Policy Research in Macroeconomics

The Greek Cliff-Hanger

Still from the production of The House of Hate,  New York City: Falk Publishing Co. 1922

Still from the production of The House of Hate, New York City: Falk Publishing Co. 1922

By Jeremy Smith and Ann Pettifor

Today, the G20 finance Ministers and Governors of Central Banks have been meeting in Istanbul. Tomorrow sees an emergency meeting of Eurozone finance ministers, to be followed by an EU finance ministers’ meeting on Monday. There is still just time to avoid disaster and reach a just outcome. But as we write, we fear that obstinate, damaging economic orthodoxy will prevail, with disastrous consequences.

The Troika, key player in this game, has let us recall, no formal legal existence, and no formal legal powers. Yet it has been tasked with leading on “negotiating” and monitoring the financial assistance programmes with states in difficulties.  Its “members” are the European Commission, the IMF, and the European Central Bank.  The aim of the Greek programme is set out on the European Commission’s website:

“to support the Greek government’s efforts to restore fiscal sustainability and to implement structural reforms in order to improve the competitiveness of the economy, thereby laying the foundations for sustainable economic growth.”

Passing over the absence of economic growth in the 4 years since 2010, we note the emphasis on “fiscal sustainability” which is important but which is not a monetary policy issue.  

We have reached a decisive point.  The Eurozone authorities and most Member State governments seem thus far unwilling to move one centimetre from the austerity-centred Greek programme enforced to date – still refusing to recognize that the Greek debt crisis was the co-responsibility of “northern” banks that lent with reckless abandon. Yet those same banks were the primary beneficiaries of a Troika-led bail-out, backed by European taxpayers.

 As Wolfgang Münchau put it in his FT column on Monday, “all that separates us from Grexit are a few more weeks like that one” – meaning last week.  That indeed presumes that we still have “a few more weeks”.  For his part, Prime Minister Tsipras, in his speech to Parliament on Sunday, reaffirmed that Greece would not seek an extension to the bail-out and its related conditions:

“The Greek people gave a strong and clear mandate to immediately end austerity and change policies. Therefore the bailout was first cancelled by its very own failure and its destructive results.”

Logically, unless there is movement by both parties, or a complete cave-in by the new Greek government, some form of Grexit would be the only alternative, much as both sides deny wanting it.

If it comes to it, a forced Greek Euro exit would certainly plunge the country into financial and economic turmoil for a while, but the consequent capacity to devalue and revive competitiveness might surprise “on the upside”, as happened with  Russia in 1998 and Argentina post 2001.  Just as important would be the political results, at a very uncertain time in relations between the EU and US, and Russia in relation to the Ukraine.  

It seems to us frankly mad for the Eurozone authorities and governments to play economic hardball with a weak and impoverished Greece at such a juncture, when this can be avoided by – in truth – small steps to ease Greece’s burden.  Refusal to negotiate sensibly would signal that strict adherence to contractionary economic ordoliberalism, and inflicting a political defeat on any government that challenges, however modestly, this orthodoxy, is the highest political value of much of the European establishment. 

After all, the Greek Troika-enforced programme has hardly delivered positive results to date.  While unemployment has fallen by 90,000 over the last year, it remains over 27%.  Industrial production fell 3.8% in December year-on-year, and by 2.7% for the whole of 2014.  This is despite the fact that nominal Unit Labour Costs (of which wages are the biggest element) have fallen by 13% since 2009, and real ULCs by almost as much.  And now the “plan”, unless changed, is for Greece to create a fiscal surplus exceeding 4% of GDP for years ahead, which is generally seen to be an absurd burden.

Which brings us to the increasingly ‘rogue’ behaviour of the ECB.

The ECB’s breach of legal mandate in the Greek crisis 

Last Wednesday, the ECB announced that it was closing one of the two channels for financing the Greek banking system, by removing the waiver that permitted low-grade bonds to be used as collateral in the Eurosystem. This leaves Greek banks with a single (and dearer) lifeline via funding from Greece’s central bank through the Emergency Liquidity Assistance (ELA) programme.

This announcement was wedged between a meeting of Greek Finance Minister Varoufakis with ECB President Draghi, and with German Finance Minister Schäuble.  To us and many others, it was evident that – given its timing and content – this was a politically-motivated announcement, aimed at maximising political pressure on the new Greek government to come to heel and accept the full adjustment programme.  See for example the blog “The ECB Has Shaken The Eurozone’s Utopian Foundations” by PRIME’s Ann Pettifor. 

Other commentators chose to interpret the ECB’s act differently.  The Financial Times in its editorial (5th February) argued that the ECB’s decision “to require Greek banks to obtain liquidity from the country’s own central bank rather than the ECB is far less aggressive than it looks.”

