Mark Copelovitch on the Political Economy of the Global Recession and the Eurozone Crisis

The how and why behind the failures of policymakers during the Eurozone Crisis and the Great Recession.

Mark Copelovitch is an associate professor of political science at the University of Wisconsin-Madison and studies the politics of international trade, money, and finance. He joins the Macro Musings podcast to discuss the politics of the global recession and the Eurozone Crisis.

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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Mark, welcome to the show.

Mark Copelovitch: Thanks so much for having me. It's a pleasure to be here.

Beckworth: Oh, it's a real treat. We've gotten to know each other on Twitter. We've discussed the Eurozone on Twitter, the Great Recession, Fed Policy on Twitter. So, we're going to bring it out in the open now with our audience.

Beckworth: You've done a lot of interesting work on global finance. You've also looked at the IMF. If we have time today, maybe we might also touch on Argentina.

Copelovitch: Sounds great.

Beckworth: But I want to first kind of focus on some of your interesting work on the Great Recession, the Eurozone Crisis, and it's great to have a political scientist on the help rein in us economists, who sometimes have our heads up in the clouds.

Copelovitch: Well, to some extent, those of us that study political economy, we have one foot... And we're the ugly stepchildren. We're not quite international relations people, not quite economists, but have really interesting discussions with both groups of people.

Beckworth: Yeah. Yeah, so it's great to have you on to kind of add some perspective. Mark, tell me, how did you get into the politics of international finance? What was your journey into this field?

Copelovitch: My journey? So, I think originally there was a sort of couple things which led me to study IPE and the global economy, and then sort of give you my university and career stuff.

Copelovitch: So, I'm a Canadian ex-pat. I was born in Montreal. We moved to the US when I was three. So, I think I picked up something I realized later on in life, early about exchange rates because my dad was always worried about the Canadian dollar and the exchange rate.

Beckworth: Oh.

Copelovitch: But I grew up in Pottstown, Pennsylvania, which is outside of Philadelphia and it's an old steel town where the Bethlehem Steel plant provided the steel for the Brooklyn Bridge and the Golden Gate Bridge and what not. So, this was in 1975. We moved there in 1978 and I really grew up in sort of declining Rust Belt America. And so I think a lot of the political economy things that I got interested in over the years, I sort of picked up from growing up in that part. But I was an undergrad at Yale and I took a history political thought course with Frank Turner my freshman year, where we read Thucydides and Locke and Hobbes and Russo and Machiavellian, the classics, and so I got hooked on political science.

Copelovitch: And then my sophomore year, I took two courses. I took a course on European immigration with David Cameron, who was ultimately my thesis advisor and I took macroeconomics with [inaudibl]. And pretty much after that, I was sort of hooked on Europe and the global economy and politics and economics and sort of trying to figure out what am I going to do to bring these things together? And I ended up, I think, like a lot of Ivy League grads in the 1990s, the path of least resistance was to kind of become a management consultant when you weren't sure what you wanted to do.

Copelovitch: And so I moved to Boston, I was working as a consultant, I wasn't especially enjoying it and this was 1997 to '99, and I was spending all of my spare time basically reading about the Asian Financial Crisis. And decided I was going to go back and get a PhD in political science and work with Jeff Frieden and Andy at Harvard. And I started in '99 and I thought I was going to write about the political economy of European monetary integration. And sort of my timing was a little bit off in the sense that the Euro was launched and the project was kind of thought to be done. And the global financial crisis is going on and that's what got me interested in really focusing on the IMF.

Copelovitch: And that was the sort of first 10 years of my academic career, was studying political economy and international finance and exchange rates and your financial crises and writing a book on the IMF. And so the irony now is I'm sort of spending a lot more time these days thinking about the thing I originally went to graduate school to study, which was Europe and the Euro Crisis and European integration. But I think that's the journey.

Beckworth: Well, very interesting.

Copelovitch: Yeah, I just kept trying to bring together political science, international relations, and the global economy stuff and been able to make a go of it.

Beckworth: Yeah. So, you kind of whet your appetite, cut your teeth on the emerging market crisis of the late '90s, and that kind of fueled your interest to come back and study the Eurozone, then the Great Recession, then back to the Eurozone. So...

Copelovitch: Yeah, I mean, there's always another financial crisis.

Beckworth: Right, right.

