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A Fix for the Euro Bug:
Modern Money Theory, Sovereignty
and Fiscal policy
Stephanie Kelton, University of Missouri-Kansas City
May 9, 2011
Croke Park Conference Centre
Sponsored by TASC and Smart Taxes
Wither the Dream
 Robert Mundell and the OCA
 Size and Openness
Stability
 “The euro should stand up very well. It has two great strengths: a
large and expanding transactions size; and a culture of stability
surrounding the ECB in Frankfurt. . . . As the EU expands, and as
the poorer countries catch up, the euro area will eventually be larger
than the dollar area.” (Mundell, 1999)
 “The euro will itself become a widely-used international currency,
conferring on the EU the “exorbitant privilege” to run a “deficit
without tears” – to use the phrases of Charles DeGaulle and
Jacques Rueff in their pungent attacks on the role of the dollar as a
reserve currency in the 1960s.” (Mundell, 1999)
Mundell’s Fundamental Flaw
 The “exorbitant privilege” to run a “deficit without tears” only applies to
nations that retain a sovereign currency
 Mundell (1999) was fundamentally wrong when he said, “given the fait
accompli of EMU and the euro, there are high costs to Britain staying out.
One is the loss of sovereignty. Macroeconomic policy will increasingly be
in the hands of the EU-11.”
 By retaining the pound, Britain retained its sovereignty
 By giving up the punt, Ireland lost hers
 Ireland is now the USER of the currency
 It cannot run a ‘deficit without tears’ the way sovereign currency
ISSUERS like the UK, US, Canada, Australia, etc. can
Principles of MMT
 Taxes drive money -- Government doesn’t “need” money in
order to spend (Manchester United)
 Taxes function to regulate Aggregate Demand, not to raise
revenue per se
 Bond Sales also provide the private sector with a safe,
interest-earning alternative to cash
 The government should not target any particular budget
balance
 Unemployment is de facto evidence that the government
deficit is too small
MMT
 Recognizes that there is a
fundamental relationship
between a nation’s power over its
currency and its power over
public policy
 Giving up power over ones’
currency implies a loss of power
in the policy sphere
 Something a handful of
economists cautioned about
prior to the launching of the euro
The Maastricht Treaty
 Underestimated the possibility of a massive banking crisis
 Overestimated the importance of price stability and the central
bank’s ability to generate it
 Underestimated the power of the bond markets to discipline
member governments
 Overestimated the feasibility of its No-Bailout clause
 Underestimated the extent to which the budget deficit reflects
what’s happening in the real economy
 Overestimated the market’s ability to “self-correct”
So When the Crisis Hit….

The Irish central bank
panicked and decided to
guarantee the banks

Deficits exploded

Financial markets (rightly)
began to worry

Debt levels increased

Government bonds were
downgraded to Baaa3

Financial markets stopped
lending to Ireland

And the ECB-IMF bailout
was negotiated
With Strings, Of Course

The government has promised to make €15bn in savings by 2014

€10bn through spending cuts

€5bn through increased taxation

Approximately €1.9bn will be raised from income tax.

VAT will increase from 21pc to 22pc in 2013, with a further increase to 23pc in 2014.
Goal: €620m.

The government will introduce a new 'Site Value' tax. Goal: €530m.

The level of the national minimum wage will decrease by €1 per hour to €7.65.

The government is aiming for a €700m full-year reduction in pension tax spending.

