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Hurricane Trichet Hits Jackson Hole

After watching Jack Layton’s state funeral, I noticed that Jean-Claude Trichet’s speech from Jackson Hole is online. The European Central Bank president does not seem to get it. Far from acknowledging that last month’s interest-rate hike was premature, he touts “price stability.”

His main theme is that the economic divergence between Eurozone countries is comparable to that between American states. From there, he jumps to the non sequitur that what both Europe and the US need is more “structural reform,” specifically deregulation of labour and service markets.

What he misses (or deliberately overlooks) is that the US is a fiscal union, in which transfers help to support hard-hit regions. The lion’s share of public borrowing is done by the central government at low interest rates underpinned by a sovereign currency (regardless of missives from S&P).

The Eurozone’s problem is being a monetary union without any semblance of a fiscal union. Member economies cannot adjust through different monetary policies or fiscal transfers. National governments must borrow at their own interest rates, which reflect a lack of currency sovereignty.

The solution to the Eurozone crisis is for European institutions such as the central bank, which has sovereignty over the Euro, to stand behind the (Euro-denominated) public debts of member states. However, Trichet wants to diagnose the problem as being “over-regulated” labour markets.

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Comment from Andrew jackson
Time: September 3, 2011, 3:09 pm

I agree, but it would be a big leap for some euro entity to guarantee all euro area debt given that the federal government in neither the US nor Canada guarantee provincial or state debt. And how much central control of subsidiary government finances would there have to be to make a debt guarantee viable?

Comment from Erin Weir
Time: September 4, 2011, 3:20 am

I am not sure that the Canadian situation is so clear-cut. Provincial bond spreads may reflect some slight default risk (but also reduced liquidity). However, when Alberta actually defaulted on its debt in 1936, the federal government stepped in.

At least one empirical study finds spillovers from federal debt to provincial bond rates consistent with lenders perceiving Ottawa as an implicit guarantor of provincial debt.

I am not aware of the US government explicitly or implicitly guaranteeing sub-national debt. However, this point is moot since Washington does the overwhelming majority of American public-sector borrowing on its own account.

So, Europe needs either some kind of central debt guarantee or a massive fiscal centralization, with Brussels collecting most European taxes and holding most European public debt. A guarantee would be the smaller leap, entailing much less loss of national sovereignty.

Also, a European Central Bank guarantee of Eurozone debt (possibly in the form of Eurobonds) would require consent from the 17 Eurozone member states. A broader fiscal centralization would require consent from all 27 European Union members.

Comment from Travis Fast
Time: September 6, 2011, 8:00 pm

Yes Erin, but,

The present is a testimony to the degree to which Europe has not managed to overcome its barbaric nationalism. The French, Germans, and English are as far away from solidarity as they were in in 1914. Clearly Spain and Italy are much humbled as then as now. They just changed the nature of the chess board but not the game.

Comment from Paul Tulloch
Time: September 6, 2011, 8:40 pm

This is a preety good add on to your discussion Erin. I agree very much with Travis, there is a whole lot of politics seemingly scuttling any real action big enoigh to stop the blood flow. Band aids are all that have been used to this point, and potenially as this article suggests, that is as much as we can expect. Nationalism still has its stench in europe.

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