politics, economy and employment & labour
by on 29th September 2021
With inadequate fiscal policy, monetary policy labours to compensate, creating damaging economic distortions in the eurozone market.
The pandemic has left millions of Europeans out of work and many underemployed, their businesses partly closed. Yet some are flourishing as never before. For European bourses, it has been marvellous. As the price of stocks has climbed, so has the wealth of those who own them.
Never have we seen such a disconnect between the real economy, the home of democracy, and the financial markets, the domicile for capitalists. And one institution has been at the centre of it all—the European Central Bank.
The ECB is perhaps the most powerful yet least understood institution in the eurozone. It has the power to engender economic, social and political change. Following the global financial crisis, the bank embarked on an epic experiment in monetary economics.
There are two macroeconomic levers: fiscal and monetary policies. Before the introduction of the euro, both largely belonged to European Union member states. With monetary union, monetary policy moved to Frankfurt, centralised in the headquarters of the new ECB. Fiscal policy, such as tax-rate formulation, belonged to member states, but under the Maastricht treaty’s Stability and Growth Pact the European Commission supervised.
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The lead-up to the crash saw profound capital misallocation in the eurozone. Pre-euro, ‘currency risk’ tempered financial venture-taking. A Munich-based bank would undertake due deliberation before converting Deutschmarks into Irish punts, due to the variability of exchange rates. Currency volatility played a risk-mitigating role, moderating investment allocation. Foolhardy owners of financial assets bore their losses and had no compensating recourse to the political domain.
But monetary union and the centralisation of monetary policy in Frankfurt abolished much of the muscle memory developed in the yesteryears of cross-currency investing. After the euro’s introduction, the credit-rating institutions mistakenly assumed the abolition of currency risk equated to the elimination of risk. Risk premia fell, driving a misplaced confidence, which saw euros freewheeling around the currency block.
The abandonment of fiscal policy as a lever became obvious when write-downs on irresponsible investment were hindered by political pressures. With short-term politics governing the long-term economy, monetary policy, the one-club alternative, stepped in.
The 2008 crunch and the politically facilitated bailouts of financial institutions grew the debt piles of member states. This led to the sovereign-debt crises of peripheral eurozone economies. In July 2012, Mario Draghi, then president of the ECB, delivered his infamous ‘whatever it takes’ speech. An epic experiment to create vast amounts of schemed money out of thin air began. With a printing press in the bank’s basement, Draghi asserted that ‘the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.’
The new authority to conjure money, for exclusive use in European money markets, represented a massive expansion of ECB power. ‘Whatever it takes’ turned into an extravaganza to inject trillions upon trillions of euro into the eurozone’s financial system. By July 2021, under the orthodoxy of ‘asset-purchase programmes’, over €4.2 trillion showered on to its thumping heart. As vast swaths of assets were hoovered up, the prices of these securities rose—along with the wealth of their owners.
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‘Quantitative easing’ is technical jargon used by the ECB when it opens the money spigot to buy assets in financial markets. QE is predicated on the hope that lower interest rates, a Trojan horse for higher asset prices, will spark more spending and borrowing throughout the economy. By design, the asset-purchase programmes drive down long-term interest rates, making bond yields unattractive.
Cash-enriched from ECB purchases, investors speculate further out on the risk curve. From 2012 until 2019, returns on risk, as measured by the Euro Stoxx 50, rose 54.4 per cent. Investors love the ECB’s easy monetary policy.
The ECB has good intentions, including increasing labour-force participation. Nevertheless, the tools used by the central bank may not only be increasing wealth inequality but also harming the real economy.
Interest rates are to finance as gravity is to Newtonian physics—a fundamental law. QE programmes manipulate interest rates. By paying good money for financial assets, the ECB lowers interest rates. But untampered interest rates are the bread and butter of economics.
The ECB’s influencing of interest rates removes the investment guardrails essential for effective capital allocation and investment appraisal. Its manipulations incentivise economic agents to direct their corporate horsepower into the financial domain protected by the central bank, rather than the real economy, retarding productivity.
Capitalism’s gift to democracy is efficiency. In reciprocity, democracy grants capitalism the rule of law and the sanctity of property rights. Capitalism may not however deliver efficiency within a rigged interest-rate market—it needs price discovery of the interest rate, which requires the central bank to close the QE spigot. The easy-money ECB profligacy risks eroding efficiency and consequently imperils capitalism’s symbiotic relationship with democracy.
From 2000 to 2020, public debt in the euro area increased from 69 per cent of gross domestic product to almost 100 per cent. Private debt increased by a greater amount: the median ratio to GDP increased from 136 per cent to 189 per cent (by 2019).
As with any factor of production, when debt capital is overused it suffers from the law of diminishing returns. Bad money begins to chase out good money and productivity declines. Average euro area nominal labour productivity declined, if EU = 100, from 108.9 in 2009 to 105 in 2020, or by 3.2 per cent (see chart).
When the economy of the eurozone runs into financial difficulties, it is better electorally speaking for the central bankers to take charge. Insolvency is not good at the ballot box. If it occurs, short-term solutions are preferred. Modern European democracies cannot sell austerity as a means to tackle escalating debts, whether derived from recklessness or unforeseen events such as pandemics. This keeps the eurozone on the elevated debt path. Titanic debt, in the absence of strong long-term fiscal policies, requires loose monetary economics, such as that espoused by the ECB, still in its experimental phase.
