Posts tagged ‘Monetary Policy’

10/26/2011

Greece Limited By Euro Monetary Union

Although the U.S. Congress controls Fiscal Policy under an unlimited Constitutional power to tax and spend, and Monetary Policy through the Federal Reserve Bank and the ability to “coin money,” European Union states, such as Greece, who elected by treaty to adopt the Euro currency, are no longer able to use a national Monetary Policy to print money, or a Fiscal Policy to spend in excess of limits set by the European Central Bank.

European unification has been a work in progress since the 1950s when certain European states created a Common Market for the purpose of trading, under a system that allowed them to maintain their control of over national economics. A Customs Union was added in 1968 to abolish tariffs between the member states, and to establish a common tariff as against goods from the outside.

The existence of several currencies and a desire for a easier flow of capital led to a Monetary Union, which created a European Central Bank in Frankfurt, abolished German Marks, French Francs, and other currencies, and replaced them with the Euro in 2002, by making it the exclusive legal tender in Euro Zone states.

The problem with the Monetary Union is the lack of a Political Union to oversee it. Unlike the U.S., where all 50 states obey Washington DC on national matters, the EU is a collection of independent countries that happen to have a Central Bank. The EU Parliament cannot pass national legislation, like the Congress; they can only follow existing treaties, or propose new ones.

It is doubtful the recent European Monetary Union financial crisis will cause the independent countries of the EU to form one Political Union. It is more likely to have the opposite effect.

The problem is national governments like Greece already gave up aspects of national control under prior EU Treaties. When the Monetary Union was made, the EU Framers required the various national governments to coordinate their economies. National Debt, for example, was not to exceed 60% of GDP. Countries that previously used Monetary Policy were no longer able to do so, since these powers were transferred by treaty to the Central Bank.

National governments that previously spent their way out of recession, now had their Fiscal Policies controlled by the EU Central Bank, which imposed spending caps. Their Stability and Growth Pact (1997) required states to pursue balanced budgetary policies, and imposed sanctions against those that failed to adjust.

The European Central Bank has the authority under treaty law to restrict the democratic wishes of the Greek people and to operate without regard to political pressures. The risk is a renunciation of the EU Treaty by Greece, which may trigger others to follow, in a manner like South Carolina’s secession from the U.S. in 1861.

While the EU is not going to allow member states to default, the question is whether the Greeks will allow the Central Bank to reduce their jobs and pensions without a secessionist revolt, which Greeks may feel is their only option, since the Bank now controls their national Monetary and Fiscal policies, under the EU Treaty.

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08/25/2011

Low Interest Rates: Correct Fed Policy

The Board of Governors of the Federal Reserve correctly used Monetary Policy to try to turn the economy around, by keeping home mortgage interest rates at their lowest level in 40 years.

Congress created the Federal Reserve System with a Central Bank in 1913 to help prevent recessions and other economic downturns from turning into depressions. Since then, all National Banks have joined the system.

The Federal Reserve has the ability to set interest rates for loans to member banks. When the Fed sets low interest rates, members are able to make loans to the public at correspondingly low rates. The availability of cheap money theoretically allows the economy to expand, provided other factors line up correctly.

Low interest rates at the Fed also help the U.S. Government when short-term loans are needed. Since interest on these loans is later turned over to the U.S. Treasury, the Fed basically provides interest-free money to the government. The principal sums borrowed from the Fed are repaid by the government with money raised from publically sold Treasury Bonds. Interest on the bonds is paid by the U.S. Treasury, until the bondholders are satisfied.

The decision by the Fed to keep interest rates low helps the federal government in terms of the annual deficit and national debt, regional banks in allowing them to offer cheap money, and the public, by enabling them to borrow at relatively low rates.

If the Fed now raised interest rates, while the national economy is still struggling to get out of a deep recession, one consequence would be a contraction, and a worsening of the economic crisis. If the Fed imposed higher interest rates, they certainly would not help, and would likely make the housing crisis worse.

Currently, factors other than interest rates are keeping the housing market from expanding. The Fed should continue to keep interest rates low, until measurable improvements are seen in the housing industry, which unfortunately may take the better part of a decade, no matter who occupies the White House or the Congress.

06/21/2011

European Union Needs More Power

Since 54% of the 483 million-member European Union (EU) come from Germany, France, Britain and Italy, too much is being made of the Euro Crisis, as only 2% of the EU population lives in Greece, 2% in Portugal, and less than 1% in Ireland. The Euro Crisis simply does not directly affect 95% of the European Union.

Britain, one of three to opt out of the Euro, with Denmark and Sweden, is now smirking on the sidelines and hyping the crisis, as the German Bank tries to craft bailouts for Greece, Portugal and Ireland. But British criticism of the Euro-zone is not the answer. The Euro instead needs more, not less power. What the UK could do to help and restore Euro confidence is to boldly abandon the Pound and adopt the Euro.

Here, in America, many are unable to follow the EU story, since the organization did not even exist when they were in school. The EU had its origins with the European Coal and Steel Community (ECSC) (1952), and the Common Market, also known as the European Economic Community (EEC) (1957). The EEC later became the European Community (EC) (1967), and finally the European Union (1992), which now has 27 member states.

The EU established an Economic and Monetary Union, which opened a European Central Bank in Frankfurt (1998), and circulated a Euro Currency (2002). Britain, Denmark and Sweden opted out of the Euro. The Central Bank controls Euro monetary policy and affects national spending, since Euro-zone states are now unable to print their own currencies and must make up for budget shortfalls by borrowing. The EU adopted a Stability and Growth Pact to limit national budget deficits, but Greece, Ireland and Portugal failed to comply. With no money to print, and none to borrow at reasonable rates, a crisis developed.

A European solution is not as easy as the one implemented in the U.S. during the recent financial crisis, where Congress and Federal Reserve Bank stopped things from spinning out of control. Although EU institutions look like those in the U.S., since they have an executive in Brussels (Commission and Council of Ministers), a 732-member Parliament in Strasbourg, and a Court of Justice, in Luxembourg, they are not as strong as their U.S. counterparts. The EU is not really a political union able to make its own decisions, but rather an organization which is dictated to by its 27 member states. The EU Parliament has no general lawmaking power and cannot tax and spend. All the EU can do is issue directives to member states and ask national governments to implement EU policy.

Some say the EU will never become the USA of Europe, but it’s just a matter of time. It took the U.S. 172 years to assemble 50 states in one union across North America, and it will take many years to complete the European Union picture.

For now, instead of Britain, Denmark and Sweden resisting the Euro currency, as they have in the past, they should courageously convert to it and give the EU more power. All 27 member-states should grant their EU institutions the authority they need to keep their currency strong, so they can correct the budgetary problems in the member states, such as Greece, Portugal and Ireland.