A range of measures will be introduced to achieve social welfare savings of €2.8bn.
Carbon
tax
Pension
reform
Water
charges
Property
tax
Minimum
wage
Death by 1,000 Cuts
The head of the IMF, Dominic Kahn said:
“The issue now is to see how the measures will be implemented,
especially those concerning the labour market.”
What are the “Experts” Saying
About all This?
 “To achieve stability, the EU must address the striking
disparities in the fiscal positions of its members,
although disagreements about how to set fiscal standards
are likely. Long-run solutions to Europe’s problems also
require economic reforms that increase competitiveness
and reduce labor costs in the peripheral countries.”
-Fernando Nechio, Federal Reserve Bank of San Francisco
 “A key element in the recovery process will be the
restoration of competitiveness through … a fall in
wage rates and other domestic costs relative to those in
Ireland’s competitors.”
-Adele Bergin, Thomas Conefrey, John Fitz Gerald and Ide Kearney, 2010
Ireland’s ‘Growth’ Strategies:
Fiscal Austerity &
Increased “Competitiveness”
Newsflash!
You’ve Already Got Competition
Portgual
 The main opposition party – widely presumed to take power in the
next election – backs continued measures to reduce debt and
improve competitiveness.
 Portugal is planning to reduce its budget deficit to 2.8% of GDP
by 2013.
 The government also plans to carry out structural reforms to
enhance export competitiveness, invest in human and physical
capital, and improve the educational system and infrastructure.
Greece
 Like Ireland, Greece is following an IMF austerity and
economic reform program
 Greece is projected to reduce its fiscal deficit from its
current 13.6% to 2.6% by 2014.
 To accomplish this, the government is required to cut
public sector wages, freeze state-funded pensions, and
strengthen tax collection
 All of this is designed to reduce the debt and increase
competitiveness
Spain
 Fitch warned that “the inflexibility of the labour market will hinder the
pace of adjustment, especially in the aftermath of the real estate boom.”
 The government then announced that it was carrying out structural
reforms of its banking system and labor market.
 Fernandez de la Vega said, 'We have implemented an austerity plan and
we've started working on labour reform, we are implementing all
measures to achieve our targets,' and 'I want to send a message of
confidence to citizens and of reassurance to markets,' she said.
 Spain followed with a 5% pay cut on government workers
Italy
 Italy’s fiscal deficit isn’t as large as some other euro-area
countries, but it has one of zone’s highest debt-to-GDP
ratios
 The government has said that labor market rigidities
and an outsized public sector jeopardize Italy’s
productivity growth and competitiveness
 The government expects to reduce its fiscal deficit to
2.7% of GDP by 2014.
 Italy is also reforming its social security system and its
labor markets
Will it Work?
 Sales create jobs
 Income creates
sales
 Spending creates
income
16
But Who will Spend?
•
•
•
•
Consumption: If unemployment
remains high, home prices
continue to fall,
and incomes are reduced,
consumption will not improve
Investment: If consumption is
stagnant, businesses will have little
reason to invest in new capital or
hire additional workers
Government: Governments are
cutting back significantly, with
austerity spreading globally
Net Exports: Many central banks
are devoting up to 3% of GDP to
manipulate their currencies.
Ireland will have to compete with
other nations for a share of export
markets
17
And This is the DoF ‘Solution’
 Ireland’s Department of Finance recognizes that households
face numerous headwinds, “not the least of which is the
continued need to repair balance sheets”
 The DoF projects deficits of 3% of GDP in 2013, and less
than 3% of GDP by 2015. It also expects the government to
adhere to the aggregate fiscal adjustment set out in the Joint
EU/IMF Programme of Financial Support for Ireland for the
period 2011-2012
 Pins its hopes for economic recovery on export growth,
which is projected at 6.75% in 2011 and 5.75% in 2012

The DoF forecast “assumes reasonably solid demand in our main
trading partners and further competitiveness gains.”
It Must Be a Good Strategy –
Everyone is Adopting It!
•
President Obama has pledged to double US exports over the next 5
years
•
Timothy Geithner is begging China to raise interest rates to
support US exports
•
UK Prime Minister David Cameron and his Finance Minister,
George Osborne, are also counting on a private sector, export-led
recovery to generate economic growth over the longer term
•
Germany is surviving (for the moment) on the strength of its export
markets
•
Ireland’s Minister for Jobs, Enterprise and Innovation, Richard
Bruton, recently travelled to India on a trade mission
•
But this is obviously not a workable
strategy for all nations
19
Maybe Ireland will be One of the
“Lucky” Ones
 Maybe your export
sector will explode
as you push wages
so low that you
leave Portugal in
the dust
 And become
Bangladesh
Austerity and Prosperity – They Don’t
Go Together, but They Do Rhyme
 The IMF and World Bank recently held their Spring
Meetings in Washington, D.C.
 There, finance ministers and central bank governors from
around the world agreed on two things:
 1. Governments must do more to counter unemployment.
“Growth is not enough. We need growth … to produce jobs.”
 2. Governments must tackle debt and fiscal problems in
advanced economies
21
Tackling Debt Tends to Raise
Unemployment
Sector Financial Balances as a % of GDP, 1952q1 to 2010q3
15.00%
10.00%
5.00%
0.00%
-5.00%
‘80(1)
’73(4)
-10.00%
‘90(3)
‘01(1)
’07(4)
’81(3)
Domestic Private Sector Balance
22
Govt Balance
Capital Account
20101
20081
20061
20041
20021
20001
19981
19961
19941
19921
19901
19881
19861
19841
19821
19801
19781
19761
19741
19721
19701
19681
19661
19641
19621
19601
19581
19561
19541
19521
-15.00%
Exactly the Wrong Move
“You never want to cut your budget
deficit when the private sector is
deleveraging… because we cut
prematurely in 1997, we entered into
a very steep economic decline and it
took us ten years to pull ourselves out
of that.”
- Richard Koo
23
The Bottom Line
 Even without the real estate bubble and the ensuing banking
crisis, a serious economic problems would have eventually arisen
in one or more areas of the zone
 One-size-fits-all monetary policy cannot target specific parts of
the zone in the event of an asymmetric shock
 More importantly, monetary policy is a weak (at best) tool, even
when problems affect the Eurozone as a whole
 The real problems are that (1) there is no lender of last resort
facility and (2) no safe funding mechanism to allow governments
to sustain large deficits in times of crisis
The Problem is with the Euro Itself
 The Euro is not a sovereign currency for any member government
 Every member of the EUR-16 is a USER of the currency – like Texas,
New York or California
 Sovereign governments – like the US, UK, Canada, Australia, etc. – are
ISSUERS of their currencies
 Sovereign governments cannot be forced into bankruptcy
 Indeed, they do not even need to issue bonds
 Ratings Agencies and bond vigilantes can be rendered powerless by
sovereign ISSUERS like the UK, US, etc.
The Most
Straightforward Way to
Restore Output and
Employment
Say “Goodbye” to the Euro,
Regain Your Sovereignty,
and
Take Back your Economy
Thank You