Getting out? UK exit from EU less likely

Getting out? UK exit from EU less likely

Getting out? UK exit from EU less likely

11 May 2014
From The Wall Street Journal

Link to press quote(s):

In or out, your Euro-nightmare begins here

In or out, your Euro-nightmare begins here

In or out, your Euro-nightmare begins here

with Matthew Parris, 31 May 2014
From The Times

Brussels launch of CER report 'How to finish the euro house' by Philippe Legrain

Brussels launch of CER report 'How to finish the euro house' by Philippe Legrain

Brussels launch of CER report 'How to finish the euro house' by Philippe Legrain

24 June 2014

With Philippe Legrain, economist and author, Shahin Vallée, advisor to President Van Rompuy, European Council, and Cinzia Alcidi, head of economic policy unit and LUISS research fellow, Centre for European Policy Studies.

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Presidential candidates, European federalism and Tony Giddens

Presidential candidates, European federalism and Tony Giddens

Presidential candidates, European federalism and Tony Giddens

Written by Charles Grant, 15 May 2014

These European elections promise to be difficult for the EU. Opinion polls are predicting a surge in support for anti-EU parties of left and right. Furthermore, if past elections are a guide to the future, voter turnout will fall again. It slid steadily from 63 per cent in the first European elections, in 1979, to 43 per cent five years ago. The European Parliament – despite gaining more powers through each successive treaty change – has failed to convince a majority of voters that it is an admirable or useful institution.

But despite these ill omens, many ‘federalists’ – who may be defined as those wanting a significant transfer of powers to EU institutions – are getting excited. This is because the European elections may, for the first time, determine the choice of the president of the European Commission. Each of the main pan-European political parties has chosen a designated candidate for that job. Many federalists hope and expect that the political party which gains the most votes will see its candidate anointed president. They believe that this method of choosing the president would make the EU more democratic: voters would see a link between the way they vote and the person running the Commission.

The designated candidates have engaged in a series of TV debates and claim to be offering voters a choice of Europes. But in fact the three most prominent candidates – the socialists’ Martin Schulz, the centre-right’s Jean-Claude Juncker and the liberals’ Guy Verhofstadt – are remarkably similar. They have spent much of their careers inside the Brussels system. Two are former Benelux prime ministers, and two are MEPs (Verhofstadt is both). Though there are minor differences among the three – such as on the degree of austerity that is desirable – they all want to shift more power to the centre. The real political argument in these elections is not between these three candidates, but between three approaches to Europe: the federalists, who want more of it; the sceptics, who want less of it (or none at all); and, in the middle, those who see the value of the EU but don’t want a lot more of it and hope that it can be reformed.

The proposal for the Commission president to be chosen through designated candidates is problematic: it would narrow the pool of talent from which the president can be drawn; risk damaging the Commission’s credibility as a regulator by making it more overtly party-political; and encourage voters to believe that the political colour of the president influences EU policy, only to disillusion them when they see this is seldom the case (these problems are explained by Heather Grabbe and Stefan Lehne in a CER policy brief).

Whatever the rights and wrongs of this method of deciding the president, the federalists who back it may end up disappointed. The EU treaties state clearly that the European Council chooses the Commission president, “taking into account” the results of the European elections. As far as many heads of government are concerned, this means that the European Council is merely obliged to choose someone from the party that wins the elections – so long as that person can muster a majority among MEPs. The European Council may end up choosing a president who is not a designated candidate – such as, on the left, Pascal Lamy, Enrico Letta or Helle Thorning-Schmidt; or, on the right, Enda Kenny or Donald Tusk.

Some federalists would then be disappointed. But they generally take a long view and, inspired by their faith, are often determined operators. Over the past 50 years, visionary federalists such as Jean Monnet and Jacques Delors have had their victories. The EU’s farm policy, trade policy, competition policy and single market are largely run on federal lines. The creation of the euro was their greatest triumph.

But from its inception the EU has been an uneasy compromise between federalists and ‘inter-governmentalists’ – those arguing that the member-states (who in practice tend to be led by the big ones) should set the agenda and take key decisions. They have ensured that matters such as foreign and defence policy, taxation and treaty change remain subject to unanimous voting, and thus under the sway of national governments.

The balance between these two schools of thought has remained fairly even over the decades. But in the past few years some authority has shifted to governments: the euro crisis has required member-states to find the money for bail-outs, which has enabled them (and Germany especially) rather than EU institutions to dominate the management of the eurozone. Meanwhile, among the EU institutions, the European Parliament has gained greater sway over some decisions, thanks to the Lisbon treaty.

