The author does not offer any objectively verifiable or quantifiable answers. Rather, questions together with opinion are offered as an observationally grounded way of thinking about what the future might hold. The exercise presumes that the future may look significantly different from the past — based on the observable fact that technological innovations in information communications are revolutionizing the financial services sector. Louis-Philippe Rochon and Matias Vernengo, in Chapter 9, examine some of the arguments of this debate from an American perspective.
They begin by exploring the differences between dollarization and monetary union, where the arguments rest on the mismatching of markets and regulators, and then move to a discussion of what they consider to be the standard arguments in the debate, namely the elimination of transaction costs and the benefits to trade, and seigniorage. They argue that the arguments presented by proponents of dollarization are not definitive, and that increased trade may not result necessarily in increased output and growth. Finally, they consider two arguments for dollarization that have been neglected in the literature.
First, dollarization, by allowing the use of the US dollar only, allows American banks to have a stronger presence in local economies, while simultaneously leading to a decrease in the number of local banks. In other words, Introduction 9 American banks gain a competitive edge over local banks. Second, American multinational firms who have connections with US banks gain greater access to local economies and local markets, given their established access to US banks.
These effects lead to the question of who benefits from dollarization and who bears the costs. This is the crucial question to be analyzed from the political economy perspective. The benefits from dollarization for American banks and multinational firms would not be the case in a common currency arrangement. Therefore the differences between a monetary union and dollarization are of particular importance.
More importantly, the increase in the number of American banks and firms extends the American brand of capitalism to other regions, and with that the advantages and costs of this particular institutional arrangement. Dollarization seems to export one of the main problems of the American system to other economies, namely: the disproportional influence of financial interests.
As a result, dollarization may very well intensify the problems generated by the increasing volatility of capital flows. Chapter 10 begins with the assertion that theoretical and empirical studies over exchange rate policy informing the debates around the European economic and monetary union and currency boards have, for the most part, overlooked a critical shortcoming of these systems: namely, monetary union agreements broadly remove major sources of deficit financing, virtually inhibiting macroeconomic management by governments.
Alex Izurieta further claims that by not putting in place a system of transfers and fiscal stimuli, which would compensate for interstate disparities or help recovery after exogenous shocks, monetary unions would lead to polarization rather than convergence. The author believes that experience seems to suggest that countries under tight exchange rate and monetary agreements are more prone to suffer from chronic unemployment or financial weakness in the aftermath of exogenous shocks.
In order to investigate this proposition, the author takes the case of a formally dollarized economy — the most radical amongst common currency settings — in which there is no exchange rate flexibility or monetary policy at all. Furthermore, by constructing an inherently consistent, axiomatic, macroeconomic model, the author concludes that fiscal policy is not only inadequate, but also left with fewer financial sources to operate. The alternative, namely tightening the fiscal stance along with the financial constraints, would rather exacerbate the adverse effects on income and employment of the initial shock.
While accepting many of the arguments put forth by the supporters of dollarization, the author concludes that dollarization is good for Latin 10 Louis-Philippe Rochon and Mario Seccareccia America, but should be rejected for Canada. The author then argues that the case for dollarizing Canada fails on all six of these grounds. This book is meant to offer a general discussion of the benefits and costs of dollarization and of other forms of monetary integration. This is of particular importance in the western hemisphere where the question is being posed, and more so since the successful adoption of the euro within the countries of the European economic and monetary union.
References Berg, A. Berg, A. Calvo, G. Chang, R. Chriszt, M. Courchene, T. Howe Institute Commentary, , June, Toronto. Dean, J. De Grauwe, P. Eichengreen, B. Grubel, H. Introduction 11 Gruben, C. Wynne and C. Hausmann, R. McCallum, J. Powell, A. Weller, C. Part I The European experience 2 The decline of the euro in its first two years Is there a satisfactory explanation?
There was a general decline throughout the first two years of the euro, with a low reached in May , and again in September A further, all-time low was reached in October , but the euro has recovered somewhat since then. However, it still remains lower than its initial value. Figure 2. The purpose of this chapter is to examine the causes of this general decline in the value of the euro. This is reflected in a relatively large number of scholarly papers providing a detailed assessment of the performance of the euro, the ECB and of the euro area macroeconomy more generally for a recent example see OECD, Although our assessment draws on these papers in a critical manner, we also focus on our own research and published output see, for example, Arestis, Brown, and Sawyer, forthcoming.
The second section reviews the decline in the value of the euro. The fourth section of the chapter attempts to construct a more satisfactory explanation. We believe this argument to be rather undeveloped. We suggest that US strength is an important but partial factor in euro decline. The fifth section summarizes and concludes the chapter. Werner Antweiler. Time period: 4 Jan — 22 Sept The decline in value of the euro Contrary to the predictions of its proponents the euro declined in value by over 25 percent against the dollar in the first two years of its life see Figure 2. Several possible explanations are reviewed and found wanting below.
We suggest two types of benchmark as appropriate measures, namely the value of the currency that would correspond to a trade balance, and a purchasing power parity level. The euro area maintains a trade surplus in , quarter 1, the surplus of exports over imports, as a percentage of GDP, was 2. On the face of it this would suggest that the euro was undervalued relative to the exchange rate that would generate a balance of trade. Chinn , Coppel et al. Both papers also survey recent attempts to estimate the equilibrium exchange rate see also the review of PricewaterhouseCoopers, , Chapter 3.
Thus Deutsche Bank Research shows that the euro moved more than 15 percent away from its PPP measure of the real exchange rate in late and onwards. We now proceed to discuss a number of explanations of the fall in the value of the euro. Obvious explanations A number of explanations of the fall in the value of the euro suggest themselves.
We discuss both in this section and we find them not persuasive enough. We begin with the first. Just bad luck? It is widely recognized that a host of contingencies affect the short run movements of the exchange rate, including the vagaries of market sentiment. This point of view can be coupled with the argument that, in historical perspective, the decline is not dramatic and the current level is not unusually low Buiter, b; Coppell et al. It can start from the observation that the decline in the euro say during the year of is not unprecedented.
We have reported elsewhere Arestis and Sawyer, that over the period to the average ratio of the maximum level of sterling relative to the mark minimum level during a year was 1. The pound, for example, fell by around 25 percent from to and by roughly the same percentage in the winter of —3; similar or greater volatility is displayed by other comparable exchange rate series. This lends some weight to the view of Favero et al. Hence a decline from a relatively high level may have been anticipated. Under these conditions exchange rate movements themselves become the focus and a signal to search for those fundamentals might explain the given exchange rate movement.
Hence, when in early the euro began to fall against the dollar, it was interpreted as a signal that the US economy was strong and the euro area weak. Given the conflicting evidence of underlying strengths and weaknesses, such a search for some fundamentals is normally successful. However, it is also correct to stress that, if the proximate causes of exchange rate movements are the beliefs of market participants, and such beliefs have a random component, then, equally, beliefs are not purely contingent.