“Rather than a declaration of economic war, it represents the ECB removing itself from a decision about whether to keep Greece afloat while its new government tries to negotiate with the European authorities. This step was perfectly understandable. Decisions about Greece’s future in the Eurozone should be taken by politicians, not by central bankers…

The ECB has let go of one of the ropes by which Greece is dangling from the cliff edge. To drop the other by removing permission for the Bank of Greece to operate the ELA would send Greece plunging, at the very least to a Cyprus-style outcome with capital controls and at worst out of the eurozone altogether.”

If your aim is to remove the ECB from the political fray, it seems an unusual, even bizarre, idea that the best way of doing so is to let go of one of two ropes by which Greece dangles over a cliff edge.

More curious is the idea put forward by Frances Coppola – with whom we are otherwise in significant agreement – that the ECB’s true target here was Germany not Greece. She wrote:

“Could it be that far from kicking Greece, the ECB’s real target is Germany? For some time now, it has been evident that Draghi is no fan of Germany’s “Austerity Forever” stance. Pressuring Germany into negotiating might be his intention.”

And curiouser and curiouser:

“If Germany was seen to force Greece out of the Euro by refusing to negotiate, it would become an international pariah. There are already voices reminding Germany of its own debt forgiveness in 1953, and anti-austerity movements in many other Eurozone countries would only be encouraged by Germany and/or the ECB looking like bullies. Forcing Greece out of the Euro could result in the disorderly unravelling of the whole thing.

I may be completely wrong, but this looks far more plausible to me than a simple explanation that fails to take account of the signals given by both Varoufakis and Draghi. In which case, Schäuble should beware. His position is nowhere near as strong as he thinks. He is dangerously close to the cliff edge himself. If Germany pushes Greece over the edge, Greece may well take Germany down with it.”

For our part, we prefer Occam’s Razor – the simplest explanation is more likely to be the right one.   And the simplest explanation – that an act limiting Greek access to financing is more likely to be aimed at Greece than at Germany – also takes into acount the ECB’s role as active and supportive “member” of the Troika.

There is, to our mind, no doubt but that the ECB has acted in breach of its legal mandate as active Troika player.  Its mandate is set out in Article 282 of the Treaty on the Functioning of the European Union, as follows:

“The European Central Bank, together with the national central banks, shall constitute the European System of Central Banks (ESCB). The European Central Bank, together with the national central banks of the Member States whose currency is the euro, which constitute the Eurosystem, shall conduct the monetary policy of the Union. 

“The ESCB shall be governed by the decision-making bodies of the European Central Bank. The primary objective of the ESCB shall be to maintain price stability. Without prejudice to that objective, it shall support the general economic policies in the Union in order to contribute to the achievement of the latter’s objectives.” 

Actually, therefore, the mandate is not just of the ECB, but of the ECB plus the national central banks of the Eurozone.  This is not just Mr Draghi, but the whole central bank edifice. This point is often, but wrongly, glossed over.  It is a collegiate responsibility between the ECB and the individual central banks.

And the EU’s objectives to which the ESCB must “contribute” (unless they lead to breaching the ESCB’s self-imposed 2% inflation target) are set out in Article 3 of the parallel Treaty on European Union; they include “the sustainable development of Europe based on balanced economic growth and price stability, a competitive social market economy, aiming at full employment and social progress..”

The reality is that the ECB has for many months undershot its “at or near 2%” inflation target which it defines as price stability, and together with the other EU institutions, has seen unemployment remain at over 11% a full 5 years after the financial crisis broke. As for Europe’s “balanced economic growth”, the problem has been that, to date, the Eurozone’s monetary and other economic policies have together achieved the precise opposite!

In sum, the ESCB has failed to achieve its primary and key secondary objectives.  Since this failure is over a long period, and the necessary monetary policy steps have not been taken (at least prior to QE), we may fairly say that it is in breach of its legal mandate.

Returning to the ECB’s role in the Troika, we can of course see that there was a major “monetary policy” dimension to the financial assistance provided first to Greece (2010) then later to Ireland, Portugal, Spain and Cyprus – and thus an appropriate role for the ECB to that extent.  But, as explained above, the Troika was not charged with monetary policy in relation to Greece (or the other states), but with “efforts to restore fiscal sustainability”  and related “structural reforms”, especially fiscal measures, labour market reforms and (fire-sale) privatisations.

Slippery language and the tangled web of EU legal instruments

The legal instruments created by the EU and Eurozone states to get round the near-fatal flaws in the Eurozone’s Treaty framework are notorious for their opaqueness.  They combine a Eurozone Member State inter-governmental framework and company (EFSF), an EU Regulation (EFSM), and a separate European Stability Mechanism Treaty, signed by Eurozone states alone but tangentially integrated into the EU Treaty framework.

