ABSTRACT
The ‘impossible trinity’ of international macroeconomics states that a country cannot have a fixed exchange rate, open international capital markets and an independent monetary policy. This is why members of the European Monetary Union all share the same monetary policy, carried out by the European Central Bank. It is my belief that Europe now faces a new impossible macroeconomic trinity: it is no longer possible to combine European Monetary Union, German political requirements and coherent macroeconomic analysis. Europe has resolved this contradiction by choosing incoherent macroeco-
nomic analysis.1 German political requirements have made it necessary to demand that the GIIPS2 countries: (i) deflate their costs and prices as much as is necessary to restore their competitiveness; (ii) live within the constraints imposed by the Stability and Growth Pact (SGP) and by Europe’s new Imbalances Procedure; and (iii) honour their sovereign debt obligations. But these objectives cannot be achieved. Any analysis which suggests that these things are possible is incoherent. Europe has chosen incoherent macroeconomic analysis for powerful rea-
sons. It is important for those Europeans who live within the Eurozone to show a continuing loyalty to the monetary union project, as part of the ongoing process of European integration. The abandoning of monetary union would be very costly in many ways. And it is important for Europeans to respect what is politically possible in Germany. Germany has found itself with responsibilities, as the new European hegemon,3 which go well beyond its own national borders. But Germany’s political imperatives are nationally driven, and they are constrained by a national sense of what is necessary and appropriate.4 As a result of these two strong forces, Europe now finds itself between a rock and a hard place. I am not the first to identify an impossible trinity within the Eurozone.5
But the impossible macroeconomic trinity which I describe goes deeper than that examined by other authors. The reforms which they propose, although both important and necessary, will not produce an acceptable outcome unless they are accompanied by the three necessary changes in macroeconomic policy-making outlined in this article: more inflation in Germany; significant fiscal expansion in Germany combined with an easing of fiscal austerity in the GIIPS countries; and forgiveness of much of the debt of southern European sovereigns. German economists and politicians have made it clear that each of these three things will be resisted. If these three policy changes are not achieved, however, I forecast a slow motion train-crash: endangering not just of Greece’s membership of the Eurozone, but also Italy’s, Spain’s and Portugal’s. And, agonisingly, we will also watch France trapped in the wreckage. The challenge of economic governance within the Eurozone is now to
ensure that these three policy changes are brought about. And the intellectual challenge facing those who live within the Eurozone is to create a climate of opinion, in Germany and elsewhere, which sees the incoherence of the current policy stance and accepts that changes are necessary. This is a challenge as large as that thrown down by Keynes in his General Theory.