Neither pure truth, nor pure whimsy, market beliefs do have some connection with economic reality. It is significant that proponents of the euro had predicted that its value would rise from January Buiter, admits that he was one such proponent. Such predictions stemmed, not only from the relatively buoyant economic outlook at that time, but also from the view that the inception of the euro would contribute to the rosy economic future of the euro area. It is in this context that the decline in the value of the euro should be appraised.
Whilst it is true that the decline provides prima facie evidence against proponents of the euro, it is the underlying causes of the decline that provide the critical evidence for any assessment of the exchange rate debate. If, on the other hand, such external causes are not sufficient to explain the decline, then the spotlight must fall on factors endogenous to the euro and its accompanying euro system institutions and the Stability and Growth Pact. Real interest rate differentials The effects of interest rate differentials on the exchange rate appear at first sight paradoxical.
A general presumption would be that raising the domestic interest rate would raise the exchange rate. The mechanism is quite simple: the higher interest rate makes acquiring financial assets in that currency more attractive, and wealth-holders acquire the currency in order to be able to acquire the financial assets.
But uncovered interest rate parity indicates that the nominal interest rate differential is equal to the expected decline in the exchange rate. Thus a high interest rate differential foretells a declining exchange rate. The immediate impact of an unexpected increase in the domestic interest rate is a sharp rise in the exchange rate, and the persistence of the interest rate differential is associated with a declining exchange rate. The extent of the initial rise in the exchange rate could be seen to depend on the expectations of the time period for which the interest rate differential persists.
An interest rate differential of, say, 2 percent expected to persist for five years would signify a cumulative decline in the exchange rate over those five years of just over 10 percent. The measure of interest rate differential depends, not surprisingly, on the interest rate chosen for the comparison, and it cannot be assumed that the different interest rate differentials tell the same story.
In terms of short-term interest rates, the differential between the US and the euro area has been positive, fluctuating around 1. But the differential in terms of long-term interest rates has generally fluctuated between negative values, particularly over the 12 months to April , as shown in Figure 2. Consequently, the picture over the sign and size of the interest rate differential between the US and the euro area is a confused 20 Philip Arestis et al. But the size of the differential is clearly not large enough to explain the rate of change in the value of the euro over this time period in terms of uncovered interest rate differentials.
With the US interest rate moving generally in parallel with euro rates, and inflation rates likewise moving in rough parallel, there has been little change in the real interest rate differential between the USA and the euro area since January This is true of both short-term Figure 2.
Thus Gros et al. Real short-term interest rates did drift against the euro area during from 2 The decline of the euro in its first two years 21 percent to below 0. Clearly, interest rate differentials do not explain the decline in the value of the euro. Clearly from that perspective the weakness of the euro can be treated as the other side of the coin of a strong dollar. The euro, however, has also declined against sterling and against the yen.
In the case of sterling, the decline of the value of the euro has been less pronounced. It is also the case that many of the arguments which have been applied to explaining the weakness of the euro against the dollar can be carried over to explaining the weakness of the euro against sterling. The UK economy has experienced relatively strong growth, and interest rates have been similar to American rates.
The Japanese economy has experienced sluggish growth zero in the second half of and in fact for most of the period under scrutiny and interest rates have been low. Although the explanation of the relationship between the euro and the yen is not the focus of this chapter, these observations are relevant to the arguments advanced below.
In this section we concentrate on explanations for the weakness of the euro by looking at the strength of the dollar, and in turn we account for the perceived strengths of the US economy. Expected and actual growth rate differentials Eichengreen forthcoming , Buiter , Corsetti and Pesenti , , Von Hagen , Favero et al.
The continuing strength of the US in coincided with a rather slower growth than had been expected in the euro area during the first half of The corresponding figures for the euro area are 1. Thus, it is argued, the 22 Philip Arestis et al. Reproduced from Corsetti We should like to thank Professor Giancarlo Corsetti for permission to reproduce this figure. However, difficulties remain in explaining the precise significance of the graph for this decline. So much so that Corsetti , p. Buiter provides a different interpretation.
According to him, growth differentials affect the exchange rate through 1 money demand and 2 the anticipated future path of short-term interest rates. On the first point, Buiter does not spell out the mechanism he has in mind, but we would interpret it as follows. Given the amount of money in existence and the level of prices, an acceleration in the rate of growth should cause an increase in the demand for money, which in turn causes interest rates to rise so that interest rates in the US are expected to be higher than in the euro area.
However, this view relies on the money supply being regarded as exogenously given. In the to our mind more realistic case of endogenous money, an increased demand for money would lead to an increase in its stock without interest rates necessarily rising. In so far as financial assets are held in the form of bonds, then the anticipation of higher future interest rates is an anticipation of lower bond prices.
Hence the anticipation of higher US interest rates would make US bonds less attractive now than otherwise and tend to generate a capital outflow rather than inflow. But financial assets may be held in the form of interest-bearing deposits. With low transaction costs, there is little reason to shift financial assets from one currency to another in this period for the prospects of higher future interest rates, but rather to shift when those higher interest rates materialize. Thus we are unconvinced that anticipated higher future interest rates can explain a rise in the value of the dollar and hence a decline in the value of the euro.
In any case, and as noted above, it is clear that the actual interest rate differential has not moved substantially in favor of the US see above, and Figures 2. Deutsche Bank Research, Coppel et al. Two explanations may be in order. Despite being vague, these explanations tied in well only with the situation in the second half of , when the decline in the value of the euro appeared as little more than a reversal of a previous rise and when the recent growth performance of the euro was disappointing, especially relative to US strength.
For they suggest that the decline in value is a purely cyclical phenomenon that will naturally reverse, 24 Philip Arestis et al. Thus, by focusing upon the growth rate differential, it is possible to justify remaining sanguine about the fall in value of the euro. In fact, as noted above, the growth performance of the euro area started to pick up in the second half of and continued on this upward path in the first quarter of growing at 3.
In any event, the value of the euro did not rise in tandem with the growth acceleration.
On the contrary, it continued to decline and only began its minor and short-lived recovery in mid-May, which was followed again by severe falls. However, in the first week of December the euro exchange rate with respect to the dollar increased, prompting commentators to declare that the euro was well on course to rise. A few statistics suggested that the assessment may have had a grain of truth. US consumer confidence in November was the lowest for more than a year, as a result of which durable goods orders were 5. These figures should have pushed the euro, in relation to the dollar, well above the level it actually reached at the time it was at 0.
