A solution for the eurozone? Listen to the people, not to the markets.
For 40 years, there has been a tug of war between government in democracies and what we may call “the other government.” By the latter I mean, of course, the financial markets. James Carville highlighted his concerns when he announced that in the next life he would want to be a bond trader. Alan Greenspan followed the bond markets religiously for signs of increased or reduced inflationary expectations.
Now Europe faces the threat of a financial market rebellion. Democracy has spoken loudly in this weekend’s elections on the Continent and in England. Voters said, “We have had all the austerity economics we can take.” They threw over Sarkozy in France and many Conservative and Liberal candidates in England. In Greece they ran for the extremes. The moderate liberal Pasok party won the least votes in memory, but it may yet form a coalition to run a new government. Italian election results will be in soon.
And democracy is working! The instinct among those in the financial markets is that democracy usually reflects the weak-willed demands of the public. But the public is generally right this time, and it has been many times before. Austerity economics is self-destructive when economies are so weak.
Yet of course the financial markets’ initial reaction to the European elections was to sell, as if austerity economics was actually working to make nations’ bond payments easier to handle. It was not! But the markets fear that a new strategy will make matters worse.
Political leaders should ignore the financial markets in the short run, pure and simple. This may drive up financing costs for a while, but the eurozone should absorb those and adjust policies. The European Central Bank (ECB) ought to accommodate its needs. The right policies are stimulus from the current account countries and the end of extreme austerity in the periphery. Wages should rise in the eurozone core and stabilize in the periphery; they can even rise from their current lows in places like Greece. The 17-nation Eurozone or the 27-nation EU should issue jointly backed bonds to provide social safety net support to the financially weak nations, to raise demand for them and get their economies going, while reducing the extreme financial pain and sacrifice that now jeopardize social stability. As examples, the Greeks voted for extremist parties, the Le Pen party did well in France, and the Tea Party runs amok in the U.S. Austerity fever even grips Washington, which makes the November election especially important.
What the crisis requires is elected government, not bond trader government. Any idea that the financial markets are rational should have been discarded four years ago. They have been absurdly wrong for decades. In the U.S., they persistently overestimated future inflation by driving interest rates too high compared to the CPI and the GDP deflator. Greenspan treated them as the height of rational forecasting, when indeed they were simply following the latest conventional wisdom. In my informal opinion, he used long-term rates as a guide to policy. Now the ECB remains too tight as well. In the U.S., the “rational” bond traders actually traded what they thought the market would think, rather than what rational foretellers of the future would think. It was Keynes’ beauty contest analogy—choose the woman you think others believe is beautiful. The belief that the markets were right was the fallout of extreme efficient markets theory.
The media too often treated the markets as rational as well. Bond traders implicitly endorsed austerity economics until fairly recently, and the media usually reported them as being right. The supposedly sophisticated financial media (with some noted columnists as exceptions) wondered what could possibly work if not austerity. Now there are signs that the press is waking up to reality and realizing that it, along with the financial markets, is not working.
There are some signs of the ice breaking. The German finance minister announced it was okay for German wages to rise. They have actively restrained wage growth to make their exports more competitive for over ten years. The main sources of their demand were the European periphery, where wages were rising a bit due to a property bubble caused by irrationally low interest rates offered in the financial markets. But there are still signs of backward thinking. Many in Europe think of growth policies as nothing more than making labor markets more competitive through deregulation and reduced wages. As if the more flexible labor markets in the U.S. are leading to rapid recovery.
In sum, what’s needed in Europe is fiscal stimulus, a more accommodative ECB, social transfers from rich states, higher wages in many nations, a change in the silly EU agreement to keep deficits absurdly low, and industrial policy to gear capital investment across the continent, free of prejudice and nationalistic tendencies. The elections may bring some of this about. Then, once policies are working to support growth and reduce financial burdens as tax revenues rise, the financial markets will at last respond constructively. They must be waited out for now.
To put it most simply, what’s needed is the will of the government of the people to ignore the financial markets and stop treating them like a more rational government than democracy itself.
Cross-Posted From The Roosevelt Institute’sNext New DealBlog
The Roosevelt Institute is a non-profit organization devoted to carrying forward the legacy and values of Franklin and Eleanor Roosevelt.