Keynes and the Europeans: Similarities of ICU and EMU

by Dirk Ehnts, Econoblog101

The International Clearing Union (also called Bancor plan) that Keynes proposed at the Bretton Woods conference has received some renewed interest over the years, culminating in the EMU’s macroeconomic imbalance procedure which is at least partly based on the ideas of Keynes. Countries with deficits higher than 4% of GDP or surpluses higher than 6% of GDP might come under pressure, and this pressure is real. The Excessive Imbalance Procedure can lead to sanction against countries (source):

Rigorous enforcement: A new enforcement regime is established for euro area countries. The corrective arm consists of a two-step approach:

  • An interest-bearing deposit can be imposed after one failure to comply with the recommended corrective action
  • After a second compliance failure, this interest-bearing deposit can be converted into a fine (up to 0.1% of GDP)
  • Sanctions can also be imposed for failing twice to submit a sufficient corrective action plan.

The decision-making process in the new regulations is streamlined by prescribing the use of reverse qualified majority voting to take all the relevant decisions leading up to sanctions. This semi-automatic decision-making procedure makes it very difficult for Member States to form a blocking majority.

Very difficult, but not impossible. Finally the periphery would have something to trade with in the political game in which the German government holds all the cards. This November’s Alert Mechanism Report says that Germany might be dealt a bad card soon:

IDRs [In-depth-reviews] will also be prepared for Germany and Luxembourg in order to better scrutinise their external position and analyse internal developments, and assess whether any of these countries is experiencing imbalances;

However, the payment system of the euro zone already worked in a way that reminds one of the original proposal of the ICU. Sergio Cesarotto has recently published a paper in EJEEP in which he highlights similarities between Target2 and ICU:

In view of the above, T2 can be interpreted as a CA surplus recycling device in favour of deficit countries, something that recalls Keynes’s proposal of an ICU. Not only can T2 accomplish the recycling of current deficits, but it can also fix capital flight (repatriation of early loans that financed previous CA deficits) from indebted countries, transforming, as we have seen, private loans into ‘official’ T2 loans. In principle, T2 may substitute the private financing and roll-over of deficit countries almost ad libitum, but there are of course limits to what Minsky defined as ‘Ponzi finance’. The austerity measures imposed by the EU on indebted countries may thus be seen as a way – unfortunately neither effective nor socially sustainable – to generate CA surpluses so as to guarantee servicing and possibly reduction of their net foreign debt. On the other hand, Keynes’s proposal emphasized the need for expansionary adjustment by surplus countries.

The last sentence shows where the political problem is. The German government does not accept that it should have to adjust in the event of macroeconomic imbalances. It stubbornly insists on austerity and falling wages, which have been triggering a deflationary problem in parts of as well as the whole currency area. Deflation, as every economists should know, is worse than inflation: when prices are falling, then a) it does not make sense to run a business (outside the service sector, maybe) because you buy inputs when they are expensive and you sell your production only later when prices have fallen and b) it becomes very difficult to repay any debt with falling profit or income.

Apart from that, the euro zone imposes a current account deficit on the rest of the world and whether this will work depends on how other countries react to that. In the case fixed exchange rates, it’s a policy decision (at least up to some point), and in the event of flexible exchange rates it depends on markets. The normal reaction to a currency area that turns from a balanced current account vis-a-vis the rest of the world towards a current account surplus would be an appreciation of that currency. This is perhaps what is driving the euro-dollar exchange rate these days.

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As always, the prediction of exchange rates is something that a serious economist should always see as an exercise in ‘guesstimation’.

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