By the end of December , however, the euro did increase more, allegedly following further weak US economic performance and expectations of a possible recession there see, for example, The Economist, 6—12 January The euro area appears to have been doing better than at any other time previously since 1 January In fact, the forecast that the growth differential between the euro area countries and the US would disappear in was so adverse for the US that the small increase in the value of the euro towards the end of is hard to justify on this explanation alone.
In any case, it is still well below its value at its inception. On the other hand, the US growth performance has matched the euro area quarterly increases growing at 5. The subsequent pickup in the euro area should, ceteris paribus, have led to profitable investment opportunities. There is no reason to suppose that the parallel growth increase in the US indicates a parallel increase in the earnings potential of direct investment. Indeed the cheap euro should have provided the euro area with an advantage in this regard, now that the euro area recovery is well under way Gros et al.
This may be one reason why, in the light of developments, Corsetti has considerably modified his explanation from that provided in Corsetti and Pesenti Now, the author Corsetti, , p. Corsetti even shows that the consensus expected growth differential between the US and the euro area in has displayed a similar pattern to that of see Figure 2.
If, given the argument of the above paragraph, Figure 2. Corsetti suggests that the high domestic US demand can explain the graph, and as a result the exchange rate movement. This is no more than to say that the real exchange rate must appreciate. At the same time the current account will move further into deficit. By definition such an appreciation can occur through nominal exchange rate appreciation or through higher US inflation, or both. It relies upon the idea that US output is determined fully on the supply side, and that it will be sold 26 Philip Arestis et al.
We would argue, however, that aggregate demand is a spur to the growth of output. This alternative is focused upon below. Investment flows Evidence on investment flows from the euro area highlights its potential importance in explaining the decline in value of the euro against the dollar see Table 2.
Table 2. But what explains the net outflow of investment? A widely discussed possibility is that the outflow is due to the strong US equity market. However, as both Corsetti and Gros et. The negative correlation has continued to the present. Interestingly enough, NASDAQ the US high-technology stock market reached its lowest value for more than a year in the last week of November , hardly affecting the euro— dollar exchange rate.
However, it ought to be noted that by the end of December , when NASDAQ lost more than 50 percent from its 10 March high and other unfavorable US statistics emerged, the dollar took a plunge with the euro appreciating, but not as much as the adverse statistics might suggest. In fact, the statistics for foreign direct investment for the fourth quarter of clearly indicate that if anything FDI increased in the US but slowed down substantially in the euro Table 2. The decline of the euro in its first two years 27 area see, for example, Financial Times, 19 December This should have increased the euro and the dollar at the same time!
Moreover, the interest rate influence on the stock market and on the exchange rate provides the economic logic for such a correlation an actual or expected interest rate increase could depress the stock market and raise the exchange rate simultaneously.
Gros et al. The figures show that euro area investors purchased around 60 billion euros more foreign-denominated equity than euro-denominated equity in However, in this case, US strength can be only half the story. A buoyant US economy will only attract foreign direct investment from the euro area if equally profitable opportunities for investment in the euro area are perceived to be unavailable.
As argued above, the actual growth pickup of the euro area would, ceteris paribus, suggest that suitable investment opportunities in the euro area are growing. It is true that the continual slide in the expected growth differential might be taken to suggest a growing lack of investor confidence in the euro area, but why should investors perceive the euro area to be weak? The import of this latter question is suggested also by a very different consideration: the validity of strong US growth figures have been the subject of significant doubt. In conclusion, if Gros et al. The timing of the investment outflow, which began about a year before the inception of the euro, is clearly consonant with the view that the inception of the euro itself has played a significant 28 Philip Arestis et al.
Indeed, this view is plausible even if a more cautious stance towards the interpretation of Gros et al.
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For it remains pertinent to ask just what market and speculative perceptions of the euro area have existed, for nearly a year and a half, and therefore helped to force down a range of currencies other than the US dollar. Summary and conclusions The US economy has been growing faster than the euro area in the past few years, and the general perception of the strength of the US economy relative to the euro area economies is likely to have contributed to the strength of the dollar and the weakness of the euro.
However, there is no consensus as to just how US strength causes the value of the euro to fall. US strength cannot, of course, explain euro weakness against other currencies such as the yen. We have suggested that the most plausible explanation concerns long-term investment flows and following Gros et al. This view would stress that the other side of the coin of US strength is euro area weakness. This, however, should be the main thrust of another paper. The narrow ECB measure includes only the thirteen main trading partners with the eurozone, whereas the broad measure includes thirty countries ECB, July The synthetic euro is based upon a weighted average of the respective exchange rates of the eleven euro area countries with the dollar, for example , where the weights used are the country share in euro-wide GDP.
It is calculated as a chain-linked index, taking the same value as the euro on 4 January Since mid-October the value of the euro has declined by more than 10 percent. The decline of the euro in its first two years 29 Arestis, P. Reprinted in P. Arestis and M. Arestis, P. Brown, and M. Buiter, W. Chinn, M. Coppel, J. Durand, and I. Corsetti, G. Duisenberg, W. Favero, C. Freixas, T. Persson, and C.
Gordon, R. Gros, D. Davanne, M. Emerson, T. Mayer, G. Tabellini, and N. Von Hagen, J. Repeated financial crises notwithstanding — first Russia and Brazil, then the US with the LTCM affair, which recalls to monetary historians the Baring crisis of — the new European currency was definitively launched on 1 January Many well-considered experts predicted at the time of its inception that the euro would be a strong currency. They did so on theoretical grounds, which already appeared then, and do even more so now, rather shallow, as can be said of so much contemporary theory. In a paper presented at a conference convened in Buenos Aires in June , by the then president of the Argentine Republic, I predicted that the euro would start weak and that it would stay weak for quite a long time.
Looking back, I can afford to be rather amused by the mistakes of the experts and smile at their attempts to justify their wrong predictions. There are no real historical precedents for the present EMU. The only comparable example history offers is that of the Latin Monetary Union. German and Italian unification in the second half of the nineteenth century did not perpetuate the component states as far as full sovereignty was concerned.
The Latin Monetary Union, on the other hand, was started by an international treaty among sovereign states, but it was a metallic currency inter-circulation agreement. It did not have a central bank as the present EMU does, and did not cover all aspects of monetary creation; in particular it was not concerned with bank money. It did not have a stability pact, regulating fiscal policy, as strict formally, at least as the one the eleven countries of the European Union have signed. The Latin Monetary Union was based on a central power which was France, whose economic and financial power was larger than that of the other member countries put together.
There is no disputing the fact that European Monetary Union is centered on the new Germany, in a way that the European Union, based on the Common Market of forty years ago, was not. The EMS was not based on Germany either, although it became centered on the DM in a way that made its smooth functioning impossible.
