Carney, Berlin and the Deutsche Mark zone
by George Hatjoullis
A remarkable speech by Mark Carney, Governor of the Bank of England, indirectly draws attention to the restructuring of the eurozone by Germany into a Deutsche mark zone (http://bit.ly/1uC6fHq). The theoretical substance of the speech should be easy to follow for readers of Gestaltz as I have gone over this ground repeatedly since the blog kicked off at the time of the troika intervention in Cyprus. However, to recap briefly will do no harm.
The UK is a monetary union. All regions have a common currency managed by a singular independent central bank.The UK is also a fiscal union, though with some devolution of fiscal authority to some regions. The UK is a political union, but again with some devolution of political power to some regions. The fiscal and political unity has made the UK economy more robust because it facilitated fiscal transfers across regions. Moreover, the UK has pursued a flexible fiscal policy, allowing expenditure to rise relative to revenue during periods of recession (counter-cyclical fiscal policy). This has not been inconsistent with a long-term plan for deficit and debt reduction. This is the thrust of Carney’s point and he is quite right. The UK (and US, a similar union) has fared better than the eurozone since the crisis precisely because of this structure. Carney urges the eurozone to accelerate integration in line with the UK form of union.
Now consider what has happened in the eurozone. The Maastricht Treaty set up a monetary union without any fiscal integration. There is a common central bank, ostensibly independent, and a common currency. There the similarity with the UK union ends. Fiscal transfers are expressly forbidden (not to be confused with EU regional funds) and the ECB cannot take any action that might be construed as a de facto fiscal transfer. Individual states are also restricted in their fiscal policy, with severe limitations on their ability to run counter-cyclical fiscal policy. Indeed eurozone members are effectively committed to running balanced budgets. This is the lack of integration to which Carney refers and deems the source of the eurozone stagnation.
The BoE conducted quantitative easing early in the evolution of the crisis. The ECB has only now embarked on this, and it may be too late to avoid deflation. This, and the asymmetric bias towards deflation inherent in the eurozone arising out of Germany’s pathological fear of inflation, has been discussed at length. The interesting part of the QE in relation to Carney’s speech is the manner of the QE. Some 80% of the asset purchases will be carried out by the national central banks and be the liability of the respective governments. The joint and several liability of the ECB has been diminished. It is no longer one central bank for the eurozone but a system of independent central banks, coordinated by the ECB in common action. Germany is not liable for losses incurred in purchasing Portugal government bonds. This fragmentation has moved the eurozone form a monetary union to a monetary cooperation. In such an arrangement the strongest partner, Germany, will dominate. This little noticed action is effectively moving the eurozone towards a Deutsche Mark block, where the Bundesbank and not the ECB will call the shots. Watch this space.