Tony Giddens, one of Europe’s most eminent social scientists and a member of the House of Lords, makes a brave case for federalism in his recent book, ‘Turbulent and Mighty Continent: What Future for Europe?’ Its chapters on economic, social, climate and foreign policy include good arguments for the EU to take on a bigger role vis-à-vis the member-states. The book is weaker, however, on the EU institutions.

Giddens’ first error is to argue that neither the EU nor the euro can survive without an economic and political federation, and that a federation is feasible. Giddens calls not just for a bit more federalism, but a radical leap forward. He wants the direct election of the European Commission president, much more power for the European Parliament, and the Council of Ministers transformed into a senate.

Giddens seeks to give these ideas plausibility by citing the support of Commission President José Manuel Barroso for ‘political union’. But Barroso does not speak for the peoples or governments of Europe. Very few Europeans want federalism. Most of them do not believe that the further centralisation of power in Brussels and Strasbourg would solve their problems.

The creation of a federal system along the lines suggested by Giddens would require a new treaty to be ratified in 28 member-states. Several of them would hold referendums, including perhaps Germany. Belgium and Luxembourg would ratify a federal treaty quite easily but it is doubtful that that many other countries would. In Italy, France, Germany and Poland there are influential federalist politicians, but whether they could persuade majorities of their parliaments or electorates to vote for Giddens’ proposed federation is highly debatable.

There is not going to be a European federation. So it is lucky that Giddens’s belief that neither the EU nor the euro can survive without one is mistaken. However, he is right that in the long run a healthy euro requires some degree of ‘mutualisation’ (sharing of risk) between its members. And it is true that, in the recent negotiations over the EU’s banking union, Germany largely avoided commitments to recapitalise troubled banks in other member-states. Berlin has also ruled out the ‘eurobonds’ – collective borrowing by the eurozone – which Giddens thinks essential for the euro to hold together.

Nevertheless Germany has de facto accepted some mutualisation. The European Stability Mechanism, the eurozone bail-out fund, has €500 billion (it and other bail-out mechanisms have so far lent about €350 billion to countries in need); the European Central Bank’s Securities Markets Programme has spent more than €200 billion on government bonds; and that bank’s ‘bazooka’ (officially known as Outright Monetary Transactions) – if ever used – could spend much more on government bonds. It seems likely that, in any future eurozone crisis, Germany would accept as much mutualisation as was necessary to calm the markets.

The euro can thrive – or even flourish – without eurobonds or other major steps to an economic federation. But it will need an effective banking union, which in the long run will require a bigger resolution fund – with a larger contribution from Germany – than the €55 billion fund agreed by the EU in March 2014. A healthy euro also requires a relaxation of the austerity that Germany and the Commission have imposed on the heavily-indebted countries. It requires more structural reform in the southern countries, to improve their potential for growth and job creation. And it requires structural reform in Germany, too. Germany’s unbalanced economy, over-dependent on exports, suffers from low levels of consumption and investment. A more balanced German economy would help to fuel growth elsewhere in the eurozone. Finally, some of the public sector debts weighing down on the Southern European economies will have to be written off, or at least have their maturities stretched out into the very long term.

Giddens’ second error is to argue that, as the EU develops, ‘variable geometry’ – the idea that members can opt out of certain policies, and that smaller clubs can exist within the broader EU – will become impossible. He writes that every member-state will have to be involved in the same policy areas. If Giddens were right, the British would have no choice but to leave – for they will never join the euro or the Schengen area.

In fact the trend is in the other direction, towards variable geometry. Not every EU state takes part in defence policy, all of justice and home affairs co-operation or the euro. The treaty provisions for ‘enhanced co-operation’, allowing sub-groups to proceed without the rest of the EU on particular laws, are starting to be used. Enhanced co-operations on the European patent and on cross-border divorce now exist, while others are being mooted for the financial transactions tax and the European Public Prosecutor.

Like many federalists, Giddens assumes that most of the ten EU countries not in the euro will join it soon. Yet apart from Lithuania, none of the ten has taken even the first steps of preparing to join (such as entering the Exchange Rate Mechanism). It may be ten years or longer before Poland – which would need to change its constitution – joins the euro, and some of the others may never do so.

The debates between Juncker, Schulz and Verhofstadt, entertaining though they may be, will not determine the future of the EU. Politics in Europe remains largely national, which is why the European elections often fail to inspire and why greater accountability of the EU needs to come, at least in part, via national parliaments (see section 1.3 of the CER’s proposals on EU reform). If politicians want to build a more federal Europe around the euro, and fulfil some of Giddens’ vision, they will need to do a better job of explaining to voters how a loss of sovereignty will deliver significant benefits.

Charles Grant is director of the Centre for European Reform.

An earlier version of this article was published in the March issue of International Affairs.