After the Maastricht Treaty, the progress to monetary union was seriously impaired by the crises of —3, and the actual achievement of a single currency for Europe was seen to be possible only by allowing a temporary widening of the fluctuation bands and the suspension from the ERM of some countries, which could be allowed back in only if their convergence to the Maastricht parameters looked realistic.
Everybody knows the most recent installments of the story. Appropriate precedents for multinational currencies not being available, we must look at cases of international currencies which were the currencies of national states, even if they were very large ones, like the US, or of formal empires, like the British Empire. How can we identify an international currency? Usual answers to this question underline the functions a currency performs in the international exchange of goods and services.
Normally, a currency becomes international when it is adopted as a vehicle currency in a sufficiently large number of international transactions.
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Historically, this has happened as the country in question has grown in importance in international trade, i. When a deep and wide network of international economic relations comes into being, an ever increasing number of international economic transactions begin to take place, with the currency of one of the two countries involved being used as a counterpart to the transactions.
This helps to make the market for the currency in question deep, wide, and resilient to shocks. Furthermore, the currency in question thus becomes more liquid than other currencies. It then becomes convenient for people who want to go from one currency to another to do so by using the widely exchanged currency. For instance, if I want to exchange Italian lire for Argentine pesos, it is preferable to sell lire against US dollars and then buy the pesos with the dollars that are obtained, for the simple reason that the lire—dollar exchange rate and the peso— dollar exchange rate will probably yield a better rate than the lire—pesos rate I would get if I went directly from the Italian currency into the Argentine currency.
The two dollar markets are in fact more liquid, as the US is a prime trade and services partner of both Italy and Argentina. As a result, transaction costs are lower and rates are more stable and predictable. We can proceed from this case of a simple spot transaction to much more complex ones involving forward contracts used for arbitrage and hedging. Each of 32 Marcello de Cecco them will turn out to be more convenient and easier to facilitate if we use the large dollar market than if we go directly from lire into pesos, two currencies used only for national transactions.
The same applies to lending and borrowing outside our national financial market. Whoever the lender or borrower may be, a loan will be easier to enter, service, and repay if we denominate it in the international, rather than in one purely nationally used, currency. Again for the same reasons, national central banks will find it more convenient to place their foreign exchange reserves in the financial market of the international currency and to conduct their international intervention operations, aimed at influencing the exchange rate of their own national currencies, on the exchange market of the international currency.
The main features an international currency possesses ought to be clear by now. It is a currency used as a vehicle, to lend, and as a reserve. These features can be conferred upon a currency only by the international markets. It is possible that international agreements reached by sovereign states formally recognize the international role of a currency, as happened to the dollar at Bretton Woods. But such agreements are purely a formal recognition of something that the markets have already decreed.
International values can be set by decree only if the will to do it is backed by sufficient military and political power: in this case we may speak of imperialism, whether it is formal or informal. The hegemonic country will rule only as far as its economic, political, and military power reaches.
When discussing these matters, it is advisable to avoid being over-deterministic. There are currencies which belong to states whose economies have become over time large and heavily involved in international transactions, and which, in spite of that, have never become full-fledged international currencies.
The two best-known cases are those of the German mark and the Japanese yen. They are two currencies which never acquired the essential features that make a real reserve currency. They are not widely used as vehicle currencies, except in limited geographical areas around those countries, and they are not often used as reserve and intervention currencies the mark was used for those two purposes inside the now defunct EMS.
This is in spite of the fact that both Germany and Japan have large shares of total international trade. Why the mark and the yen never made the full transition Leaving aside more distant history, we can say that after having been defeated in the Second World War, Germany and Japan were allowed to re-acquire an important European Monetary Union: a preliminary assessment 33 position in the world economy as exporting countries, with exchange rates which were punitively low at the start and therefore compelled them to export a lot in order to import enough to survive and prosper, neither of them being well endowed with raw materials and liquid fuel.
Having a relatively low exchange rate then became a virtue rather than a curse, and both countries learned to govern their economies in a way that would not allow the relative depreciation of their currencies to seep into their domestic economies in the form of high prices. For more than a crucial early decade, the US opened its market to imports from both countries, in order to wean them from their prewar protectionism, autarky, and organized trade practices. It also gave additional viability to free trade by Marshall Aid and by providing liquidity through the European Payments Union.
The Bretton Woods rules, as long as they lasted, discouraged both countries from revaluing. And the values of their currencies lasted twenty-five years. After the demise of Bretton Woods, caused by US withdrawal, both countries were able to govern their economies to couple currency revaluation with domestic macroeconomic stability, obtained by lingering corporatism, transformed into neocorporatism because of the democratic framework imposed by the winning Allies, and to discourage international capital flows by investing most of their external surpluses abroad, as direct and portfolio investments, or as reserves held in US Treasury bonds.
By keeping the international value of their respective currencies quite low compared to the domestic cost situation, Germany and Japan have managed to keep the industrial core of their economies virtually intact, and it is in both cases a core producing mainly investment goods and automobiles and electronic products, in the case of Japan of which a good many are exported. The strategic sectors have been kept internationally competitive by being mercilessly rationalized, and by sacking workers, who became redundant because of continuous high productivity gains.
Germany prefers to keep these millions of workers idle by giving them high unemployment benefits. Japan redistributes redundant workers in the inefficient and labor-intensive tertiary sector of its economy. The net result of these activities, which involve the joint action of the government, central bank, the banking system, entrepreneurs, and labor unions, has been that the mark and the yen have never acquired the status of full-fledged international currencies. And the costs are those represented by a loss of control over the neocorporatist macroeconomy, because of international capital flows going in and out of the country, influencing interest rates and through them the economic structure which it is deemed desirable to keep unchanged for as long as possible.
Another cost Germany and Japan have not wanted to face is that of the likely enmity of the US, which has repeatedly and openly shown the desire to remain the only monetary hegemony for as long as possible. It goes without saying that the US does not seem to have been discouraged by the costs involved in keeping the dollar as the main international currency.
However, there are countries that have tried to keep an international role for their currency long after they had ceased to be the political, economic, and military hegemony.
Britain, for instance, chose to keep the pound overvalued every time it had a chance to do so, in the hope that this would lure foreigners into using it for their trade and especially for financial transactions. These efforts notwithstanding, the day the pound ceased to be an international currency did finally arrive. The City has kept its role as a prime international financial center, but international transactions in London do not use the pound, and most of them are conducted by financial firms that have been sold to foreigners.
Germany at the center of the euro area It is interesting to note that the European Monetary Union that came into being on 1 January has as its center one of the two countries that, after the war, refused to see their currencies acquire a full-fledged international status. Germany can still be described as an export economy, one of the few that have remained in the world and the only one among large European countries.
Recent research by the Bundesbank has shown that German GNP was and still is more profoundly and rapidly influenced by the mark exchange rate dynamics than it is by interest rate dynamics. German monetary authorities have thus, understandably, focused their policy moves on the mark exchange rate, with the money supply M3 used as an instrumental variable.
