German Chancellor Angela Merkel speaks with French President Francois Hollande during a round table meeting at an EU summit in Brussels. (AP Photo/Geert Vanden Wijngaert)
German Chancellor Angela Merkel speaks with French President Francois Hollande during a round table meeting at an EU summit in Brussels. (AP Photo/Geert Vanden Wijngaert)

It is now almost three years ago since Greece’s government announced an austerity package that promised to reduce a budget deficit that was at least 4 times larger than the then agreed to limit under the Stability and Growth Pact. A promise was made to reduce the deficit to the requisite 3% threshold by 2012. We all know that such a promise could not be kept and deficits will no doubt exceed the wished for EU maximum for several years to come. Meanwhile, new austerity measures continue to be introduced. While Greece no longer makes the headline (as much), this is not because all is well in that country. Instead, Europe has turned its attention to Italy and Spain. The government is dysfunctional in the former country while Spain keeps recording staggering levels of unemployment (over 27% at last count).

Meanwhile Germany’s government, arch defender of continued austerity supported by Jörg Asmussen, a German national on the Board of the European Central Bank (“Delaying fiscal consolidation is no free lunch”), has now been turning its attention to monetary policy matters. Chancellor Angela Merkel, in a speech last week (see FT) has suggested that monetary policy might need to be relatively tighter in Germany than in some other (read Southern Europe) parts of the euro zone. Indeed, recent research that asks what interest rates might have been appropriate, had the single currency not existed, in Germany and other euro zone members before and since the financial crisis erupted confirms that monetary policy was too loose before the crisis before turning too tight since the onset of the crisis, at least for the Southern European members. In contrast, ECB policy was just about right for Germany, at least until the crisis hit. This research simply confirms what we already knew. However, it bears noting that, even in the US and Canada, monetary policy need not affect all regions the same way. Unlike Europe, however, we accept this, in return for labour mobility and the ability to borrow nationwide, among other benefits. The same, of course, is far less true in Europe. Can you imagine capital controls in a single province or as many banking regulators and supervisors as there are provinces and territories?

As if the recent fiasco in Cyprus is not enough, a leaked document in French written by Francois Hollande’s Socialist Party and posted on Le Monde’s website, protests against the German Chancellor’s policies and accuses the ‘forces’ of the right – called “Thatcherite” no doubt in memory of the recently deceased former UK Prime Minister – of killing the ‘European Project’ thanks, in part, to Merkel’s “selfish intransigence” supported by the British preference for an a la carte European Union.

Not a week goes by, it seems, when some speech, decision, or announcement of continued economic misfortune in that part of the world does not keep on giving the impression that the euro zone is nearing a breaking point. Never fear, however, as monthly meetings of senior government officials or Heads of government may well manage to paper over disagreements in the early hours of the morning.

With May upon us and the summer months just around the corner, look for Europe to come back into the picture with renewed ferocity. This time, monetary policy actions will not be the only game in town. Politicians, except possibly in Germany where elections will be held this Fall, will want looser fiscal policy together with an easing of monetary policy, that is, until the recent spate of weak economic data from Germany starts to change minds even in that country. It promises to be a long hot summer.

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.
  • Pierre Siklos is a CIGI senior fellow. His research interests include applied time series analysis and monetary policy, with a focus on inflation and financial markets.