A Europe Made of Money: the emergence of the European Monetary System (Cornell Studies in Money)
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The so-called Transportation Revolution opened the vast lands west of the Appalachian Mountains. Her trip was less than five hundred miles but took six weeks to complete. The journey was a terrible ordeal, she said. At Wheeling, Virginia, her coach encountered the National Road, the first federally funded interstate infrastructure project. The road was smooth and her journey across the Alleghenies was a scenic delight. Engraving based on W. If a transportation revolution began with improved road networks, it soon incorporated even greater improvements in the ways people and goods moved across the landscape.
New York State completed the Erie Canal in Soon crops grown in the Great Lakes region were carried by water to eastern cities, and goods from emerging eastern factories made the reverse journey to midwestern farmers. Robert Fulton established the first commercial steamboat service up and down the Hudson River in New York in Soon thereafter steamboats filled the waters of the Mississippi and Ohio Rivers.
Downstream-only routes became watery two-way highways. By , more than two hundred steamboats moved up and down western rivers. State and local governments provided the means for the bulk of this initial wave of railroad construction, but economic collapse following the Panic of made governments wary of such investments. Government supports continued throughout the century, but decades later the public origins of railroads were all but forgotten, and the railroad corporation became the most visible embodiment of corporate capitalism. By Americans had laid more than thirty thousand miles of railroads.
Railroad development was slower in the South, but there a combination of rail lines and navigable rivers meant that few cotton planters struggled to transport their products to textile mills in the Northeast and in England. Such internal improvements not only spread goods, they spread information.
The transportation revolution was followed by a communications revolution. The telegraph redefined the limits of human communication. By Samuel Morse had persuaded Congress to fund a forty-mile telegraph line stretching from Washington, D. Within a few short years, during the Mexican-American War, telegraph lines carried news of battlefield events to eastern newspapers within days. This contrasts starkly with the War of , when the Battle of New Orleans took place nearly two full weeks after Britain and the United States had signed a peace treaty.
The consequences of the transportation and communication revolutions reshaped the lives of Americans.
Farmers who previously produced crops mostly for their own family now turned to the market. They earned cash for what they had previously consumed; they purchased the goods they had previously made or went without. Market-based farmers soon accessed credit through eastern banks, which provided them with the opportunity to expand their enterprise but left also them prone before the risk of catastrophic failure wrought by distant market forces. In the Northeast and Midwest, where farm labor was ever in short supply, ambitious farmers invested in new technologies that promised to increase the productivity of the limited labor supply.
The years between and witnessed an explosion of patents on agricultural technologies. Louis, Mo. Most visibly, the market revolution encouraged the growth of cities and reshaped the lives of urban workers. In , only New York had over one hundred thousand inhabitants. By , six American cities met that threshold, including Chicago, which had been founded fewer than two decades earlier.
The steamboat turned St. Louis and Cincinnati into centers of trade, and Chicago rose as it became the railroad hub of the western Great Lakes and Great Plains regions. The geographic center of the nation shifted westward. The development of steam power and the exploitation of Pennsylvania coalfields shifted the locus of American manufacturing.
By the s, for instance, New England was losing its competitive advantage to the West. Meanwhile, the cash economy eclipsed the old, local, informal systems of barter and trade. Income became the measure of economic worth. Productivity and efficiencies paled before the measure of income. Cash facilitated new impersonal economic relationships and formalized new means of production. Young workers might simply earn wages, for instance, rather than receiving room and board and training as part of apprenticeships.
Moreover, a new form of economic organization appeared: the business corporation. States offered the privileges of incorporation to protect the fortunes and liabilities of entrepreneurs who invested in early industrial endeavors. A corporate charter allowed investors and directors to avoid personal liability for company debts. The legal status of incorporation had been designed to confer privileges to organizations embarking on expensive projects explicitly designed for the public good, such as universities, municipalities, and major public works projects.
The business corporation was something new. Many Americans distrusted these new, impersonal business organizations whose officers lacked personal responsibility while nevertheless carrying legal rights. Many wanted limits. Woodward the Supreme Court upheld the rights of private corporations when it denied the attempt of the government of New Hampshire to reorganize Dartmouth College on behalf of the common good.