A very important part of German exports has thus been directed towards other European countries, and recently also towards those countries of the former Soviet bloc. It is not too risky a statement to say that Germany agreed to be part of the EMU because a common currency would eliminate intra-European exchange rates, where the currencies of countries like Italy and France tended to fluctuate with the dollar when the US currency was weak, thus making it difficult for Germany to remain competitive.
It was thought that by creating a new currency that would be the expression of most European economies, it would shield German producers from competitive devaluations in Europe and excessive dollar devaluations. The main interest of Germany in the EMU was that the euro would not have the same structural strength of the mark. European Monetary Union: a preliminary assessment 35 One money for Europe The euro is the official currency of an array of very affluent countries, which have taken the relatively untrodden path of starting out toward political federation by first of all uniting their monies into a single currency.
Nor do they have a common military policy, in spite of the recent crusade against Milosevic, fought under the NATO flag, and the creation of joint brigades by Germany and France and of a Southern European Force headquartered in Florence and commanded by another Spaniard. They are still informally subjected to the hegemony of the only remaining superpower, the United States. A policy of benign neglect towards the external consequences of monetary policy, and a single-minded concentration on domestic macroeconomic policy targets, are only imaginable as long as the objective is to depreciate the common currency in order to maximize exports outside the euro area and thus obtain from outside the demand for European goods which cannot be created directly by fiscal stimulus.
This is because of the unfortunate adherence to the Stability Pact, a fiscal rule imposed on their euro partners by German Christian Democratic politicians before the elections to calm down their fractious Bavarian Social-Christian allies. As long as the central power of the Monetary Union, that over-industrialized area which includes Germany, part of France and the northern part of Italy, suffers from structurally insufficient internal demand, the interest rates of the European Central Bank, mirroring the old Bundesbank strategy, will stay lower than their US equivalents. Low domestic demand is thus replaced by exports, which, combined with the other ten countries of the Union exporting to the rest of the world, thereby generating a high level of demand for German investment goods, automobiles, and trucks, would reduce unemployment in many countries of the Union, even if it stays at a level deemed high by US standards.
Let us, however, imagine the opposite situation. I strongly doubt it! The EMU has at its center an area of great exporters, particularly German ones. European domestic demand is structurally unable to absorb all the productive capacity of that area. It is therefore the structure of the European economy, particularly of its industrial heart, to dictate depreciation and fight appreciation of the euro with 36 Marcello de Cecco respect to the other two major currencies.
European direct investments by European companies, which have, since the inception of the euro, been very large, especially in the direction of the US, are motivated mostly by productive and commercial strategies to be present as producers in the most innovative area of the world, at the same time benefiting from the, allegedly stable, non-correlation of European and US business cycles. This is made easier by the fact that Europe is a demographically old area and by definition its pension funds need to invest in demographically younger areas.
But the financial markets of the really young countries are not yet developed enough to absorb all European savings potential. European savings thus goes to countries like the US, which have a developed financial market and have generated a supply of new shares and financial and housing asset inflation brisk enough to absorb European spare funds. If Russia picks itself up politically, it will also renew its demand for foreign funds, and European especially German savings will find their way there.
This last point has been the permanent dream of German industrialists and geo-politicians for two centuries. The dream is currently being revived by the joint efforts of Romano Prodi and Gerhard Schroeder, in the time-honored form of an exchange of European investment goods and knowhow, to rehabilitate and develop the Russian raw material industries oil, in particular and be rewarded by a number of long-term raw material supply contracts.
If the asymmetric behavior that was typical of the Bundesbank until the inception of the ECB were inherited by the latter and we can largely count on this, especially as long as Britain stays out of the EMU , the United States will be able to have one large payments deficit after another, as they have done for two decades, and as the structure of their domestic demand now requires, since private saving has virtually disappeared there.
It is thus probable that the European economic policymakers will try to generate a domestic rate of growth capable of absorbing the non-structural part of European unemployment by even more radical rationalization of European productive structures, to capture the obvious economies of scale made available by the demise of national currencies, which were managed to segment national markets and keep national producers alive. It is altogether possible, indeed likely, that in this grand rationalization activity by large US multinational corporations will play a very important role.
They have for years considered Europe as one large economic area, of a size comparable to that of the US — one single market in which they can operate better than any European competitor, through their long experience of uniting and running as a single market the huge American economic area. European firms have remained tied for too long to their national production base and are still new to world-based production, as they still mostly export from their home base. This is, European Monetary Union: a preliminary assessment 37 of course, changing rapidly, but it will take time until the large European companies achieve the stage at which their US competitors have been for some time.
All this implies a reversal of the direction of direct investment flows that we have seen in more recent months between Europe and the US. When the US economy finally slows down, large US corporations will want to concentrate on Europe if the latter inherits the phase of new-economy fervor that the US is in today, and which cannot last indefinitely.
It is, however, not the goods markets but the financial and service markets that will receive the greatest boost by the EMU. They are the ones that have been, hitherto, kept unnaturally separated from each other. This is because of the relative unimportance of the European stock markets as markets for corporate control and the superior role of banks as providers of funds to European industry second only to reinvested profits. The national ownership of banks has been jealously guarded in all countries of continental Europe. This is about to finish, and we can confidently expect a wave of intra-European mergers and acquisitions to sweep the European banking world.
Whether it will be strong enough to overpower the concomitant drive to transform more and more banking transactions into off-balance-sheet ones, and to transfer them to markets directly linking lenders and borrowers, is not clear. Both trends will probably manifest themselves in Europe, because both of them are coming into relief in the huge American financial market.
This goes against the expectations of those who had detected in the United States an unequivocal trend toward securitizing all transactions, to bring them to the market, and toward the extreme specialization of individual financial institutions. Will the department store or the shopping mall prevail in finance? Whatever trend prevails, we cannot refrain from noting that the unification of the continental European financial market, which the euro will bring in its wake, must result in a much larger private and public European bond market. All European banks, for instance, will be euro banks.
This is extremely important for enterprising bankers in countries like Italy or Spain, who have been smarting under the negative impact of a balance sheet written in a structurally weak or just a small currency. That is now gone, and enterprising bankers will be able to prove their worth wherever they are located in Europe, on a level playing ground. The same must be said of corporation managers on the periphery of Europe. They will be able to devise finance strategies for their firms without being penalized by the consequences of writing their own balance sheet in a weak currency.
The whole of Europe will be potentially able to compete to finance them. They will be able to reap previously non-existent economies of scale, by tapping a pan-European commercial bills market, which already exists but is now reserved only to very large corporations. All EMU countries, moreover, redenominated their public debt in euros on 1 January and, as a consequence, public debt managers, like their 38 Marcello de Cecco private counterparts, will be able to devise debt management strategies that see the whole euro financial market as their natural environment.