Barroso sees Britain as a 'special' case within EU

Barroso sees Britain as a ‘special’ case within EU

Barroso sees Britain as a 'special' case within EU

08 May 2014
From Financial Times

The consequences of Brexit for the City of London

The consequences of Brexit for the City of London

The consequences of Brexit for the City of London

Written by John Springford, Philip Whyte, 08 May 2014

See more on this item

Video interview on 'The consequences of Brexit for the City of London'

Video interview on 'The consequences of Brexit for the City of London'

By John Springford, 08 May 2014

Quantitative easing alone will not do the trick

Quantitative easing alone will not do the trick

Quantitative easing alone will not do the trick

Written by Christian Odendahl, 28 April 2014

Very low inflation poses a mounting threat to the economic stability of the eurozone. The rate of consumer price inflation has been below 1 per cent since October, and hence far below the European Central Bank’s (ECB) target of just below 2 per cent. This highlights the degree of weakness in the eurozone economy – and reinforces it – notwithstanding the optimism generated by a return to modest growth. And it further increases doubts over debt sustainability across the currency union: without a healthy dose of inflation, it is much harder for households, firms and governments to reduce their debt burdens.  To make things worse, in the most indebted countries, such as Greece, Portugal, Spain and Italy, inflation is even lower than the eurozone average. In response, many observers argue that the ECB should employ unconventional tools like quantitative easing (QE) to boost inflation. The problem is that QE alone is unlikely to be effective without a significant change in the ECB’s approach to monetary policy. The ECB needs to manage people’s expectations about the future path of demand, income and inflation more forcefully if it is to generate a proper economic recovery across the Eurozone.

According to one view of monetary policy, central banks set short-term interest rates to keep the economy close to full employment and inflation at the target level. In exceptional cases, this interest rate can fall to zero, but not below. In such circumstances, the central bank has to find other ways to stimulate the economy. One approach is QE: buying long-term assets like government bonds in order to drive up their price and bring down their ‘yield’, or interest rate (the price and yield of a bond are inversely related). Buying these bonds also tends to drive up the prices of other long-term assets like corporate bonds, equities and even property. QE thus lowers long-term interest rates, increases the value of firms and real estate, and drives up the wealth of households. Ideally, this induces firms and households to invest and consume more, and help the central bank reach its target on inflation.

A different view of monetary policy claims that interest rate setting or bond buying are just tools to keep firms’ and households’ expectations about the future path of income, demand and inflation on a reasonably stable and appropriately optimistic path. Such stable and optimistic expectations are a precondition for the investment and consumption decisions that keep an economy close to full employment, and inflation close to target. Of course, effective tools are necessary so that people believe that the central bank can steer the economy and, hence, so that the central bank can influence people’s expectations. But without properly managing economic expectations, the tools alone will be ineffective, according to this second view. Tools and expectations are thus complementary.

With these two approaches in mind, the ‘tools view’ and the ‘expectations view’, it is worth assessing the potential for QE to revive the eurozone economy, and hence, inflation. Starting with the tools view, there are several channels of transmission of QE.

* Lower long-term market interest rates could boost (larger) firms’ investment. But European firms raise finance predominantly from banks, not capital markets where the impact of QE would be directly felt. QE will therefore affect firms’ financing costs less than in the US, where capital markets are more important and where QE has effectively reduced long-term rates for firms. Given that banks are currently reluctant to lend in the most troubled southern European economies, the impact of QE on firms’ investment decisions in these countries is therefore likely to be low – just as in core countries like Germany where rates are already very low. If the ECB were able to buy bundles of bank loans to firms, QE would be more effective in lowering borrowing costs; but the current eurozone market for bundles of such loans is small.

* For households and investors, lower interest rates would make buying property more attractive. A rise in property prices usually stimulates the economy via construction and real estate services; the UK knows a thing or two about that. In the eurozone, however, a property-led boost to the economy is unlikely to be large. Spain and Ireland just came out of property bubbles and are healing only slowly; others, including core countries like the Netherlands, are struggling with falling prices whereas prices in France are already at very high levels and bound to fall. A slight boost in these countries means softening the hit, not driving a recovery. In Germany, the effect could be stronger but rising prices (and hence rents) would depress the consumption of the more than 50 per cent of Germans who rent. The effects of QE on the property market are therefore likely to be weaker in the eurozone than in the US or the UK.

* Property and other assets are also part of households’ wealth: QE would push up the prices of such assets, and households could thus consume more and save less (the so-called 'wealth effect'). However, the evidence on the size of this effect is mixed. According to an ECB paper, housing wealth does not seem to have much of an impact on consumption in the eurozone at all; financial wealth has a larger impact but it is still lower than in the US where households often own stocks and property for their pensions. Banks, as large owners of assets, are likely to benefit from QE. In current circumstances, where banks have insufficient capital and the ECB is likely to require many of them to raise more, higher asset prices help banks to repair their balance sheets and raise capital if need be. How much that would impact the overall economy is debatable: a pretty impressive recovery in asset values has already taken place without QE; banks’ ability to raise equity in markets is currently not in doubt; and banks’ lack of capital is only one of several reasons that prevent them from increasing lending to firms and households.