Still, suspicions remained. Slave labor helped fuel the market revolution. By the early nineteenth century, states north of the Mason-Dixon Line had taken steps to abolish slavery. Vermont included abolition as a provision of its state constitution. Gradualism brought emancipation while also defending the interests of northern masters and controlling still another generation of black Americans. In New Jersey became the last of the northern states to adopt gradual emancipation plans.
There was no immediate moment of jubilee, as many northern states only promised to liberate future children born to enslaved mothers. Quicker routes to freedom included escape or direct emancipation by masters. But escape was dangerous and voluntary manumission rare.
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Congress, for instance, made the harboring of a fugitive slave a federal crime as early as Hopes for manumission were even slimmer, as few northern slaveholders emancipated their own slaves. Roughly one fifth of the white families in New York City owned slaves, and fewer than eighty slaveholders in the city voluntarily manumitted slaves between and By , census data suggests that at least 3, people were still enslaved in the North. Elderly Connecticut slaves remained in bondage as late as , and in New Jersey slavery endured until after the Civil War.
Emancipation proceeded slowly, but proceeded nonetheless. A free black population of fewer than 60, in increased to more than , by Growing free black communities fought for their civil rights. In a number of New England locales, free African Americans could vote and send their children to public schools. Most northern states granted black citizens property rights and trial by jury. African Americans owned land and businesses, founded mutual aid societies, established churches, promoted education, developed print culture, and voted.
Nationally, however, the slave population continued to grow, from less than , in to more than 1. Cotton drove the process more than any other crop. Water-powered textile factories in England and the American Northeast rapidly turned raw cotton into cloth. Technology increased both the supply of and demand for cotton. White southerners responded by expanding cultivation farther west, to the Mississippi River and beyond. Slavery had been growing less profitable in tobacco-planting regions like Virginia, but the growth of cotton farther south and west increased the demand for human bondage.
Eager cotton planters invested their new profits in new slaves. The cotton boom fueled speculation in slavery. Many slave owners leveraged potential profits into loans used to purchase ever increasing numbers of slaves. Wikimedia Commons. New national and international markets fueled the plantation boom.
Project MUSE - A Europe Made of Money
American cotton exports rose from , bales in to 4,, bales in Northern insurance brokers and exporters in the Northeast profited greatly. While the United States ended its legal participation in the global slave trade in , slave traders moved one million slaves from the tobacco-producing Upper South to cotton fields in the Lower South between and And of course it facilitated the expansion of northeastern textile mills. While industrialization bypassed most of the American South, southern cotton production nevertheless nurtured industrialization in the Northeast and Midwest.
The drive to produce cloth transformed the American system of labor. In the early republic, laborers in manufacturing might typically have been expected to work at every stage of production. But a new system, piecework, divided much of production into discrete steps performed by different workers. These independent laborers then turned over the partially finished goods to the owner to be given to another laborer to finish.
As early as the s, however, merchants in New England began experimenting with machines to replace the putting-out system. To effect this transition, merchants and factory owners relied on the theft of British technological knowledge to build the machines they needed. In , for instance, a textile mill in Pawtucket, Rhode Island, contracted twenty-one-year-old British immigrant Samuel Slater to build a yarn-spinning machine and then a carding machine. Slater had apprenticed in an English mill and succeeded in mimicking the English machinery.
The fruits of American industrial espionage peaked in when Francis Cabot Lowell and Paul Moody re-created the powered loom used in the mills of Manchester, England. Lowell had spent two years in Britain observing and touring mills in England. He helped reorganize and centralize the American manufacturing process. A new approach, the Waltham-Lowell System, created the textile mill that defined antebellum New England and American industrialism before the Civil War.
The modern American textile mill was fully realized in the planned mill town of Lowell in , four years after Lowell himself died.
Jens Weidmann: The role of the central bank in a modern economy - a European perspective
Powered by the Merrimack River in northern Massachusetts and operated by local farm girls, the mills of Lowell centralized the process of textile manufacturing under one roof. The modern American factory was born. Soon ten thousand workers labored in Lowell alone. They lobbied for better working hours. But the lure of wages was too much. Extreme cases illustrate one aspect of the costs of inflation.
