EDP) We discuss the legal basis for the EDP and the relevant accounting definitions We also provide the initial settings of the SGP, as well as a summary of the contents and the related assessment of the revised SPG in March 2005 The. .. and social factors, on the system of industrial relations and the militancy of trade unions, on the structure of industry and its regional deployment, as well as, on the building into the general psychology of expectations of inflation or price stability generated by demand-management policies, which in the past consistently may, or may not, have aimed at guaranteeing the full-employment level of monetary. .. First, the transfer of savings is not free, as the country in difficulties will have to pay the interest and principal of the loans received from the country of the monetary union experiencing an economic expansion More importantly, the higher payments necessary to service the debt reduce the margin of manoeuvre of the country negatively affected by the shock This happens at the very moment when the country... (ZPLIA) and provided the legal basis for the policy of re-industrialisation This implied that companies planning on expanding projects and investing in the area would enjoy such perks as subsidies to stimulate investments and employment, fiscal bonuses, etc – Creation of the Commission for the Economic Promotion of Sagunto (CEPS) in charge of the management of the policy of re-industrialisation The objectives . The Theory of Optimum Currency Areas M. Sanchis i Marco, The Economics of the Monetary Union and the Eurozone Crisis, SpringerBriefs in Economics, DOI: 10.1007/97 8-3 -3 1 9-0 002 0-6 _1, © The Author(s). understand- ing of the problems faced by the Eurozone. The last two chapters of the book turn towards an analysis of the crisis of the euro and how to get out of this crisis. Spain is used as the. Speaker. They pro- posed that in autumn I give a set of six Guest Lectures on The Economics of the Monetary Union and the Eurozone Crisis. Over the summer, I was very engaged with the preparation of

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  • Foreword

  • Preface

  • Contents

  • 1 The Economics of Monetary Union: The Theory of Optimum Currency Areas

    • Abstract

    • 1.1 Introduction to the Analytical Framework

    • 1.2 The Theory of OCAs: The Costs of Having a Common Currency

      • 1.2.1 Mundell: Factor Mobility

        • 1.2.1.1 Scenario A: Countries with National Currencies

        • 1.2.1.2 Scenario B: Regions with a Common Currency

        • 1.2.1.3 Scenario C: Regions of both Different Countries and Currencies

      • 1.2.2 McKinnon: Openness of the Economy

      • 1.2.3 Kenen: Product Diversification

      • 1.2.4 Magnifico: “National Propensity to Inflation”

      • 1.2.5 Ingram: Degree of Financial Integration

      • 1.2.6 Vaubel: Real Exchange-Rate Changes

    • 1.3 The Benefits and Costs of a Common Currency

      • 1.3.1 Benefits

      • 1.3.2 Costs

    • References

  • 2 The Economic Rationale of Fiscal Rules in OCAs: The Stability and Growth Pact and the Excessive Deficit Procedure

    • Abstract

    • 2.1 Why Don’t Regions Leave Currency Areas When they Experience Asymmetric Shocks?

    • 2.2 The Economic Rationale of Fiscal Rules in a Monetary Union

    • 2.3 The Stability and Growth Pact

      • 2.3.1 The Preventive Arm

      • 2.3.2 The Dissuasive Arm: The Excessive Deficit Procedure

        • 2.3.2.1 Legal Basis and Accounting Definitions

        • 2.3.2.2 A Few More Economic Definitions

      • 2.3.3 The Long-Term Sustainability of Public Finances

        • 2.3.3.1 The Initial Setting of the Stability and Growth Pact (SGP)

        • 2.3.3.2 The Revision of the Stability and Growth Pact

    • 2.4 An Assessment of the Revised Programme

    • 2.5 The Six Pack: Scoreboard for the Surveillance of Macroeconomic Imbalance Procedure

    • References

  • 3 Coping with Asymmetric Shocks in the EMU: The Role of Labour Market Flexibility

    • Abstract

    • 3.1 Conditions for Success

    • 3.2 Nominal and Real Wage Growth: The Experience from the 1970–1997 Period

    • 3.3 Coping with Asymmetric Trans-European Shocks

    • 3.4 Adjustment to Shocks

    • 3.5 Behavioural Changes of Economic Agents and Institutions

    • 3.6 Wage Negotiations Within Member States from an European Perspective

    • 3.7 Price Setting and Wage Bargaining Behaviour

    • References

  • 4 The Concept of Labour Market Flexicurity in the Eurozone

    • Abstract

    • 4.1 A Tentative Proposal for the Concept of Flexicurity

    • 4.2 The Concept of Labour Market Flexibility

    • 4.3 The EU Policy Approach to the Flexibility-Security Nexus

    • 4.4 Definition of Labour Market Adaptability

    • 4.5 How the European Commission Understands Flexicurity

    • 4.6 Wilthagen’s Definition of Flexicurity: The Dutch Approach

    • 4.7 Madsen’s Definition of Flexicurity: The Danish Approach

    • 4.8 The Flexicurity Approach in Austria

    • 4.9 The Flexicurity Approach in Spain

      • 4.9.1 Elements of Flexicurity in the Spanish Labour Market Reforms (1984–1997)

      • 4.9.2 New Reforms During the 1997–06 Period

      • 4.9.3 Latest Reforms During the 2010–12 Period

    • References

  • 5 The Spanish Case: The Housing Market Bubble and External Disequilibria

    • Abstract

    • 5.1 Gliding Economics Did Not Solve the Spanish Meltdown

    • 5.2 Spain’s Major Macroeconomic Imbalances and Weaknesses

    • 5.3 A Huge Current Account Deficit, Though Now Close to Balance

    • 5.4 Over-Dimensioned Sectors and Structural Reforms

      • 5.4.1 The Housing Market

      • 5.4.2 The Financial Sector

      • 5.4.3 Labour Market Reforms

      • 5.4.4 Changes in the Fiscal and Budgetary Scenarios

    • 5.5 Is Spain a Heavily Indebted Economy?

    • References

  • 6 The Global Crisis and Alternative Scenarios to Save the Euro: A Spanish Perspective

    • Abstract

    • 6.1 Origins of the Great Recession

    • 6.2 Lessons That Can be Learned

    • 6.3 How the European Union Reacted

    • 6.4 From Financial to Debt Crisis: The Weaknesses of the Euro at Sight

    • 6.5 Some Institutional Responses

    • 6.6 The Euro Project: The Economic and Political Rationales are Conflicting

    • 6.7 What Does Fiscal Union Mean So Far?

    • 6.8 Alternative Scenarios to Save the Euro

    • 6.9 The January 2012 European Summit: The Need for a European Approach

    • 6.10 A Sort of Epilogue: The EU at the Crossroads

    • References

  • Ideology and Economics in the Failure of Lehman Brothers

  • References

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