On the binariness of the euro, or lack of it

Following on from my last post, a part of the argument that the Eurogroup will try to strike a deal at all costs is that they are seeking to protect the sacrosanct nature of the euro, which involves preserving that it is not possible to exit from it.  Once there is an exit, all the euroness is gone and the project is in tatters, and the euroness possessed by those that are left behind is suddenly tainted and now temporary.

Two points on this.

First, nothing is credibly forever.  The euro is a set of rules flowing from a series of agreements signed by past member state governments, long since gone.  Like all constitutions, given sufficient changes in public opinion of its signatory countries, it can and would change.  There is no credible ‘foreverness’ that a Grexit spoils for good.

There are simply probabilities of various currency and fiscal possibilities, defined by the signatories, and the rules governing how different policy instruments covered by them (including interest rates, asset purchases, fiscal redistribution) are set.  Grexit might well change those probabilities, but how much is moot.  As I argued in my last post, saving Greece now may not change the probabilities of a future Grexit that much, because they could find themselves in the same situation in a year or two.  And for different reasons the large country exit probabilities might not alter much [they are too big to save anyway] and the same for the smaller ones [they are easy to save, and their ‘good behaviour’ has instilled the solidarity to save them].

Part of the reason things are not – and never have been – credibly, forever, is that circumstances, including what we know about what is optimal monetary and fiscal policy, change.  Setting out to claim that this is the answer [eg the euro, with current membership] once and for all, is hubris.  It’s understandable that the euro pilots did this at the outset, of course, because they hoped to make its continuity a self-fulfilling prophecy.  But no-one should have believed it, and I presume not everyone did.  Instead, as Tom Sargent once pointed out, monetary arrangements can be seen, at best, as a form of slow-motion trial and error, hopefully feeling one’s way towards the arrangement that best fits the times and one’s state of knowledge.  Those that argue that Eurogroup will value permanence of membership above all else are arguing that there would never, rightly, come a time when people sit down and think ‘actually, we should never have got into this’ or ‘you now, maybe this isn’t working out any more’.

Moreover, part of this trial and error could be the evolving assessment of the nature of other aspects of the currency arrangements aside from the permanence or otherwise of its members.  Suppose permanence is valuable [the above has been about arguing permanence also has costs, but, leave that aside].  But so might be adherence to a set of rules of monetary and fiscal conduct by member states.  Since adherence to these rules would govern what was sustainable monetary and fiscal policy for the collective, in the future, and thus, what the benefits of membership were.

Of course these rules in the Eurozone have, through the process of trial and error, been bent and changed, and there is much argument about whether the twists and turns have improved matters or not [see contrasting views of Hans Werner Sinn and, well, most economists outside Germany for a sample of the controversy].  The stability and growth pact was set aside frequently.  And we are inventing embryonic fiscal transfers via the banking union, the ESM/EFSF, and the Troika loans and its terms.

But in assessing what should be the enduring nature of the euro for the future, it would not be rational – and I naively assert, therefore, will not be part of the calculus – to weigh non-exit above all else.  Permanence of membership might have its advantages.  But so might enduring rules of membership.

In short, avoiding Grexit for the sake of preserving expectations that no-one would ever exit is futile, because those expectations won’t be altered that much by this deal:  nothing is or should be forever.  Second, in so far as it’s good that things are enduring, if not forever, Eurozone policymakers will no doubt value maintaining the expectation that the rules of the game don’t change as well as expectations about who gets to be in the club.

 

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4 Responses to On the binariness of the euro, or lack of it

  1. q says:

    First-time visitor here. WIll probably visit more given the high quality of this post.

    May I ask a question which is not completely tangential to the contents (this may have already been addressed somewhere here, if so I apologise): does the increased power of taxation in Scotland make the UK less of an optimal currency zone?

    • Tony Yates says:

      Welcome! Answer: yes, a bit, in my view. I blogged about this a while back, retrieved by searching ‘devolution’ in the search box. Some are more relaxed about it than I.

  2. It’s the ECB that is expected to blink first, not the Eurogroup finance ministers. And this is a crucial difference. The ECB has a mandate for price stability. The simplest way to achieve that is to avoid surprises and big changes. This means, among other things, helping the banks in Greece as they run out of funding. Twice this week already, the ECB has “blinked” and extended more ELA to Greek banks [1]. If the ECB is pressuring anyone, it may be the creditors that are the target, not the Greeks [2].

    You might naively assume that the Eurogroup would stop ECB from doing this. But they can’t. The European court system has given a (very prelimary) ruling that the courts will not interfere in ECB decision-making as “[the courts] lack the expertise and experience which the ECB has in this area” [3]. The ECB is under no legal or democratic accountability, and they are rigidly focused on their mandate. What other option do they ECB have? If the EU want to change the mandate of the ECB, they need to make the relevant treaty changes.

    Greece will stay in the Euro. The ECB will do “whatever it takes” to provide the bare minimum assistance to Greek banks and/or the Greek government. There will be a lot of bluff and bluster from Dijsselbloem and his cronies over the coming days and weeks, but eventually they’ll wake up to the new reality.

    [1] http://www.zerohedge.com/news/2015-02-18/ecb-grant-greece-additional-%E2%82%AC4-billion-emergency-liquidity-%E2%82%AC64-billion-total

    [2] http://ftalphaville.ft.com/2015/02/18/2119460/the-unwitting-euro-enforcer/

    [3] http://curia.europa.eu/jcms/jcms/P_152763/

  3. Phil Koop says:

    I’ll raise your two points to three:

    1) “Nothing is forever” is a straw man. Nobody thinks that European authorities place infinite value on preserving the euro, only that they place a surprisingly high value on it. I think this is based mostly on historical observation, and if you want to argue that conditions have changed, then fine. But you’ll find the going a little tougher than just asserting a tautology.
    2) Point 1) is common knowledge: everyone knows that everyone else knows that nothing is forever. The “beauty contest” condition is satisfied. That precisely why there is a debate in the first place.
    3) There is a very simple mechanism by which Grexit could destroy the euro: Greece succeeds. By which I mean that, after a relatively brief period of chaos, Greece enjoys a relatively longer period of growth, following a trajectory like Argentina’s, and its example provides inspiration for others. That outcome is obviously not a foregone conclusion, but its possibility is the logical implication of what many prominent economists are arguing. I do not say this would be a bad thing, of course!

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