The political economy of European macroeconomic policies

Political Economy of European Integration Nikos Koutsiaras Lecture VI: The political economy of European macroeconomic policies, 1950-2000 A. Macroeconomics – a theorist’s joy and anguish, a politician’s friend and foe From Say to Keynes back and forth, with the help – or was it intrusion? – of maths, but still way afar from the (inaccessible) ideal of hard science – the legacy of the inter-war depression and the ‘this-time-is-different’ impulse (Reinhart and Rogoff, 2009) Defunct economists …and the revenge of politicians – practical macroeconomics Enter political macroeconomics – interests, institutions and ideas and macroeconomic policymaking – macroeconomic policies in Europe: a historical overview of domestic and international political economy, policies and macroeconomic performance

B. The heyday of Keynesian – and Keynesianist – macroeconomics, 1950s-mid1970s: An era of (national) state optimism The macroeconomics of Keynes and Keynesian macroeconomics: price and wage rigidities, coordination failures, failures of aggregate demand and steady-state unemployment equilibrium, demand management and macroeconomic management, stabilisation, fiscal dominance and monetary policy, the Philips trade-off – Neoclassical synthesis (yet, the policy and political nearly irrelevance of the long-run classical framework) – state and policy optimism – ideological movements along the Philips curve (partisan models of macroeconomic policy, D. Hibbs, 1977) The glorious days of (exceptionally rapid) growth and full employment, stability…and redistribution, founded on technological/ productivity catch-up, demographic growth (baby boom) – the ascent of labour and the welfare state (broadly conceived)/ the Keynesianist 3pillar economic consensus … …founded, also, on the international politico-economic regime: (credible) regional (goods) market integration, cautious international trade liberalisation, not fully convertible current account/ capital controls and the Bretton-Woods system of fixed (but adjustable) x-rates alleviating currency pressures on external balances, providing for an anchor to inflation expectations and allowing for domestic macroeconomic stabilisation (monetary and fiscal policy) Nevertheless, demand for demand management was genuinely low (stable growth)… …and macroeconomic policy, incl. monetary policy, was largely left out of the European system of economic cooperation and policy coordination – policy optimism (though little challenged) thereby justifying macroeconomic sovereignty, Bretton-Woods and the US ($) hegemony, national divergence, including in macroeconomic policy preferences – yet, the Werner report – the case of Germany – comparative political science and neo-corporatism Although the (productivity) slowdown was all but inevitable, the seeds of its prolongation were politically planted – enter labour market institutions, esp. trade unions – political upheavals (France, 1968)

C. Stagflation, the end of Keynesianism as we knew it and European macroeconomic coordination and convergence, mid1970s-1990s The oil shocks, inflation and unemployment (stagflation) and divergent macroeconomic policy responses in European economies – the empirical refutation of Keynesianist versions of Keynesian macroeconomics – the changing domestic political economy – the demise of the Bretton Woods system and its implications for Europe and integration, the Smithsonian agreement and the snake in the tunnel, the European (monetary) core or the Deutsche Mark zone – the 1979 EMS / ERM, ECU and the European Monetary Cooperation Fund (+ - 2.25%, + - 6%) The reformists, the Bolsheviks and the Mensheviks (Blanchard) in modern macroeconomic thought: market optimism and (rational) expectations, efficient financial markets – monetarism, new classical macroeconomics, incl. Real Business Cycles, and the New Keynesian response – macroeconomics for sustainable growth and the short(est)-term relevance of monetarypolicy-driven stabilisation – time inconsistency, Ricardian equivalence and implications for monetary and fiscal policy – the end of fiscal dominance – the public choice literature, rational partisan models and pure political business cycles models: mistrust of governments and policies – credibility, rules and constraints (independent central banks) Keynesianism in one country…and the failure of the (1981-83) French expansionary attempt – the US and UK orthodox macroeconomic policy turn – macroeconomics of disinflation at the global level European regional and international market integration (partly) associated with ICT technology, the microeconomic retreat of the state and the (rapidly) changing domestic and international political economy – the monetary trilemma/ impossible trinity EMS, the three phases: 1979-86, realignments and divergent macroeconomic preferences – 1987-92, almost stable parities, anti-inflationary policy convergence, UK entry (1990), the German hegemony – 1992-98, German unification, doubtless lack of credibility of imported, nearly violent disinflation, coupled with fiscal consolidation and associated with increasing unemployment, the 1992-93 EMS crisis (and the black Wednesday Sept. 16, 1992 of the sterling) and ERM II (+ - 15%) – on the road to EMU, yet with lessons unlearnt (e.g. efficient markets, credibility)….to be continued