The world has recently witnessed the Greek people stand up and opt for their government to continue managing the country’s fiscal policies during the current financial crisis.
Kiki Verico, Jakarta | Opinion | Thu, July 09 2015, 7:03 AM
The world has recently witnessed the Greek people stand up and opt for their government to continue managing the country’s fiscal policies during the current financial crisis.
The Greeks have chosen to keep Keynesian counter-cyclical fiscal policies instead of austerity. It is important to know how the European Central Bank (ECB) responds to this referendum result, given its initial refusal to extend Greece’s bail-out program.
As a member of the European Union and eurozone, Greece is subject to the region’s real (trade, investment and people) and monetary (single monetary union and currency) integration.
This comprehensive economic integration comes with a condition named the Optimum Currency Area (OCA), which was formally adopted in the Euro Convergence Criteria (also known as the Maastricht Criteria) agreements requiring member states to meet the following criteria:
- a maximum inflation rate of 1.5 percent higher than the average of the three best performing member states,
- a ratio of annual government budget deficit to gross domestic product (GDP) of less than 3 percent,
- a ratio of total government debt to GDP of less than 60 percent,
- a nominal long-term interest rate of less than 2 percent of the average of the rate’s of the three lowest member states,
- before joining the Euro, an exchange rate that has passed both the Exchange Rate Mechanism (ERM) and European Monetary System (EMS).
The Economic and Monetary Union (EMU) uses these measures, known as the Stability and Growth Pact (SGP), to monitor the economic performance of its members and formulate policies accordingly.
Member states, including Greece, must comply and meet the real sector criteria to ensure the stability of the eurozone.
However, what we are now witnessing in the standoff between ECB and Greece is a reminder for the EMU that the SGP only applies in normal situations.
Unlike the United States, the EU is not a “one-country form” and its supranational monetary union framework is now challenged by Greece’s financial situation.
The so-called “political union” of the single-monetary and currency union is merely an “option”. For instance, the UK, Denmark, Sweden and other six other new members of the EU have not joined the eurozone, one of the reasons being a desire to keep their fiscal policies — a basic indicator of a country’s economic sovereignty — under their own government’s authority.
By becoming a member of a single currency a country must transfer its fiscal policy independence as well as its political economic freedom to the supranational institution.
This may lead to member states losing their ability to implement the fiscal policies needed to stimulate their economy during a crisis. This is in fact the fundamental issue of the current difficulties between Greece and the ECB.
Now, the world is witnessing a new challenge: a single currency union where a member state is not only free to join, but also to quit. If Greece leaves the eurozone, the EU’s cooperation will be rattled yet the adjustment period will not be too long given that financial integration is merely an option.
Unless Greece leaves the EU, not just the eurozone; then the adjustment will be more severe for the region and costly for the member states. This is unlikely to happen.
What do ASEAN and Indonesia need to know and prepare for?
These events come as a strong reminder for ASEAN and East Asian regions that a single currency is again, an option. That it is a “means” rather than an “end”, and most importantly, that each member’s protection against financial crises is not absolute.
The latter prevents member states from potential “moral hazards” as there is no such thing as “full-coverage insurance” in the world of economic integration. For this reason it is clear now that single monetary and currency unions do not necessarily protect member states from financial crises, because in the end, the ultimate solution relies on a country’s own capacity.
Therefore, financial crises, whether they come from global or regional instability, must be managed through both regional cooperation and the country’s internal efforts. A lesson learned in combating economic crises is that there always needs to be a balance between regional interests and national efforts. As for ASEAN, adopted and adapted from the OCA’s requirements (Mundell, 1961 and Fleming, 1971), there are at least five core lessons that ASEAN needs to learn.
Firstly, a currency union is effective if the exchange rate of a high-inflation country is pegged to a low-inflation currency, a mechanism called the advantage of “tying one’s hands”.
Secondly, labor mobility is used as the adjustment factor for currency union shocks. Unfortunately, as seen in the EU’s recent case, unemployed Greeks could not freely get jobs in other EU’s member countries.
Thirdly, economic openness. However, the more open an economy is, particularly in finance, does not necessarily mean it will have a more stable economy. In fact it may leave a country more exposed to external shocks.
Fourthly, an increase in tax revenues in a country with a growing economy should equate exactly to the increased transfer in the country whose economy is in recession, as a result, the region’s budget will be balanced.
This is not an easy task as it consists of several different countries, not merely provinces. As opposed to Indonesia, for instance, which consists of different provinces with one central bank, international reserve deficits in one province will be covered by surplus from another province without facing reluctance from the surplus province residents.
Fifthly, a need for a positive correlation of monetary and real sector integration as it lessens the adjustment costs of any currency crises.
This is a future issue for the upcoming ASEAN Economic Community (AEC) during transformation of ASEAN from the real to monetary integration phase.
As for Indonesia, it needs to prepare several strategic actions in the short-term to prevent potential external impacts from Greece and the Euro’s instability.
First, Indonesia needs to have sound macroeconomic policies to anticipate dynamic financial markets.
Second, anticipate and prevent contagious financial instability by putting priority on regional currency swap arrangements, rather than those on bilateral levels.
Third, implement prudent macroeconomic policies, including a rigid commitment to target inflation and secure exchange rate stability as well as high economic growth.
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A currency union is effective if the exchange rate of a high-inflation country is pegged to a low-inflation currency.
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The writer is a lecturer at the Faculty of Economics and Business University of Indonesia in Depok.