Indeed, many people lost their financial wealth in these times. On the other hand, the burden of debtors - the government, in particular - was easily wiped out. It is the weakest groups of society who typically suffer most from inflation. Wage earners and transfer recipients like pensioners have only limited possibilities to hedge against it. Governor Kganyago explained it in a recent speech when he said: "Where monetary policy tolerates higher inflation, this tends to reduce spending power, especially for the poor. However, history has taught us that deflation, a general, sustained and self-reinforcing decline in the price level, can also be devastating for the economy, as the Great Depression demonstrated in the s.
Price stability is a socially desirable goal. A few decades later, economists perceived a seemingly stable trade-off between inflation and unemployment: the Phillips curve. It was thought that unemployment could be lowered by accepting higher inflation.
A Europe Made of Money
Thus, policymakers were under the impression that they could simply choose a combination of inflation and unemployment that fitted social preferences - or rather their preferences. But in the s, the previously downward-sloping Phillips curve turned vertical. Efforts to reduce unemployment simply raised inflation and contributed to stagflation, the combination of stagnation and inflation.
What had happened? Central to monetary policy is a problem that permeates many areas of economic policymaking: time-inconsistency. Princeton professor and former Fed Vice-Chairman Alan Blinder once illustrated this problem with an example that fits very well with today's venue. Let's assume that a university professor has two goals.
On the one hand, he wants his students to learn as much as possible. On the other hand, he wants to spend as little time as possible marking exams. The professor announces an exam to be held at the end of the semester and hopes this will induce his students to learn. Given his students have indeed studied, the best decision for the professor would be to cancel the exam to save himself the hassle of grading the exam papers. Thus, his optimal discretionary behaviour is time-inconsistent. But if the students see through the professor's incentive, they might not study hard, and all of them end up worse off.
What's the way out of this dilemma? University examination rules which make end-of-semester tests compulsory instead of leaving them to the discretion of the professor. In a seminal paper, the economists Finn Kydland and Edward Prescott once explained why time-inconsistency gives rise to an inflation bias. Using monetary policy to create surprise inflation can thus be tempting politically.
However, like the students who see through the professor's incentive, economic agents understand the incentives of the monetary authority. If they anticipate a monetary policy stimulus, inflation will rise, but real wages will remain constant. In the expectation of inflation, trade unions will already have negotiated a wage increase. The result will be a world with higher inflation, high unemployment and low growth, just like the s in advanced economies. What's the way out of it? The solution to overcome the political incentive to create surprise inflation is similar to the case of the professor: a credible and firm commitment.
An independent central bank tasked with ensuring price stability is a precondition.
The Origins of the Euro Crisis
Today, there is consensus in economic thinking around the world that price stability is the best contribution a central bank can make to enhance social welfare and to support sustainable growth. It can mitigate the cyclical fluctuations of growth and unemployment, but it cannot steer an economy onto a permanently higher growth path, nor can it permanently reduce joblessness to below the natural rate of unemployment.
Structural unemployment, for example, can only be addressed by economic policy measures. Hyperinflation episodes were one of the reasons why central banks should be prevented from printing money in order to finance public expenditures. Monetary policy and fiscal policy need to be separated.
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In pursuing price stability, there is also consensus among economists that central banks should aim for low but non-negative inflation rates to have a safety margin against deflation. Nevertheless, even if a central bank has the mandate to deliver price stability, there is a strong temptation to exploit monetary policy instruments for other objectives, even though the benefit is only short-term. And that makes independence and a time-consistent commitment so important. Both economic theory and history have shown that independent central banks are better equipped to keep inflation in check than central banks that are less shielded from the influences of a political cycle focused on the short term.
The Bundesbank has been among the most independent central banks from its inception. Over decades, Germany enjoyed low inflation rates. Even during the inflation-ridden s, Germany kept inflation rates at comparatively modest levels. During the s and s, many central banks were granted independence. The European Central Bank, which was established during that era, has been independent from the outset.
On 1 January, the single European currency - the euro - turned The average euro area inflation rate over the first 20 years was 1. The promise of stability was kept. Compared with the average loss of purchasing power of its legacy currencies like the Deutsche Mark or the French franc, the euro is even more of a stable currency. Key to this success, in my view, has been the monetary framework of our currency union. It rests on two cornerstones - the mandate and the independence of the Eurosystem, which is made up of the European Central Bank and the national central banks of those EU countries that adopted the euro as their currency.
