In memory of Dr. Andreas Höfert

Wicked games in the Eurozone

| Tags: Andreas Höfert

Usually when any crisis nears its end, finger pointing and blame gaming start. Who or what was responsible, or can be used as a scapegoat by those who suffered from the crisis?

The bickering in the Eurozone over the last couple of weeks takes this blame game to a new level - already at full speed while the crisis has yet to start. There are two main fracture lines: one between the European Central Bank and the European politicians, and another between France and Germany.

Many European politicians blame the ECB for failing to do enough. The Eurozone is on the brink of deflation. The International Monetary Fund now estimates this risk to be 20-30%. At last in September, ECB President Mario Draghi half-heartedly announced some monetary expansion measures, though the official size of the program and details regarding the channels of expansion remain vague. Draghi moreover counters his critics by arguing that monetary policy alone cannot take the whole workload, politicians should also do their part through reforms and astute fiscal policy.

This rift, and the interplay between monetary and fiscal policy, is a traditional dominance game in economics. While in the US and the UK we have seen a form of fiscal dominance since the 2007/8 financial crisis with monetary policy in a supporting role, in my view the power play is reversed in the Eurozone. Here monetary dominance (also called tough love) has so far taken the lead, with fiscal policy in austerity straightjackets for the sake of the euro. However, given the poor macroeconomic results, European politicians are starting to scream. To the chagrin of Germany, an ardent tough love defender, Italian Prime Minister Matteo Renzi wants to use the full scope of the Maastricht deficit criteria to revive the ailing Italian economy, while France is also rebelling - creating a new set of games with Brussels and Germany.

Indeed, after having already gotten a two-year postponement until 2015 to bring its deficit-to-GDP ratio back within the –3% criteria, France is now asking for a postponement until… 2017. This date is not very credible, given that it will be a presidential election year. Nonetheless, France is justifying its plea by arguing exceptional conditions, a tack unlikely to impress Brussels. France faces better growth prospects than Italy, pays less interest than Italy on its debt, has a significantly lower debt-to-GDP ratio and thus lower debt service than its southern neighbor, so why can France not meet the Maastricht criteria (while Italy should)?

France’s other line of defense is that Germany, whose economy doesn’t seem as strong as it was a couple of months ago, should start thinking about growth stimulus, which could help the Eurozone overall. France does have a point. In my view, it is rather difficult to watch Germany celebrate its balanced budget, while there is a risk of a second successive quarter of economic shrinkage in 3Q14, its infrastructure is crumbling according to many German studies, and its army is so poorly equipped.

France and Germany have thus entered a prisoners' dilemma: Germany is asking France to enact reforms and France is asking Germany to boost the Eurozone economy. While cooperation would deliver the best outcome, doing nothing on both sides now appears the dominant strategy. This could ultimately reignite the euro crisis. One can only hope that both countries understand that this is a high-stakes game.