Mervyn King has been criticised for crossing a line which separates monetary policy (the Bank’s remit) and fiscal policy (the Treasury’s remit). That line is imaginary: a legacy of Keynes’s assurance that fiscal deficit spending is non-inflationary during a recession: “an increase in the quantity of money will have no effect whatever on prices, so long as there is any unemployment” (Keynes, 1936). Similar commentary has been heard in recent times: “we are in a kind of parallel universe … when the normal rules are turned upside down” (Brittan, 2009). That this is nonsense was demonstrated by the fiscal impropriety of the 1970s – the “Heath-Barber boom” – which raised UK inflation to levels not seen since the time of Henry VIII.
The interdependence of fiscal and monetary policy is central to the tragedy of the eurozone. As monetary authority was passed to the European Central Bank (ECB), fiscal responsibility was left with individual states. Sovereign debt within the eurozone thereby acquired default risk.
When a state can print currency to redeem debt, there is no risk of default; but, as with Zimbabwe under Robert Mugabe, currency can quickly become worthless. Yet, Keynes had favoured monetary autonomy in advocating bond-financed deficit spending in the 1930s. Such interventions are doomed to fail because they lack foundation: economic malaise requires particular (microeconomic), not economy-wide (macroeconomic), adjustments.
The use of monetary policy to stimulate an economy in recession is no substitute for spontaneous and selective micro-price adjustments within free markets. This conclusion is consistent with the use of a single currency – such as the euro – where there is no “interest rate option” to moderate or to boost growth selectively across different parts of the economy. Here lies much confusion.
The interest rate option is a non-issue where nations are in similar shape. If nations are at different phases of a business cycle, the first relevant question is: “Why should it matter? Is it not possible for economies in recession to sell into those enjoying boom conditions?” A second relevant question is: “How could this have happened?” One plausible explanation lies with the different histories of fiscal mismanagement, which is the reason differences now exist between Germany and Greece, and those nations whose “plight” lies somewhere in between.
Such considerations provided the rationale for the pre-entry convergence criteria of the Maastricht Treaty. Fiscal deficits and sovereign debt respectively were to be no higher than 3% and 60% of GDP. Had those criteria been enforced, few states would have been admitted to the euro. Cheating was rife.
Although the Maastricht Treaty (1) had guaranteed the independence of the ECB “to pursue its mandated ultimate objective, that is, price stability, without interference from government”, and (2) had prohibited “any monetary financing of the public sector or privileged access to financial institutions”, it was inconceivable that political agendas would not test those features. German unification had shown how political pressure was applied to an “independent” Bundesbank to secure par values for disparate currencies.
The euro débâcle is symptomatic of a general tendency for economic stability to be compromised by politicians seeking to appease their electorates. Although interest rate and/or exchange rate readjustments are readily presented as the key to international competitiveness, monetary policy affords no means by which to reduce government wastage of resources; nor to re-equip the unemployed with saleable skills; nor to bring cheap credit to industries unable to compete for funds; nor to bring affluence to poor regions. Rather, the inspiration of speculative entrepreneurship offers the only viable route to prosperity; though never with any particular guarantees of success.