Both the mandate and independence are stipulated in the EU Treaties. This protects the two cornerstones from legal changes, because any changes to the Treaties would require unanimity among all EU member states. The primary objective of the Eurosystem is to maintain price stability. Without prejudice to this goal, the Eurosystem shall support the general economic policies in Europe. So there is a clear hierarchy of objectives. The independence of the ECB and national central banks is also enshrined in the Treaties which, in addition, prohibit the monetary financing of governments.
This strong monetary framework has been the sound foundation of monetary stability. Nevertheless, the euro area experienced a significant economic and fiscal crisis over the past decade. Figuratively speaking, you could say that the euro had an easy childhood but difficult teenage years. Or, as Martin Wolf recently wrote in his FT column: "Like many people of 20, the European currency has experienced a traumatic adolescence. The underlying causes of the sovereign debt crisis were considerable macroeconomic imbalances in euro area member states: too much borrowing, too much unproductive spending, the loss of price competitiveness, a lack of structural reform.
However, the crisis was also borne out of institutional weaknesses. You could say that the monetary union has a strong leg and a weak leg. The strong leg from the outset has been the monetary framework which I have already elaborated. The weak leg is the fiscal and economic policy framework, the lack of a genuine economic union. This framework, which was set up in the s, was neither able to prevent the adverse economic developments in member states nor was it ready to resolve a crisis.
When the crisis occurred, fiscal emergency measures were taken to prevent it from escalating. And the Eurosystem was forced to act as a "crisis response unit". Understandably enough, this helped to stabilise the situation. The flipside was that some of the measures - in particular, the sovereign bond purchases - took the Eurosystem to the outer limits of its mandate.
In hindsight, however, judgments about what happened must be more nuanced. Germany was sustaining a single currency that had been of benefit to its export sectors and was ensuring that loans made by its own financial institutions would be repaid. Moreover, the approach taken to these bailouts had unfortunate economic and political consequences that will haunt Europe for some years to come.
The negative economic consequences are most evident in the case of Greece, although there are some parallel features in the treatment of Portugal and Ireland as well. Greece suffered a classic debt crisis as a result of profligate public spending and inadequate systems for tax collection. While fiscal cutbacks are necessary in the wake of such a crisis, experiences of other debt crises suggest that countries will emerge from them only if most of the debt is written off, inflation reduces the real value of the debt or a revival of economic growth reduces the scale of the debt relative to GDP.
The policies of the ECB and global economic circumstances militated against inflation, and the rescue packages of the EU initially ruled out writing off the debt. Although Greek debt was written down by a large amount, equivalent to two-thirds of Greek GDP in March , this initiative came too late to offer adequate relief. Thus, the capacity of Greece to emerge from the crisis has depended largely on its capacity to grow economically. But the terms of the bailout programs specified such high levels of fiscal austerity that economic growth became virtually impossible.
These programs required Greece to move from a 15 percent fiscal deficit to a 3 percent primary surplus within the space of three years, something few other countries have ever accomplished. Time and time again, the rosy projections for growth offered by the troika the European Commission, ECB, and IMF supervising the bailout conditions proved illusory. By , Greek GDP remained 25 percent below its level in The loans offered to Greece were not sufficient to allow it any sort of fiscal stimulus: 90 percent of those loans went to pay the interest and principal due on existing loans.
There was no room left to support aggregate demand in the context of deep cuts to wages and social benefits. As gross domestic product shrank, Greek debt as a proportion of GDP grew ever larger, further reducing confidence in the economy. The response of the creditor governments to such concerns has been to emphasize the value of the structural reforms to liberalize product and labor markets imposed on Greece as a condition of the bailout.
Some of those reforms are likely to have desirable effects on economic performance, but only in the long run. In the short run, structural reforms undertaken in the context of fiscal austerity often have negative effects. Why then did the creditor countries of northern Europe insist that structural reforms in the context of fiscal austerity were the best basis for growth? To some extent, this stance was simply pragmatic politics. The creditors were already lending Greece sums equivalent to its total annual GDP. Such views had resonance in northern Europe because they conformed to the modes of macroeconomic management that worked best there.