Copelovitch: It's always similar and it's always different, right?

Beckworth: Right, I've had people tell me, "Well, David, monetary policy's becoming boring. Things are calming down. What are you going to do next?" And I say, "Just you wait."

Copelovitch: Yeah, I mean, as someone in political science and international relations who studies political economy, one of the things you always hear is, "Where is the politics in exchange rates and finance?" And sort of the last 10 years has made it abundantly obvious where the politics are on these topics.

Beckworth: Yeah, so along those lines, let's segue into a paper of yours titled "This Time Should Have Been Different: The Causes and Consequences of Macroeconomic Policy Failure in the Great Recession." So, a clever title there, a play on "this time it is different," but you say this time should've been different.

Copelovitch: Yeah.

Beckworth: And you mention that policymakers have failed spectacularly. So, how have they failed and why should've it been different?

Copelovitch: Yeah, so this was a conference. A group of my professional colleagues who'd been in Switzerland last year, thinking about the politics of crises around the world and rising populism and what not. And there's a huge debate right now in political science about the rise of populism and Trump and is it about economic anxiety versus other things like racism and nationalism and what not. And as someone who studies international political economy, I kind of have this view of there's a sort of bigger picture thing going on.

Copelovitch: Which is, we had a massive global financial crisis, a crisis in the US and the Eurozone Crisis. And they were serious crises, but they shouldn't have turned into lost decades. And that a lot of the politics in the shift of political experience that we've seen, my view is it's very much not as bad as the 1930s, but it's very much that type of story. Again, that we knew a lot about what to do with fiscal policy and monetary policy in response to crises, and we didn't follow those lessons. And to some extent, I think the politics and the move towards populism and nationalism and more extreme politics is a predictable outcome of a lost decade, right?

Copelovitch: When the economy is bad and democratic political systems don't deliver economic growth and don't deal with economic problems, the center gets hollowed out and people shift to the extremes. And you and I have talked on Twitter a lot about monetary policy and inflation ceilings instead of inflation targets, and so I think one aspect of it is the constant fear of inflation of central bankers who grew up in the 1970s and 1980s. And as much as we think about monetary policy being loose with quantitative easing, arguably it actually hasn't been loose enough.

Copelovitch: And on the even more serious, I think, on the political side is the fiscal austerity that we've seen in the Eurozone, that we've seen in the US. I'm in Wisconsin, so we've been living through eight years of fiscal austerity at the state level. And so one of the things I talk about in the paper, is people look at the UK and think about austerity. People look at Greece and the Eurozone and think about austerity. But in the US, we sort of say, "Well, the US was different." And we pursued fiscal stimulus, but the fiscal stimulus was about a third of the size of the output gap.

Copelovitch: And it ended in the middle of the recession. If you sort of take federal spending, and then state and local government spending, we're engaging in austerity by 2012, 2013 when unemployment is still very high and the economy hasn't recovered. And so I sort of see it... When I give talks about this, I think about it as a sort of massive goal. I'm a big soccer fan.

Beckworth: Okay.

Copelovitch: So, I think about this as the crisis was severe, and there would've been economic and political consequences to it. But in 2018 we really shouldn't still be talking about it, had we thought about the monetary and fiscal policies that we knew, economically, that we should've followed. And look, I'm a political scientist. I understand all the political reasons why we have adopted these policies. But there's sort of great tragedy about the last decade that it didn't need to be nearly as serious as it has been.

Beckworth: Yeah, I'm sympathetic to much of what you said there, particularly on monetary policy. And it's interesting, I was reading the paper about the Great Depression just a few days ago.

Copelovitch: Mm-hmm (affirmative).

Beckworth: And in it, the Federal Reserve officials were worried, since 1935, about inflation taking off. So, they just kind of turned the corner in 1933 from the Great Contraction.

Copelovitch: Yeah.

Beckworth: And they're beginning to worry about inflation and it just echoed, it reverberated to what we had here. The Fed did not want to allow any kind of overshoot. And again, I'm not advocating for some massive, runaway 1970s inflation. But if you fall, you're supposed to bounce back up proportionally, and that just didn't happen.

Copelovitch: Right, yeah. I mean, if you think it's a symmetric inflation target and we've had 10 years under 2%, you can certainly see the case for not going over 2% for that long. But for that to be the ceiling and in Europe, not even by a little but arguably by a lot.