 For present purposes, we may note that a similar formula is used in each, whereby the European Commission is given the role of drawing up the conditions to attach to  an assistance programme, and to the monitoring thereafter, all “in liaison” with the ECB – and so far as possible “together” with the IMF. (The EFSM Regulation also refers to the Commission acting “in consultation with the ECB”).

Now “liaison” is a notoriously slippery word, and can be interpreted as involving only relatively distant connection between parties, little more than a smooth flow of information between the parties; or it can involve detailed joint working, even though the legal decision is that of the other partner.  From the start, the ECB chose to be fully involved as full partner in the economic and fiscal dimensions of the financial assistance programmes, and not just dealing with monetary policy.

This is borne out, if ever in doubt, by the recent Opinion of the Advocate General of the European Court of Justice, in the Gauweiler case in which Herr Gauweiler and others, including the German left party Die Linke, challenge the legality of the ECB’s Outright Monetary Transactions (OMT) programme.  This is how Advocate-General Cruz Villalón puts it, in a significant passage that questions the ECB’s role in the Troika:

“The applicants in the main proceedings, particularly Die Linke, have stressed that the ECB is not referring simply to compliance with an assistance programme from which it is wholly detached. On the contrary, the ECB actively takes part in those financial assistance programmes. Those applicants submit that the ECB’s argument is seriously undermined by its ‘dual role’, as (i) holder of a claim the basis for which is a government bond issued by a State and (ii) supervisor and negotiator of a financial assistance programme applied to the same State, with macroeconomic conditionality included.

I am substantially in agreement with that position….the ECB’s role in such [financial assistance] programmes goes beyond its simply unilaterally endorsing them. The rules of the ESM, but also the experience of financial assistance programmes which have been implemented or which are still ongoing, amply demonstrates that the ECB’s role in the design, adoption and regular monitoring of those programmes is significant, not to say decisive.

Moreover, as Die Linke have submitted in their written and oral arguments, the conditionality imposed in the framework of the financial assistance programmes which have hitherto been granted and in which the ECB has been actively involved has had a considerable macroeconomic impact on the economies of the States concerned, as well as in the euro area as a whole. That finding confirms, so Die Linke argues, that the ECB, in participating in the assistance programmes concerned, has been actively involved in measures which, in certain circumstances, might be perceived as going beyond ‘support’ for economic policy…

Unilaterally making the purchase of government bonds subject to compliance with conditions when those conditions have been set by a third party is not the same as doing so when the ‘third party’ is not really a third party. In those circumstances, the purchase of debt securities subject to conditions may become another instrument for enforcing the conditions of the financial assistance programmes.

The mere fact that the purchase may be perceived in that way — as an instrument which serves macroeconomic conditionality — may be sufficient in its impact to detract from or even distort the monetary policy objectives that the OMT programme pursues.” (Our emphasis).

The ECB as fiscal enforcer

This opinion prophetically foreshadows the ECB’s actions on 4th February. The Governing Council used its power to control access to ECB financing as a means of imposing pressure and enforcing the conditions of the financial assistance programme, conditions which it had helped establish and monitor.  

This means that the ECB in reality has exceeded its mandate, and engaged in non-monetary policy activities outside its legal remit.  Wearing an allegedly monetary policy hat, the ECB Board withdrew a key financing facility from a “beneficiary” that had dared question the non-monetary conditions imposed and enforced with full involvement of the very same ECB! 

We therefore conclude that in all probability, the ECB’s sudden removal at such a crucial moment of one of the “two ropes” preventing Greece from falling over the cliff was neither an act cunningly aimed at pressurising Germany, nor one of an independent central bank simply aiming to pass all responsibility on to the politicians.

The ECB is a deeply flawed, unaccountable body with a deeply flawed Treaty-based mandate. A mandate that it has succeeded both in breaching and in over-reaching as it rushed into non-monetary economic policy and enforcement via its role in the Troika.  It has acted crudely to put sharp pressure on a newly elected government to cease its attempt to ease austerity, and to accept the harsh conditionality that the ECB helped to impose.

All this makes this week’s finance ministers’ meetings of great importance. The Obama administration, as well to some extent as the UK government, has dropped strong hints that it is in everyone’s interests for there to be flexibility shown by all parties, to avoid a new crisis and Grexit.  The Greek government has made new proposals which offer positive elements. But the Eurozone authorities have thus far shown not a hint of movement.

We don’t often cite Tony Blair these days in PRIME, but in today’s FT he writes:

“The rest of Europe has imposed a burden on Greece that could never be borne for any length of time. I do not know what would happen in the UK if our economy contracted by 25 per cent; but I suspect it would be revolutionary.”

Amen to that. It’s high time for the ECB to stick to its own legal mandate; and for the EU and Eurozone to grant a fair deal for Greece. It is time to put an end to cliff-hanging, and time for a fresh start in Greece. 

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