In coordinated market economies operating an export-led growth strategy based on high levels of inter-sectoral wage coordination to hold down unit labor costs, a restrained macroeconomic stance is desirable because it reduces the incentives of trade unions and employers to exceed desirable wage norms. In their case, economic growth depends more heavily on the expansion of domestic demand. Accordingly, economic growth is returning to Ireland, whose liberal market economy, oriented toward foreign direct investment, which is attracted by favorable tax treatment and a skilled, English-speaking population, has been buoyed by a resurgence in global demand.
But growth remains elusive in southern Europe where multiple years of austerity have taken a toll on productive capacity and levels of investment. Spain is growing again but at rates not yet high enough to reduce an unemployment rate close to 25 percent, and growth remains sluggish in Portugal where the unemployment rate is close to 15 percent. In Greece, 26 percent of the workforce is still unemployed despite a decline in nominal wages of 25 percent since The bailout program has left it floundering in political as well as economic terms.
In retrospect, it looks as if it would have been better if the country had been allowed to restructure its debt in and given aid designed to ease its transition toward a primary surplus rather than focused on paying back lenders. Such an approach would have imposed a larger share of the adjustment costs on European financial institutions and those who invest in them but potentially lower levels of suffering on the Greek people. The response to the Euro crisis also laid bare a series of political paradoxes consequential for the future of European integration.
In the context of coping with the crisis, the heads of government of the Eurozone met together or with other EU leaders an extraordinary fifty-four times between January and August On the one hand, these high-level meetings reflected unprecedented levels of consultation and cooperation among the member states. On the other, this modus operandi sidelined the Parliament and Commission, institutions that were supposed to gain influence under the Treaty of Lisbon, in the name of advancing European democracy.
The crisis years have also been marked by the ascendance of Germany to a position of virtual hegemony with the councils of the EU, a paradoxical result given that France initiated the move to EMU partly in order to reduce German influence over European economic affairs.
Although it was inevitable that a reunified Germany would gradually become more willing to assert its national interests because it paid the largest share of the bailout bills, the Euro crisis rapidly thrust it to prominence and power, arguably before the German government had time to reflect carefully about how to balance national and European interests.
In many respects, Germany is a reluctant hegemon—less willing to pay the costs of providing public goods for a large number of states than the U. In the coming years, much will depend on what Germans think their leadership role in Europe entails. In another paradoxical result, a crisis that ultimately called forth intensive cooperation among the political elites of the member states has ended up fostering hostility among the citizenry at large.
Political leaders bear some responsibility for this state of affairs. The initial response of many northern European politicians was to treat the crisis not as the existential dilemma that it was for Europe, but as a moral issue about whether the citizens of other countries had been adequately self-disciplined. When Syriza took office in Greece, it was repaid by accusations that the Germans were behaving like Nazis. Sentiments such as these have eroded the sense of transnational solidarity on which electoral support for effective cooperation within the EU depends.
The extensive conditions attached to its bailout agreements, and policed by the troika, have often been forced on reluctant national governments, notably in Ireland, which was forbidden from imposing a haircut on the holders of bonds in its failing banks, and in Greece, where the troika dictated highly-detailed sets of spending, tax, and industrial policies. The reasoning, of course, is that European officials know better than their national counterparts how to secure the growth necessary to pay back substantial European loans, and there are precedents in the conditions imposed by the IMF on debtor countries.
But the European Union has pretensions to democratic governance that the IMF does not, and many wonder why it could not have negotiated a required level for budget surpluses in the debtor countries while leaving the decisions about how to meet those levels to elected governments. This new assertiveness is gradually altering the relationship between the EU and its constituent states. In this context, the most pressing issue is whether the single currency can endure and operate successfully without deeper political integration. Among the European political elites, there is currently a strong impetus to centralize economic power in Brussels.
Many in the north want to give the EU more substantial powers over national budgets in order to avoid a repeat of the fiscal foibles that brought Greece to the brink of bankruptcy. Politicians from the south are more likely to argue for an economic government equipped with new sources of funding and the capacity to promote reflation in Europe. They are supported by many economists who argue that the single currency will survive only if the Eurozone moves toward this type of fiscal union with supervisory powers over national budgets and ideally with a budget of its own to provide the social insurance benefits that might cushion the member states facing recession from such shocks.