* By reducing long-term interest rates, QE would make the euro less attractive to investors, lowering its value, all else being equal. The fall in the value of the Japanese yen in the past 15 months, after the Bank of Japan’s (BoJ) aggressive QE programme, can attest to that. A lower euro would in turn support world demand for European exports, especially from southern Europe. Herein lies possibly the strongest channel through which QE can boost the eurozone economy directly.

* Finally, QE would help the treasuries of troubled countries such as Italy or Spain. By lowering the yield on their sovereign bonds – real yields are still high – QE would lower the cost of government borrowing. This lowers the pressure on governments to implement (mostly self-defeating) budget cuts in times of recession or weak growth, which would help the economy. It takes time for this effect to play out, however, as the costs of servicing existing debt are unaffected.

Overall, these direct channels are weaker in the eurozone than they are in the US or the UK. This is one reason to be sceptical about the likely impact of QE on the eurozone economy.

The second approach to thinking about monetary policy, the expectations view, induces further pessimism: firms' and households' expectations would be unlikely to change much for the better if the ECB simply implemented QE. And without such a change in expectations, the direct channels discussed above would do little to change firms' and households' behaviour.

The reason is that the ECB has failed to convince households and firms that it is doing all it can to lift the economy out of recession. It raised rates in mid-2011 at the height of the eurozone crisis when more stimulus would have been warranted and the bout of inflation was clearly temporary. Then it was slow to cut rates, even though the underlying price dynamic signalled clearly the future low inflation which has now shown up in headline figures. And the ECB has been reluctant to use unconventional tools at a time when high unemployment and a weak economy would have called for more aggressive measures than incremental cuts in interest rates – not least because inflationary dangers were non-existent. Starting QE now, after inflation has undershot the ECB's own forecasts repeatedly – essentially being dragged to the QE altar – is unlikely to convince anyone. The conservative approach of the ECB towards the economy and inflation, its hawkishness, is now firmly entrenched.

To make QE a success, the ECB needs to accompany it with the sort of strong commitments the BoJ in Japan or the Fed in the US have made: the BoJ said that it intends to continue a policy of QE and low rates until it has reached the new inflation target of 2 per cent (up from a de facto target of zero); the Fed has tied the duration of its unlimited QE programme to reaching certain targets on economic activity and unemployment. Both approaches led firms and households to change their expectations about the economy – about demand for their products or their income and future inflation – which in turn shaped their consumption and investment decisions.

A higher inflation target is, of course, out of the question for the ECB. With a mandate that is strictly focused on price stability and not much else (contrary to that of the Fed), it is also difficult for the ECB to tie QE to unemployment or economic growth – though reasonable people disagree on this.

However, the ECB does have the power to make a commitment that is purely focused on inflation (and hence firmly in line with its mandate). The ECB should announce that it aims to reach 2 per cent inflation on average over the next five years (an approach called ‘price-level targeting’). It might sound innocuous, but the word 'average' makes all the difference: since inflation is currently low and likely to remain low for a while, the ECB would commit to overshooting on inflation in the future. In other words, such a target would require the ECB to tolerate a mild boom in the eurozone to get the 3 per cent inflation necessary to reach a 2 per cent average over five years. Anticipating this, firms and consumers, financial markets and banks would increase consumption and investment.

If the ECB were to combine unlimited QE with a temporary price-level target – 2 per cent on average for five years – it could stimulate the economy and inflation, while remaining true to its mandate of price stability close to 2 per cent. Such a temporary price-level target would be new territory for the ECB, as would QE. But after years of misjudging the state of the economy and inflation, it is time for the ECB to be bold and innovative. The 19 million unemployed in the eurozone certainly deserve that the ECB makes every attempt at spurring a recovery worthy of the name.

Christian Odendahl is chief economist at the Centre for European Reform.


Added on 12 Oct 2014 at 13:10 by William Holland

Absolutely brilliant, thanks for a great read.

Launch of the final report of the CER commission on the UK and the EU single market

Report launch of the CER Commission on the UK and the EU Single Market

Launch of the final report of the CER commission on the UK and the EU single market

11 June 2014

With a keynote speech by Lord Mandelson, chairman, Global Counsel, former European commissioner for trade, and former secretary of state for business, innovation and skills

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Event information download: View the report 'The economic consequences of leaving the EU' here

Event speeches download: View the text of Lord Mandelson's speech here

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