The Mythology of European Monetary Union

Abstract

The global economic crisis that began in 2008 with the failure of American financial institutions has appeared in Europe as a crisis of Economic and Monetary Union (EMU) which poses the most profound challenges the European Union (EU) has faced since its founding in 1958. People are asking: how did the EU get itself into this situation and why it is having so much trouble getting out of it? Although many factors converged to produce this perfect storm, at the heart of the crisis is a persistent failure to recognize that there are durable differences in the institutional structures of the European political economies, which cannot readily be erased and offer comparative institutional advantages that national governments often exploit (Hall and Soskice 2001; Amable 2003). Economic prosperity in Europe has long depended on the operation of these national varieties of capitalism (Hall 2001a). From its inception, however, EMU has been built on the assumption that such institutional differences are transient deviations from neo-classical economic models, which should be corrected rather than accommodated. Of course, officials engaged in day-to-day policy-making have a more nuanced understanding of how their economies operate, but the major policy initiatives associated with the Euro have been justified in terms of this view. As a result, the Euro operates on a distinctive mythology. Mythologies have their uses, especially in politics, as Machiavelli (1984) noted; and this one was instrumental to securing agreement to the establishment of a monetary union with a particular institutional form in 1992. This was the high water mark of a rational expectations economics whose doctrines left a distinctive imprint on the new union. In contrast to preceding Keynesian views, which saw active macroeconomic management as the key to stable growth, the new classical economics held that fiscal policy was rarely stabilizing and monetary policy largely without lasting effects on the real economy. Prosperity was said to depend, not on demand management, but on supply-side measures to make markets in labor and goods more competitive (Crystal 1979; Cuthbertson 1979). Since active fiscal policy was deemed counterproductive, no effort was made to give the new monetary union capacities for coordinating its member states’ fiscal policies over the medium term. A Stability and Growth Pact (SGP) placing crude limits on national deficits and debt was considered sufficient. Since monetary policy was said to be of value only for controlling inflation, and best done through monetary rules, the new union was endowed with a European central bank (ECB) entirely independent of political control, with circumscribed powers that kept it focused on inflation and unable to purchase sovereign debt directly. EMU acquired these features ultimately because this is what the member states, who were interested in EMU for political as well as economic reasons, could agree on; but images of the economy purveyed by