FRANKFURT AND BRUSSELS, THE EURO ZONE MISINTERPRETED

Frankfurt and Brussels, The Euro Zone Misinterpreted

Introduction

Even after a crisis of more than six years, the European Central Bank (ECB) and the European Commission (EC) do not understand what’s going on in the Euro zone. The result is a wrong attitude towards Meditteranean countries, a bad monetary policy, and a terribly bad budget policy. In this short essay I will explain this misinterpretation, which makes that all policies with respect to the crisis appear ineffective. The reason why the overall economic performance in some countries, such as Germany and the Netherlands is not too bad, is that other regions in the world function well, thereby supporting the euro zone. A better understanding would lead to significantly better policy results.

Economic Research and Education

From the 80s on academic economic research and education in the Western world underwent an important transformation. In the first place, there is barely place for economic methodology and the methodological differences between the different schools of thought anymore. In the second place, most schools were excluded from the programmes, and the neoclassical analysis conquered a near-monopoly position. In the third place, the space for quantitative methods increased significantly. Research and education became increasingly dominated by empirical research without a carefully formulated theoretical foundation.

Micro > Macro

Implicitly the foundation was the simple neoclassical homo oeconomicus, which is assumed to be economic, rational and non-social. So, human nature was considered to be constant – not influenced by the situation. It means that for all economic problems, whether on the micro, or on the macro level, there was just one explanation, which has a micro-orientation. Macroeconomic analysis is just the aggregate of microeconomic analyses. A market economy disfunctions if there are several or many markets, which do not function well. To solve the macro problem the institutions of the various markets should be improved; that is, should be deregulated. When we apply this neoclassical methodology to the current situation of the euro zone, we try to solve the macro problem by reforming the market institutions. Every country should change its institutions in such a way, that the market mechanisms could function without too much artificial barriers, created by the government.

Unfortunately students in economics are educated in a strict neoclassical way. In macroeconomics textbooks there is no other story. Macro problems must be solved by liberalised markets, characterized by flexible prices. The problem in de euro zone must be solved by a decline in goods prices, wages, interest rates and the exchange rate (in this case the euro). There are, however, alternative views. We will shortly sketch the post-Keynesian approach. This perspective takes the analyses of Keynes as its starting point. His analysis was meant to give an explanation of the capitalist system in its mature form. Post-Keynesians try to update it for all sorts of different situations. When applied to the current situation of the euro zone, we get the following results. The labour market is not characterized by the supply and demand function, which cross each other, somewhere in the middle. This market is characterized by a vertical demand and a vertical supply curve. The first results from the fact that a shift along the demand curve as a consequence of a decreasing wage rate, also leads to a shift of the demand curve, namely to the left. The second results from the fact that in every micro market unempoyed people might go to other markets, in their search for a job, but on a macro labour market, workers stay in that market, even if they are unempoyed for a long period. It is clear that a market economy, once in disequilibrium, cannot return to equilibrium by declining prices! Equilibrium can only be reached by a shift of the demand for labour curve to the right. This will only happen if the government increases its effective demand for goods.

As long as an economy is in disequilibrium, most markets are in disequilibrium too. This makes it difficult to establish whether the institutions of the various markets are effective or not. It means that the current situation is not suited for the implementation of institutional reform. First we should solve the crisis; then we can find out which reforms are necessary.

We can conclude that the ECB and the EC analyse the situation of the euro zone in terms of the neoclassical methodology. It means that they assume that the euro zone is more or less in equilibrium (!). [technically speaking the neoclassical demand for labour and goods curves  do not shift; wage decline does not affect the quantity demanded on the goods market negatively]. That takes them to the position that they know a priori which institutional reforms are necessary to solve the crisis. The post-Keynesian perpective is more realistic. They accept that a market economy can become an unstable situation, if the disequilibria make the spenders (over)pessimistic. They are less ideologically biased, and advise government intervention, if necessary.

Conclusion

The political power is in the hands of people, who frame their situation in a neoclassical way. When looking at the academic educational programmes, this is not surprising. That’s the reason why the people of the countries, who belong to the euro zone, must (completely unnecessarily) accept the continuation of the crisis, and the application of a series of reforms, which might be inefficient.

Academic economists should not wait any longer to start a serious debate about the quality of their research and education programmes.

 

Dr. Piet Keizer

Associate Professor Economic Methodology

Utrecht University of Economics

15-03-2015

Word count: 907.

 

 

 

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