It is highly unlikely political leadership will embrace living within our means as a method to repay obligations. Austerity is political kryptonite and consequently disfavoured as a fiscal-policy response. Therefore, the price variable of monetary policy remains shoehorned towards the zero bound, resulting in a fantastical under-pricing of risk. That there may be unintended consequences is a real concern—one cannot just extend the debt and pretend everything is okay.
Walter Bagehot, a 19th-century titan of finance, cautioned that low interest rates instigated bubbles. ‘Bagehot’s dictum’ is that the lender of last resort should lend freely at high rates of interest and on good banking securities.
When European democratic institutions choose not to use fiscal policy—for instance to recapitalise their banks—they project capital misallocation into the realm of the monetary domain, a province wholly ill-equipped to deal with it. Yet the medicine of low interest rates and high asset prices is far more palatable than treating the underlying disease of insolvency, with the associated painful debt restructuring.
Capital misallocation begets lower interest rates, which beget even more capital misallocation, begetting ever-lower interest rates and so on. What Europe should be doing is forcing painful debt write-downs to allow the interest-rate lever to rise above the zero bound—more ‘monetary space’ in the jargon. Stimulating the economy with just monetary torque is anathema to the spirit of democracy, as it exacerbates wealth inequality and reduces efficiency.
Those in authority have assumed the financial system is knowable and controllable, when more humility in their modelling would be appropriate. Financial history tells us markets are not controllable, cannot be determined and do not equilibrate—and bad things can happen. Unlike Newtonian physics, macroeconomics is not deterministic: it is a complex system with tipping points and unintended consequences.
Rising asset prices rob younger generations of their purchasing power and sacrifice the role of money as a reward for social co-operation. As Ben Bernanke, former chair of the Federal Reserve Bank put it, ‘The problem with QE is it works in practice but it doesn’t work in theory.’
Much will depend on whether the ECB doubles down on the paradigm of ultra-loose monetary policy as the panacea to cure all ills within the macro economy. The beating heart of the financial system is now certainly addicted to its astonishing stimulus. Separated from the short-term politics of fiscal policy, monetary policy is widely accepted as the only game in town.
Bercan Begley is a fellow chartered accountant with Chartered Accountants Ireland with over 18 years of experience working in complex international financial and digital matters. He has worked as a senior associate with PwC and as a director with NQSN Limited, where he advised companies operating in financial, aeronauctical and technology sectors. He is currently working as a consultant with ARHS Technologies.
The strengthening of the social dimension of the EU is back on the agenda of European politics. The European Pillar of Social Rights, the revision of the Posted Workers Directive and the initiative for a European minimum wage are interpreted by some as a turning point. However, the road to a more social Europe is still very long. Against that background, this paper formulates a social Europe thus: social minimum standards plus a reconfiguration of the internal market and economic and monetary union in a manner compatible with the pillars of the European social model.
To understand the diversity of job retention schemes implemented in the Covid-19 crisis, the two co-authors developed a typology, distinguishing among three underlying types: short-time working (STW) schemes, furlough schemes and wage subsidies. They provide a comparative overview of the different schemes implemented in the context of the crisis, considering their design as well as their size in terms of expenditure, and map adjustments made to them in the course of the crisis. Finally, they analyse the evolution of the take-up of the schemes in the course of 2020.
The third round of Eurofound’s Living, working and Covid-19 e-survey, fielded in February and March 2021, sheds light on the social and economic situation of people across Europe following nearly a full year of living with restrictions. The report analyses the main findings and tracks developments and trends across the 27 EU member states since the survey was first launched in April 2020. It pinpoints issues that have surfaced over the course of the pandemic, such as increased job insecurity due to the threat of job loss, decline in mental wellbeing, erosion of recent gains in gender equality, fall in trust vis-à-vis institutions, deterioration of work–life balance and growth of vaccine hesitancy. The results of the survey highlight the need for a holistic approach to support all the groups hit hard by the crisis, to prevent them from falling further behind.
Social rights for platform workers, fiscal-rules reform and EU enlargement, as well as the challenges and opportunities for social democrats in the post-pandemic context, are the main topics of the latest Progressive Post magazine.
After more than a year of the pandemic, we are in a crucial political moment: policy decisions made now will drive reforms and sustainable growth in the years to come. For progressives to take ownership of these topics, this issue of the Progressive Post analyses some of these opportunities.
Global Wage Report 2020/21: wages and minimum wages in the time of Covid-19
The ILO’s Global Wage Report is a key reference on wages and wage inequality for the academic community and policy-makers around the world. This seventh edition examines the evolution of real wages, giving a unique picture of wage trends globally and by region. The report includes evidence on how wages evolved in the first half of 2020 during the Covid-19 crisis: in the case of Europe, the report shows 1.2 per cent real wage growth during 2019, while the impact of Covid-19 would have reduced the total wage bill by 6.5 per cent by the second quarter of 2020.
The report reviews minimum-wage systems across the world and identifies the conditions under which minimum wages can reduce inequality and presents extensive data on levels of minimum wages, their effectiveness and the number and characteristics of workers paid at or below the minimum wage. It highlights how adequate minimum wages, statutory or negotiated, can play a key role in a human-centred recovery from the crisis.
‘The Global Wage Report is central to the analysis of wage trends and labour market developments as well as to the theoretical debate about the role of labour in the econom’—Hansjörg Herr, Berlin School of Economics and Law.
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