As Pollack : has pointed out, it also lies behind liberal intergovernmentalist accounts of EU integration such as that of Moravcsik and Schimmelfennig However, this framework of analysis neither implies fixed preferences Crespy and Schmidt , nor does it have only an empirical use. Beyond its empirical applications, the logic of two-level games also has a normative interpretation Savage and Weale providing a model by which we can evaluate the justifiability of constitutional arrangements. The neglect of the normative logic of two-level games in the construction of EMU is compounded by a second problem within legal constitutionalism: namely, its disregard of the existence of reasonable differences in political judgement over the principles that should govern a monetary union made up of different sovereign states, each with their own traditions of economic and monetary policy.
Indeed, even within the broadly neoliberal tradition of thinking about economic constitutions, there are important differences of substance as well as emphasis. When the conditions for continuing contestation over policy measures and organization exists, the putative political legitimacy of EU legal constitutionalist arrangements, such as those underlying EMU, the SGP and the TSCG, reinforce the practical contradiction of the two-level game implicit in the economic constitution.
By contrast with this attempt to entrench legal constitutionalism, we suggest that the design of an economic constitution ought to respect the principles of political constitutionalism, with its requirement that governments be responsive to the public reasoning of their citizens within the continuing democratic conversation that makes up a political society Bellamy In pursuing this argument, the contribution proceeds as follows.
In the next section we lay out the normative logic of the two-level game embodied in the construction of EMU. According to this logic, those participating in international agreements have a dual duty: to deal fairly with one another, on the one hand; and to be responsive and accountable to the democratic reasoning of the people whom they represent, on the other. In acknowledging this dual duty, they should also acknowledge that their fellow negotiators have a similar duty in respect of their own peoples.
The penultimate section indicates why, given reasonable disagreement about the principles that should govern an economic constitution, the legitimacy of EMU cannot be simply secured by framing the related fiscal rules in legal constitutionalist terms. The long-term legitimacy of EMU is compatible only with political constitutionalism.
We suggest this result can be achieved through the empowerment of national parliaments in EU policy-making. At the centre of the issue of political legitimacy is the question of the credibility, and consequently the justifiability, of the reasoning underlying the norms and principles on which the construction of EMU is based. Yet, how might one evaluate such credibility? We approach this question through contractarian political theory. According to contractarian theory, political authority is to be understood as arising from a contract to mutual advantage implicitly or explicitly agreed among the members of a political association.
The need for political organization can be modelled as the solution to dilemmas of collective action Buchanan and Tullock ; Gauthier ; Ostrom ; Weale These dilemmas occur when unco-ordinated action by separate agents gives rise to potential gains from co-operation, as in an agreement on weights and measures or the rules of the road, or where unco-ordinated individual action leads to harmful side-effects from otherwise legitimate human activity, of which pollution and resource depletion are the obvious examples. If we think of political associations as having a contractarian logic in this sense, then we can address the issue of credibility by asking what conditions have to be satisfied for actors to find a contract that they can rationally support Gauthier The general logic of contractarian analysis can be applied not only to the study of natural persons but also to relations between states.
States can impose harmful externalities on other states and their populations through cross-boundary pollution, trade restrictions or population movements. They can also fail to secure common advantages through a lack of political co-ordination. The EU has often been portrayed as a mechanism for overcoming these problems in the international arena Moravcsik The assumption is that the policies that fall within the competence of the EU are in the long-term common interest of the member states, offering Pareto improvements over a prevailing status quo for all concerned.
However, many such issues are subject to the logic of the prisoner's dilemma. Each member state may be better off with an agreed policy with which all other member states comply but with which it does not, than it would be when it complied as well, even if all would be worse off without any agreement.
Yet, if this logic is clear to all, none would rationally comply and so the policy will either never be agreed or will unravel over time. Thus, the fundamental problem to be solved in any political contract between states is that of inducing credibility in others of one's commitment to the policy to be agreed to avoid defection from a mutually beneficial agreement. To overcome this free rider problem requires states to be able to make credible commitments to one another about their willingness to fulfil their obligations, even on those occasions when fulfilling those obligations proves onerous.
The logic of the N-person prisoner's dilemma was reflected in the construction of EMU. As Issing : —6 has clearly explained, it was thought that, because democratic competition works to create deficit financing, thereby undermining the long-term stability of the currency and public finances, the euro was designed to represent depoliticized and hence stable money. On this analysis, the political benefits of deficit spending in the form of votes gained by governing parties are enjoyed by national players, while the potential negative effects, notably higher interest rates, are felt by all states.
The alternative to such a rule is to leave discipline to the markets. However, within a currency union there is no exchange rate risk to a national government from deficit financing, and so borrowing premiums remain low over a period of time and credit risk builds up Issing : —4. Aware of this possibility, no rational state would prudently enter into a currency union without a no bail-out rule. Hence, in order for any such agreement to take place, states must commit to funding their own borrowing. Each state has to be able to make a credible commitment to other states about the maximum deficits that they are willing to tolerate in their public spending plans.
This, in short, was the rationale of the no bail-out clause of the Maastricht Treaty. The SGP arose from the recognition that the Maastricht rules of no bail-out and no exit were insufficient to prevent member states continuing to run excessive deficits. The idea was that the scope for fiscal adjustments among participating states had to be defined once and for all.
Political representatives at the member state level could still co-ordinate fiscal and monetary policy, but only on condition that the monetary component was fixed exogenously by an independent European Central Bank, the ECB, that had been deliberately isolated from political interference see Issing [ : —5]. When Germany in and then France and Germany in breached the provisions of the SGP, member states within the contract of monetary union had an incentive to strengthen monitoring and compliance even more.
With the coming of the financial crisis, the next stage of the contractarian logic was to embed the SGP in the European Semester, together with the Six-Pack and the Two-Pack, the effects of which were not only to increase the intensity of the monitoring of budgetary plans, but also to ensure co-ordination among member states before those plans were put to national parliaments. The Fiscal Compact, the aim of which is to alter the institutional structure of domestic political arrangements to prevent excessive deficits from arising or rectify them as quickly as possible if they do exist, reinforces these provisions.
As contractarian theory predicts, these devices emerge where previous commitment has been shown wanting and there is no alternative to continuing collective association. In other words, when commitments turned out not to be credible, the contractarian logic leads actors to a search for greater compliance by increased monitoring, penalties and institutional restructuring Weale forthcoming. Does this contractarian rationale provide a justification of the political legitimacy of EMU as it has been constructed?