It is difficult to see where the popular support necessary to alter the European treaties so as to build new European institutions would come from. The capacities to decide whom to tax and how to allocate the proceeds, however, are the most important powers of a democratic state. Accordingly, many observers have argued that a Eurozone authority equipped with such powers must be democratically governed, and diverse sets of schemes for doing so have been produced, including proposals to elect the President of the Commission and to strengthen greatly the powers of the European Parliament.
On this view, deeper fiscal union requires a political union based on the development of more democratic European institutions. However, none of these schemes for turning the European Union or its Eurozone into a supranational democracy are really viable. In the absence of effective competition among genuinely European political parties, even the most ambitious schemes for making European institutions more democratic offer, at best, highly tenuous lines of electoral accountability, and, in the wake of the Euro crisis, popular support for passing more powers to Brussels is at a low ebb.
Majorities in most European electorates continue to favor the Euro and membership in the EU, but enthusiasm for further political integration has declined, and radical right parties opposed to European integration are on the rise across Europe. Moreover, the torturous negotiations accompanying the Euro crisis have worn away the sense that the single currency is a positive-sum enterprise offering manifest benefits to all.
Because those negotiations have been dominated by a search for national advantage, as well as endemic conflict between the ECB and European governments about which would bear the risks associated with new initiatives, the response to the Euro crisis has looked like a zero-sum enterprise in which the risks or costs of new initiatives are borne more heavily by some actors than others. As a result, it has become more difficult to argue that further European integration is an enterprise from which all the member states will gain.
The Eurozone may become locked into a deflationary macroeconomic stance that condemns some of its member states to slow rates of economic growth for years to come. Therefore, the EU finds itself on the horns of a dilemma. Influential figures are arguing that the single currency will survive only if the Eurozone has an economic government of its own. But, since there seems no way of making such a government truly democratic, moves in this direction threaten to replace embryonic democratic institutions with a new technocracy.
Caught between Scylla and Charybdis, the member states are currently temporizing. With a fiscal compact committing the member states to budgetary balance and new regulations for the supervision of national budgets, the European authorities have acquired unprecedented powers of purview over national budgets, but it remains unclear whether those powers will ever really be exercised. As I have noted, because the political economies of the member states are organized in different ways, they cannot all emulate the export-led growth strategies of Germany. Some can prosper only via demand-led growth strategies that require more relaxed fiscal policies.
The clear-cut danger is that the Eurozone may become locked into a deflationary macroeconomic stance that condemns some of its member states to slow rates of economic growth for years to come. The important issue is what sorts of decisions would emerge from any new set of European institutions, and those decisions will depend on the relative power and positions of the national states represented there. A new set of institutions dominated by a German government convinced that the budgets of every member state should always be balanced and that trade surpluses reflect virtue while deficits result from vice might yield policies no more conducive to growth than the current ones.
Macroeconomic coordination at the European level will not be successful until those supervising it realize that there is more than one route to economic success. Does this mean that, if the member states of the Euro do not move closer to fiscal and political union, the single currency is doomed to disintegrate? Not necessarily. The Eurozone does not yet have robust institutional mechanisms for economic adjustment.
But it is arguable that, with a slightly more-developed institutional exoskeleton built on recent practice, the single currency may be able to endure. One key condition for economic success is a robust banking union capable of identifying and winding down insolvent banks so as to maintain transnational financial flows.
Also of interest
Although stalled on the issue of cross-national deposit insurance and equipped with a bank resolution fund that is currently too small, plans for such a banking union are proceeding. Another condition underlined during the Euro crisis is the presence of a European central bank with the capability to act as a lender of last resort both to banks and to sovereigns in order to deter speculative attacks in the financial markets.
Much depends on whether these practices are accepted as legitimate modes of operation going forward, and it is conceivable that they might be. From my perspective, the key issue is whether the single currency can be sustained even if some member states run endemic deficits on their current account while others run persistent surpluses, since the presence of multiple varieties of capitalism inside the Euro makes that likely.
For that to be possible, investors in the states that acquire funds by running surpluses must be willing to invest some of those funds in states running deficits. A banking union offering reassurance about the solvency of counterparties helps make that possible.