He sympathises somewhat with the notion that prior to the Euro, fiscal freedoms, which were subsequently given up, were abused, but suggests that that prior experience would have suggested a stability and growth pact but whose limits were qualified to allow for some counter-cyclical policy.
In a sense, given that the fines were limited, and the SGP was largely ignored, it is moot what the SGP actually comprised.
But, that aside, I think it’s within the range of rational judgement to have decided against allowing that extra component of discretion, for such is the nature of judging the state of the cycle.
To give a topical example closer to home, Simon himself has written regularly suggesting that he thinks that the UK output ‘lost’ post-crisis relative to pre-crisis trend is recoverable. If I were Germany thinking of a new monetary union with the UK, and I thought Simon was going to be on the fiscal council, I’d anticipate I would be in for some heated debates about fiscal policy in that context.
Leaving aside who is right, you can imagine the reluctance to expose oneself to a fight over output gaps that would have at its root concerns about the tragedy of the fiscal commons.
At any rate, it would be interesting to try to formulate what such a policy might mean; capturing the flavour of optimal counter-cyclical fiscal policy, but constraining it somehow to avoid prior abuse.
Simon takes on my argument that central banks should not be configured to prohibit monetary financing in the event of a default. Such prohibitions, he argues, are meaningless, or, if they are not, are harmful.
Meaningless or not they are built into every legal system that I know about.
The limitations are there to create the expectation that there will be fiscal discipline not to use the printing presses, and thus that inflation will be whatever it is promised to be. And the benefit of that is that the economy is not exposed to high and volatile inflation, and the fiscal authority can raise money at lower cost.
Simon seems to presume that default would always be the worst option. That would be so if inflation wasn’t costly. But very high and accelerating inflation – the sort you need to do monetary financing when people know what you are up to – is, I maintain, ruinous.
I can’t be sure I am right about the effectiveness of these measures. Central bank independence may simply have been caused by the insight that money financing and inflation were bad, rather than causing low inflation. But I’d settle on the conclusion that these prohibitions have been worth a try.
But I don’t think Simon can be sure either. He writes that central banks would always be swept away in the determination to avoid default. But this was not true of the past. Many countries wind up defaulting without hyperinflating. And it figures: hyperinflating defrauds your own citizens. Defaulting typically spreads the burden onto foreign creditors who can easily be cast as the enemy.
Simon also addresses my discussion of OMTs being a bluff. [See also some excellent, critical comments on that post by Malcolm Barr from JP Morgan]. But I’ll save that for another post.