It could only do so provided that the states in question could be regarded as unitary actors. Yet, treating states as unitary actors is merely a simplifying assumption, useful for the purposes of some types of analysis but distorting if taken as an accurate representation of an empirical situation. States are collective entities made up of constellations of many actors. In political associations modelled according to the norms of two-level games, the political representatives of each state simultaneously owe obligations to the political representatives of other states and to their own populations Savage and Weale , with implications for their ability to comply with their contractual commitments.
The credible commitment that each state has to be able to make to every other concerns such matters as the maximum budget deficits that they will allow in their public spending plans, the rate at which deficits will be rectified and the balance between the growth of GDP and the growth of public expenditure. However, the commitment of states with regard to these policy strategies can only be made credible provided that each state enjoys the confidence of its citizens. Only with the confidence of their citizens will these states possess the capacity to implement the policies implied by the international agreement.
In the modern world, this confidence and the resulting capacity to implement policy rest upon democratic political legitimation. Monetary union implies, then, that each state can have the confidence that all other states can secure sufficient ongoing domestic support to meet their consequent obligations. Hence, only if states enjoy democratic legitimacy will other states have reason to believe that their commitments are credible.
A similar interlocking logic arises in the relationship of states to their citizens. For international agreements to be credible, the governments responsible for implementing them must be able to give domestic populations good reasons for compliance, showing how an agreement will serve the collective interest. At the same time, each state must recognize that all other states that are parties to the agreement are similarly acting as representatives of their citizens.
The state parties are thus engaged in a two-level game, in which the terms of the agreement have to be simultaneously acceptable to other negotiating parties and to their domestic constituents. Simultaneity in this context does not mean 'occurring at the same time', but indicates that any international agreement must fulfil two sets of conditions. First, an international agreement requires 'fair dealing' among states in their relations with one another as the representatives of their peoples.
Second, states must ensure the general acceptability of the agreement to their respective peoples and be able to justify their international commitments, including any provisions for side payments, as being a reasonable way of advancing their joint and several common interests. Unless this second condition is met, so that a state can guarantee the backing of the people it represents, no other state party to the putative contract can be confident that a commitment made to it is credible.
In short, the logic of collective commitment in a monetary union presupposes the logic of political democracy at the national level. Unless all the state parties to an agreement possess a credible democracy at the national level, it is a practical contradiction at the international level for them to enter into commitments with each other, since, in those circumstances, no state could rationally trust the commitments of the other states or be trustworthy itself. Consequently, pace certain analysts of the EU Majone ; Scharpf input legitimacy at the domestic level cannot be substituted by output legitimacy at the international level — particularly if the beneficial effects of those outputs vary over time and between the different parties to the agreement in ways that might be regarded as unfair Bellamy [ ]; a point acknowledged by the post-crisis analyses of Majone [ ] and Scharpf [ ].
The need for domestic political legitimacy is not simply a political fact; it is also a reason within a normative order. An international agreement involves each state recognizing that all other states are embedded within a normative order that governs their internal and external relations. Consequently, each state requires democratic legitimation for its commitments. The most elaborately worked out example of the logic of such a normative order is that provided by the German Federal Constitutional Court in its jurisprudence on EMU starting with Brunner Federal Constitutional Court That jurisprudence recognizes that the German state needs to be able to enter into long-term international commitments in order to be able to secure benefits that are only available through internationally co-ordinated action.
At the same time, the jurisprudence of the Court insists that any international commitment must be consistent with those principles of the Basic Law that bind the German state in perpetuity to the principle of democratic authority stemming from the people. In particular, the voting rights of German citizens should not be compromised by the German parliament losing meaningful control over the direction of economic policy.
Therefore, the Court has seen its task as being to make it legally and constitutionally possible for the German state to enter into and honour international agreements that are in its interests and in the interests of other states who are party to the agreement, whilst at the same time retaining the principle of the democratic self-determination of the German people that is a fundamental element of the Basic Law. In a series of judgements, the Court has reasoned that these different demands can be reconciled through the doctrine of delegation.
So long as the international agreement could be said to rest on the delegated authority of the member state and the Bundestag retained the power of revoking Germany's participation in the international agreement, then the principle of democratic self-determination was respected. As Gustavsson noted, the Court's reasoning in Brunner rested upon three assumptions about EMU: its revocability by the Bundestag ; its marginality in terms of the scope of obligations it implied; and its predictability.
The subsequent jurisprudence of the Court has had to deal with the failure of one or more of these assumptions to obtain in practice.
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Thus, in a recent judgement on the constitutionality of the policy of OMT by the ECB Federal Constitutional Court a , a majority of the judges ruled that OMT were unconstitutional, because they involved an open-ended commitment by the German government. In other words, the scope of the obligations implied by OMT was neither limited nor predictable. Although the Court referred the matter to the Court of Justice of the European Union, it offered its own sceptical interpretation of the compatibility of the ECB's planned action with treaty and constitutional requirements.
However, the kernel of its judgment turned on the force of Article 38 1 of the German Basic Law. In line with its previous jurisprudence, the Court interpreted this Article as requiring that state authority could not be transferred to the extent that democratic control becomes nugatory. The right to vote is in effect defined as the right to vote in an election where the result will lead to meaningful parliamentary control over the conditions of collective life, thereby expressing the self-determination of the people. Democratic self-determination means that the scope of the Bundestag's authority cannot be rendered nugatory, and, if the German government failed to contest the policy of OMT, then its actions can be revoked for this logic, see also Lindseth [ : 24].
On many matters of international agreement, domestic acceptability can be presumed by national decision-makers because the issues involved are technical, have low political salience or can be negotiated with the agreement of specific interest groups who share a consensus on which polices best serve their mutual advantage. In other words, they satisfy something like a marginality requirement. Prior to EMU, the EU's competences largely concerned such low salient issues and hence aroused comparatively little democratic contestation Moravcsik However, the logic of monetary union does not fall into any of these categories.
Although it is technical, its ramifications are wide. Few items are as politically salient as the reliability of a nation's currency. And interest groups typically take different and incompatible positions on the desirability of different monetary policies. In these circumstances, the assumption that states are acting as authorized representatives of their populations will break down, unless there are good reasons for thinking that the authorization is open-ended hence the shift in the post-crisis analyses of Scharpf [ ] and Majone [ ], which, unlike Moravscik [ ], have moved close to the argument made here.
However, as the jurisprudence of the German Federal Constitutional Court shows, after no other state had reason to think that the authorization was open-ended in the case of Germany. It was predictable that at some stage the limits of monetary integration would be met. This line of argument can be generalized. For just as other states had no reason for thinking that Germany would have an irrevocable commitment to all the implications of EMU, so no one in Germany could reasonably think that all other states could retain a democratic mandate for abiding by the rules of EMU when those terms became unpredictably onerous.
