The Politics of Economic The Politics of Economic Crisis in EuropeCrisis in Europe

OverviewOverview

Teaching Political Economy from a Teaching Political Economy from a theoretically-informed perspectivetheoretically-informed perspective

A quick history of domestic political economyA quick history of domestic political economy The current crisis in EuropeThe current crisis in Europe

Teaching Political Economy from a Teaching Political Economy from a theoretically-informed perspectivetheoretically-informed perspective

Models of PoliticsModels of Politics Thinking about causal relationshipsThinking about causal relationships From causal relationships to policy-makingFrom causal relationships to policy-making

A Model of National PoliticsA Model of National Politics

ExampleExample

The US and the Netherlands both have lower The US and the Netherlands both have lower houses of their national legislature (The US houses of their national legislature (The US House of Representatives and the Tweede House of Representatives and the Tweede Kamer)Kamer)

US House members are elected in plurality US House members are elected in plurality elections from single member districts.elections from single member districts.

Tweede Kamer members are elected by Tweede Kamer members are elected by proportional representation—% votes for each proportional representation—% votes for each party≈% seatsparty≈% seats

Latest Election ResultsLatest Election Results

An Example ExerciseAn Example Exercise

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

Assessing Causal Relationships: Assessing Causal Relationships: Correlation vs. CausalityCorrelation vs. Causality

When X is high, Y is lowWhen X is high, Y is low When X is high, Y tends to be lowWhen X is high, Y tends to be low Higher values of X cause higher values of YHigher values of X cause higher values of Y Higher values of X tend to cause higher values Higher values of X tend to cause higher values

of Yof Y

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Four hurdles on the way to evaluating Four hurdles on the way to evaluating causal relationships (Xcausal relationships (XY)Y)

1) Is there a credible mechanism that connects 1) Is there a credible mechanism that connects X to Y?X to Y?

2) Can we eliminate possibility that Y causes 2) Can we eliminate possibility that Y causes X? (YX? (YX)X)

3) Is there covariation (correlation) between X 3) Is there covariation (correlation) between X and Y?and Y?

4) Is there some Z related to both X and Y, 4) Is there some Z related to both X and Y, that makes the observed association between that makes the observed association between X and Y spurious?X and Y spurious?

Shameless Self-PromotionShameless Self-Promotion

A quick history of domestic political A quick history of domestic political economyeconomy

History of the rise and fall of ideas about History of the rise and fall of ideas about politics and economicspolitics and economics– Mercantilism Mercantilism Classic Liberalism Classic Liberalism– Classic Liberalism Classic Liberalism Keynesianism Keynesianism– Keynesianism Keynesianism Monetarism Monetarism– And now…And now…

Political-Economy Schools of Political-Economy Schools of ThoughtThought

Classical Classical LiberalismLiberalism

Keynes-Keynes-ianism Iianism I

Keynes-Keynes-ianism IIianism II

MonetarismMonetarism

Period of Period of DominanceDominance

~1900 to~1900 to

~1945~1945

~1945 to ~1945 to ~1960~1960

~1960 to ~1960 to ~1980~1980

~1980 to ???~1980 to ???

Primary Primary BeliefsBeliefs

Market Market EfficiencyEfficiency

Market Market InstabilityInstability

Market Market Instability, Instability, Phillips CurvePhillips Curve

Market Market Efficiency, Efficiency, the power of the power of the money the money supplysupply

Policy Policy PrescriptionsPrescriptions

Laissez-faireLaissez-faire Demand Demand ManagementManagement

Targeted Targeted Demand Demand ManagementManagement

M= M= S + S + PP

Effinger and Schaling Index of Central Effinger and Schaling Index of Central Bank Independence 1985-1995Bank Independence 1985-1995

Austria 3Austria 3 Belgium 3Belgium 3 Denmark 4Denmark 4 Finland 3Finland 3 France 2France 2 Germany 5Germany 5 Italy 2Italy 2 The Netherlands 4The Netherlands 4

Portugal 2Portugal 2 Spain 3Spain 3 Sweden 2Sweden 2 UK 2UK 2

Maastricht CriteriaMaastricht Criteria

Entry into the currency union was supposed to be Entry into the currency union was supposed to be determined by three macroeconomic targets:determined by three macroeconomic targets:– National Debt as a percentage of GDPNational Debt as a percentage of GDP– Budget Deficit as a percentage of GDPBudget Deficit as a percentage of GDP– InflationInflation

How would we expect the pursuit of these targets to How would we expect the pursuit of these targets to affect the relevant national economies?affect the relevant national economies?

In the end, all EU nations except Greece were ruled to In the end, all EU nations except Greece were ruled to have qualified but Denmark, Sweden, and the UK have qualified but Denmark, Sweden, and the UK opted out.opted out.

The Mechanics of Currency UnionThe Mechanics of Currency Union

The stability pact or the “straightjacket” The stability pact or the “straightjacket” and the new European Central Bankand the new European Central Bank

A new institution, the Central Bank of Europe, was founded in June 1998 A new institution, the Central Bank of Europe, was founded in June 1998 to oversee the new currency.to oversee the new currency.

The official missions of the Central Bank are to:– Design and implement currency policyDesign and implement currency policy– Issue notes and coinsIssue notes and coins– Promote smooth operation of payment systemsPromote smooth operation of payment systems– Conduct foreign exchange operationsConduct foreign exchange operations– Collect data and follow trendsCollect data and follow trends

In order to maintain its target of low inflation, the bank has substantial 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 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 called the stability pact. Informally, it has often been described as a “straightjacket”.“straightjacket”.

The new European Central BankThe new European Central Bank

The power structure of the Central Bank is made up The power structure of the Central Bank is made up of:of:– The Governing Council: one member from each nation in The Governing Council: one member from each nation in

the currency union and the Executive Board. This is where the currency union and the Executive Board. This is where all decision-making power currently residesall decision-making power currently resides

– The Executive Council: The President, Vice President and The Executive Council: The President, Vice President and four regular members all selected by the nations in the four regular members all selected by the nations in the currency unioncurrency union

– The General Council: The executive council and one The General Council: The executive council and one member from each EU member nation. This is a purely member from each EU member nation. This is a purely advisory body.advisory body.

The stability pact or the “straightjacket” The stability pact or the “straightjacket” and the new European Central Bankand the new European Central Bank

The stability pact is the key to the Central The stability pact is the key to the Central Bank’s ability to achieve its target of low (2% Bank’s ability to achieve its target of low (2% or less) inflation:or less) inflation:

Under this pact, the budget deficit of any Under this pact, the budget deficit of any member nation may not exceed 3% of GDPmember nation may not exceed 3% of GDP

Officially violators of this pact are first warned Officially violators of this pact are first warned and then fined at a rate which is designed to and then fined at a rate which is designed to compensate other member nations for their compensate other member nations for their contribution to Euro-inflation.contribution to Euro-inflation.

Monetarist or Keynesian?Monetarist or Keynesian?

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