• aiseoneil

America Might Be the Next Europe

In Europe, macroeconomic policy is decided by the competition of two factions: rich states and poor states. Rich countries like Germany want to fight inflation, while poor countries like Italy want to fight unemployment. There’s a risk of the same thing being true about the United States.

In this article I will show that there is a widening gap between the state of the economy in Republican and Democratic states. I will then clarify the impediments to good monetary policy in Europe. I will then summarize what this means for our country.

Different Economies:

The chart below depicts the state of the economy and political inclinations of all 50 states and DC. The y-axis represents the unemployment rate as of April 2021. The x-axis represents the margin of victory (or 0 minus the margin of loss) Hillary Clinton has in each state in 2016. I am using 2016 results rather than 2020 results to make it clear the relationship cannot be explained by votes in states with a bad economy voting against the incumbent.

There are two obvious outliers in the chart. The extreme outlier is DC which is much more strongly democratic in voting pattern than any state. The outlier which depicts a low unemployment rate but strong democratic voting behavior is the state of Vermont. With or without these outliers, the statistical relationship between Democratic party affiliation and unemployment has increased over time as the chart below shows.

Clearly the relationship got very strong during the initial outbreak of Covid. There are two explanations I can think of, but more may exist. The first is that more population dense states which are naturally more susceptible to a viral outbreak lean Democrat. The second is that Democrat-leaning states imposed stricter lockdowns which, despite obvious public health benefits, could have hampered their economies more in the short term. It is likely that both of these explanations compounded on each other, and possibly more factors, to see this rise in relatedness of ideology and unemployment.

In any case, the parts of the country that vote Republican are generally more worried about inflation and labor shortages. Meanwhile, the parts of the country that vote Democrat are probably worried about finding a job.

European Politics and Macroeconomics:

Political rhetoric over monetary policy may come off to American audiences as a bit too boring or complicated to garner any votes. However, in Europe it is a hot topic. In 2019 for instance, the Dutch Government publicly criticized the Europeans for low interest rates, according to Bloomberg. In that same year, 6 former ECB officials (3 German, 1 French, 1 Dutch and 1 Austrian) all signed a public memorandum claiming the ECB’s inflation target was too high.

Within the past month, according to Reuters, Bavaria’s Finance Minister addressed an open letter to the ECB urging them to raise interest rates. He claimed Germany was a country of savers and that the monetary policy of European Central Bank was unfair to them.

So, what’s happening with all the public statements on monetary policy? Isn’t it incredibly boring and not worth talking about in public?

First, yes, it is true that it is incredibly boring. However, the reason people care about it regardless is a form of tribalism. Essentially, different countries in Europe want different things out of monetary policy and the desire to beat one's chest and say “we are a country of savers” (aka: those lazy Greeks aren’t) overpowers the instinctual urge to not talk about monetary policy because of how boring it is.

But why do different countries want different things out of monetary policy? Well it’s complicated. But here is the simple answer: South-European countries want more monetary stimulus but the Germans don’t.

South-European countries like Spain, Italy and Greece have problems that can only be solved by monetary policy. They have at the same time high unemployment and low inflation, while simultaneously having debt problems. Those countries cannot do enough stimulus (i.e. borrow money) to deal with unemployment and inflation without seriously risking a debt crisis. At the same time, if they try austerity to deal with their debt, they will end up with weakening economies, political instability and perhaps an even higher debt to GDP ratio (austerity could shrink GDP more than the debt). That could make their debt issues worse.

This problem could be solved by monetary policy. If the ECB just printed out enough money and bought government debt with it, the South-European countries could keep their economies going without a debt crisis.

But the richer countries of Europe, especially the Germans, don't want lower interest rates. The Germans have had much lower unemployment and higher inflation than Italy or Greece since 2008. They don’t view the economy as in need of support as much as Southern Europe does. Furthermore, Greece’s debt crisis was good for German industry: Merkel used it as an opportunity to privatize Greek public services and have that sold off to German companies. On top of that, a lot of people don’t really understand economics, so they think Greece, Italy, Spain and other countries could only have debt issues by being “lazy.”

The structure of the ECB is undemocratic. It is also designed in a way that does not lead to the best outcomes from a technocratic sense. Most voting officials in the ECB who decide interest rates are directly appointed by a country. Germany has their representative in the ECB, as does Italy. On top of that, there are 6 other voting members who are basically elected by a majority vote of the heads of state in the EU. Essentially all ECB decisions are indirectly the result of choices made by the political leadership of nations, not technocratic economists who want to optimize some variables.

Implications for Future American Public Policy:

It is unclear how long this relationship between political orientation and economic behavior will last, but it could threaten to derail an already tenuous consensus on what is best for the economy here in the U.S..

It is clear that Republicans generally tend to be more fiscally conservative than Democrats. However, this is largely a weak trend which is only generally true. For example, the current Treasury Secretary Janet Yellen, a Democrat, was a staunch supporter of deficit-reduction when she advised the Clinton Administration. And certainly the Republicans did not seem worried about the inflationary impact of the Trump administration’s tax cut bill and spending agreements with Democrats. Admittedly, Republicans took a hardline stance against Obama’s and Biden’s stimulus proposals. However, this is closer to obstructionism than political disagreement. Furthermore, Republican Fed appointees tend to be more hawkish than Democrat appointees. But this too is not always the case. There is usually broad consensus across the FED board about policy actions.

But what if these general disagreements between Democrats and Republicans were made an animating issue of politics? It is likely that the Republicans would get their way more than Democrats. The Republicans already have strong control over the FED. The seven member Board of Governors which appoints Fed Presidents and votes with them on interest rate policy is currently Republican-controlled by a margin of 5 to 1, with 1 vacancy.

Meanwhile, while the Republicans likely couldn’t pass any austerity measures into law, they could likely obstruct the Democrats from passing any new stimulus most of the time. It is not hard to imagine Republicans spinning the inevitable debt crises of Democratic states as a matter of fiscal irresponsibility. It is also not hard to imagine them using this as a means to privatise public infrastructure.

In other words, the economic troubles Europe had after 2008, may mirror economic troubles we are about to experience.

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