The practical contradiction at the heart of EMU is that member states could only find the terms of the contract credible on condition that they could assume that the commitments entered into by all other member states went beyond the scope of democratic legitimation within those states. That the contradiction revealed itself in the instability of the political contract on which EMU rested arose in part from the predictable unpredictability of monetary union.
That feature in turn stemmed from the fallibility of political judgement within the circumstances of politics, an element of the normative logic that we discuss in the next section. Legal constitutionalism of the sort that underlies the constitution of EMU represents one tradition within the liberal inheritance, one that is notably counter-majoritarian in its implications. According to that tradition, if modern democracies have the characteristics attributed to them by neoliberal legal constitutionalists, these commitments could not be credible, since the governments of the same states that entered into the contract would be prone to myopic and short-term sectional pressures such that they would take any opportunities that might arise to free ride on the co-operation of others.
If the temptation to free ride is built into democratic governments in this way, then there is no credible basis for commitment on the part of any potential party to the contract. The only basis for a credible agreement on monetary union would be through the general establishment of legal economic constitutions at the national level, underpinned by powerful counter-majoritarian institutions, so as to break the link between public expenditure and responsiveness to the preferences of the population.
Of course, this proposal is an implication of the neoliberal legal constitutionalist analysis, and the first steps along such a path are embodied in the requirements of the TSCG. However, counter-majoritarian legal constitutionalism in the economic realm is only one way of reading the liberal inheritance. The burdens of judgement arise from such general features of human judgement as the complexity of empirical evidence, the different weight that different persons will put on different types of evidence, the vagueness of relevant concepts and the problems of assessing evidence.
Given the burdens of judgement, a constitution should refrain from imposing requirements on those subject to it that will be matters of reasonable disagreement, matters, in other words, in which no knockdown arguments are possible. Rawls used this argument to exclude the constitutional entrenchment of religious doctrines because they rested on controversial philosophical premises, an issue that also arose in the convention on the putative EU constitution Olsen Does the entrenchment of a particular form of Hayekian theory in the constitution of EMU fall foul of this condition?
There are a number of reasons to suppose that it does. Firstly, Hayek himself opposed EMU in part because he recognized economic policy, even of a libertarian kind, was not a matter that could be legally entrenched. Instead, he advocated free competition between rival currencies provided by private rather than public banks Hayek Although this is a position that Issing attempted to contest on neo-Hayekian grounds, Hayek's scepticism about EMU was a logical consequence of his belief that viable economic orders were the evolutionary product of human action but not of human design Hayek In other words, the attempt to construct an international monetary order by political fiat would replicate the fallacies of central planning on which the road to serfdom was based.
Secondly, even within neoliberalism, there are other traditions of theory that take a non-evolutionary view of the economic order. As various commentators for example, Sally [ ]; Streit and Wohlgemuth [ ] have noted, this ordoliberal tradition contrasts with the Hayekian position in being rationalist and constructivist. It presupposes that the institutional form of the economy is determined within an already established legal order and political community.
Economic integration is not an instrument to create a political community, but an expression of the political choices of that community. Thirdly, this ordoliberal view is consistent with the worries many economists and policy-makers had expressed about the sequencing of European political union and monetary union and the design flaws built into EMU before the euro crisis had revealed these problems. For example, in a paper summarizing a wide range of work, Bordo and Jonung : 43—4 pointed out that EMU lacked both a lender of last resort, by contrast with other modern monetary systems where central banks were able to ensure liquidity, and a central authority to supervize financial systems, including the commercial banks.
Finally, and as many other economists also noted, they pointed out that Europe is too large and diverse an area to form a well-functioning currency union, with the efficiency gains from increased trade not large enough to outweigh the costs of surrendering control over national monetary policies. Fourthly, it is well established that different national traditions of economic policy-making fed into the creation of EMU. For reasons of history and intellectual tradition, German policy-making gave pride of place to the goal of price stability underpinned by the independence of the central bank.
Historically and institutionally rooted traditions do not disappear in a new policy framework, but manifest themselves in different ways. In particular, when it comes to questions of how countries recover from large economic shocks, there will be differences in what is seen as justifiable requirements; for example, how quickly and by what methods to re-establish internationally credible debt levels within the framework of the Excessive Deficit Procedure.
Similar differences of judgement will affect how countries think about the institutionalization of debt brakes and other constitutional devices under the TSCG. The implication of these points is that legal constitutionalism presupposes that there can be agreement on the basis of the constitutional essentials of a European monetary order, although the epistemic conditions do not exist to establish that agreement.
Indeed, even the German Bundesbank , so often presented as a model apolitical central bank, had its independence from the German government tested both by Adenauer and Schmidt Kennedy : 37— If within a single country, with powerful political and intellectual traditions justifying a strong independent central bank, the issue can be contested, it is not surprising that a rigid pan-European economic constitution based on the idea of automatic rules will be contested even more. The argument so far may be summarized as follows: credible commitment by governments at the international level presupposes political legitimacy at the domestic level; but the domestic legitimacy of democratic governments in turn presupposes that commitments may be modified or altered through political processes.
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Moreover, the epistemic conditions arising from the burdens of judgement reinforce the need for open discussion and democratic deliberation. Legal constitutionalism at the international level, therefore, risks undermining rather than reinforcing the credibility of state commitments if the measures legally entrenched are matters that should be subject to ongoing political debate by domestic electorates. Political constitutionalism offers an alternative to legal constitutionalism Bellamy By contrast to legal constitutionalism, political constitutionalism contends the terms of the political contract must be subject to ongoing debate among citizens with regard to both the procedures of decision-making and the substance of decisions.
Judgments about either cannot be legitimately entrenched or handled by judicial or technical bodies that are isolated from democratic processes because such isolation fails to recognize the equal legal and political status of citizens. Political constitutionalists argue that the functional complexity, ethical diversity and openness of liberal societies make individual judgements about the public good inevitably partial and fallible.
Because we are inescapably limited in our knowledge and experience, even the most conscientious persons will tend to reason from their own values and interests and be prone to error with regard to the present and future interests of others. If the collective decisions needed to regulate social life are to be not only impartial but also well informed with regard to the views and circumstances of those to whom they apply, so that they treat citizens with equal respect and concern, then citizens must have equal influence and control over the direction of public policy.
Pace neoliberal thinkers, such as Hayek, such equal influence and control cannot be provided by markets but only by a democratic process, albeit indirectly through the election of decision-makers Bellamy Legal constitutionalism in its purest form tries to place the legal and political system itself and even many public policies beyond political contestation, defining in substantive and concrete terms how both might be best configured so as to realize equal concern and respect.
By contrast, political constitutionalism in its purest form regards legitimacy as dependent upon the ability to employ existing political procedures to contest the procedural and substantive adequacy of the democratic system and its policies through the constant struggle of citizens to exercise equal influence and control over both.