The Politics of Economic Crisis in Europe

Overview  Teaching Political Economy from a theoretically-informed perspective  A quick history of domestic political economy  The current crisis in Europe

Teaching Political Economy from a theoretically-informed perspective  Models of Politics  Thinking about causal relationships  From causal relationships to policy-making

A Model of National Politics

Example  The US and the Netherlands both have lower houses of their national legislature (The US House of Representatives and the Tweede Kamer)  US House members are elected in plurality elections from single member districts.  Tweede Kamer members are elected by proportional representation—% votes for each party≈% seats

Latest Election Results

An Example Exercise  What political parties do you think would be represented in the US House if we switched to a PR system with a 1% threshold?

Assessing Causal Relationships: Correlation vs. Causality  When X is high, Y is low  When X is high, Y tends to be low  Higher values of X cause higher values of Y  Higher values of X tend to cause higher values of Y

Ice Cream and Murder in Houston, 1999

Four hurdles on the way to evaluating causal relationships (X  Y)  1) Is there a credible mechanism that connects X to Y?  2) Can we eliminate possibility that Y causes X? (Y  X)  3) Is there covariation (correlation) between X and Y?  4) Is there some Z related to both X and Y, that makes the observed association between X and Y spurious?

Shameless Self-Promotion

A quick history of domestic political economy  History of the rise and fall of ideas about politics and economics –Mercantilism  Classic Liberalism –Classic Liberalism  Keynesianism –Keynesianism  Monetarism –And now…

Political-Economy Schools of Thought Classical Liberalism Keynes- ianism I Keynes- ianism II Monetarism Period of Dominance ~1900 to ~1945 ~1945 to ~1960 ~1960 to ~1980 ~1980 to ??? Primary Beliefs Market Efficiency Market Instability Market Instability, Phillips Curve Market Efficiency, the power of the money supply Policy Prescriptions Laissez-faire Demand Management Targeted Demand Management  M=  S +  P

Effinger and Schaling Index of Central Bank Independence  Austria 3  Belgium 3  Denmark 4  Finland 3  France 2  Germany 5  Italy 2  The Netherlands 4  Portugal 2  Spain 3  Sweden 2  UK 2

Maastricht Criteria  Entry into the currency union was supposed to be determined by three macroeconomic targets: –National Debt as a percentage of GDP –Budget Deficit as a percentage of GDP –Inflation  How would we expect the pursuit of these targets to affect the relevant national economies?  In the end, all EU nations except Greece were ruled to have qualified but Denmark, Sweden, and the UK opted out.

The Mechanics of Currency Union

The stability pact or the “straightjacket” and the new European Central Bank  A new institution, the Central Bank of Europe, was founded in June 1998 to oversee the new currency.   The official missions of the Central Bank are to: –Design and implement currency policy –Issue notes and coins –Promote smooth operation of payment systems –Conduct foreign exchange operations –Collect data and follow trends  In order to maintain its target of low inflation, the bank has substantial power to fine member nations that do not follow its guidelines. This is called the stability pact. Informally, it has often been described as a “straightjacket”.

The new European Central Bank  The power structure of the Central Bank is made up of: –The Governing Council: one member from each nation in the currency union and the Executive Board. This is where all decision-making power currently resides –The Executive Council: The President, Vice President and four regular members all selected by the nations in the currency union –The General Council: The executive council and one member from each EU member nation. This is a purely advisory body.

The stability pact or the “straightjacket” and the new European Central Bank  The stability pact is the key to the Central Bank’s ability to achieve its target of low (2% or less) inflation:  Under this pact, the budget deficit of any member nation may not exceed 3% of GDP  Officially violators of this pact are first warned and then fined at a rate which is designed to compensate other member nations for their contribution to Euro-inflation.

Monetarist or Keynesian?  “Nor is the question before us whether the market is a force for good or ill. Its power to generate wealth and expand freedom is unmatched, but this crisis has reminded us that without a watchful eye, the market can spin out of control…”