Beckworth: Yeah, they have it even worse over there, so in some regard maybe I should be grateful for what we have in the United States. But with that said, I guess a takeaway for me, is if policymakers were susceptible to this concern in the Great Depression, once again they're susceptible to it here in the 2000s. I wonder whether any lessons have been learned, or will lessons be learned?

Copelovitch: Yeah.

Beckworth: In fact, I was talking to Matt Yglesias about this. One of the big tragedies is the confusion over race versus levels, right? So, we get worked up about inflation jumping to maybe 3%. "Oh, that'd be the end of the world," versus looking at the fact that the price levels on a lower path or a nominal GDP or real GDP is on a different path.

Copelovitch: Yeah.

Beckworth: For whatever reason, I don't know if it's wired in our brains or just because inflation targeting's been around so long, we get worked up about inflation rather than the level of activity.

Copelovitch: Yeah, Matt was actually out here for a few talks, and he and I were on a panel and we were talking about this as well. I mean, I think a lot of it is we found what we thought was a technocratic solution in the 1980s and 1990s to the problems of the 1970s, right? You know, you have the Volcker Shock, you have this increase in central bank independence, the global spread of independent central banks. And a lot of it is thinking we found this technocratic solution and for reasons that were more about everybody focusing on a focal point maybe on the optimal level, we kind of fix on 2% as the level of inflation that has to be the target.

Beckworth: Yeah.

Copelovitch: But again, as I'm a political scientist and I think about, "Well, it's hard to find technocratic solutions," and you delegate to independent central bankers. But they are operating in the shadow of political oversight. And if they adopt policies that are seen by the politicians as too radical, then the independence is going to be reined in, right?

Copelovitch: And so I think a lot about the pressure to normalize monetary policy and that language about normalization. And we have to start maybe preemptively raising rates. I think there's a lot of central bankers looking over their shoulders and saying, "We've already pushed the envelope politically and if we go too far, then our independence is going to get reined in." And you think about Ron Paul and Audit the Fed and that he used to be seen as very much kind of the extreme, outlier view. And that starts to become a more normal, mainstream political view that the independent central bankers need to be reined in. And it, unavoidably, I think it affects the technocrats' behavior as they're thinking about this political oversight.

Beckworth: Sure. Yeah, there's no doubt. And Ben Bernanke received a lot of rough treatment when he went before Congress. I remember in 2010, he was berated for currency manipulation, the base in the currency, when in fact inflation was actually really, really low at the time.

Copelovitch: Yeah, and you saw it in fiscal policy, too.

Beckworth: Right.

Copelovitch: If you think about what we know about the internal debates in the Obama Administration with Romer versus Summers, and Summers sort of putting up the view of, "Look, this is as much as we think we can feasibly get through Congress." And so you have the same kind of fears, economically, maybe how big the stimulus should be versus, politically, what can we actually get done? And again, that's where the politics of this stuff comes in.

Beckworth: Yeah, it does. I guess in the case of the Fed, I often wonder, and I've talked about this with some other guests, the Fed expends a lot of political capital in doing the QE programs. They were radical when they first did them, right?

Copelovitch: Yeah.

Beckworth: And Bernanke's Fed received a lot of flack for it. I just wonder if they had instead spent it on tolerating low inflation overshoot, aiming for a level target instead.

Copelovitch: Yeah.

Beckworth: But that's Monday morning quarterbacking. But I want to go back to your article because you bring up some other points. We're focusing on central banks, but in the Eurozone in particular, I think this is more of an issue. Although in the US, there's a little bit of an issue. But the debt issue in the Eurozone became a big issue and you talk about the morality of debt. The Germans in particular were looking around and they were pointing fingers. And what's frustrating about this conversation, for me, is a lot of that debt that grew...

Beckworth: So, yeah, it's true, Spain's GDP ratio grew dramatically. But it grew as a response to the Great Recession. It was actually declining before the Great Recession and it grew as a consequence of a slowdown in economic activity, which affects both tax revenues coming in as well as the government spending more on social safety nets. So, part of the conversation, to me, seems confused and you bring up this nice application of what we call "Gresham's law."

Copelovitch: Yeah.

Beckworth: And normally we think of Gresham's law as bad money drives out good money. But tell me how you apply it to political ideas.

Copelovitch: So, I think about bad ideas about economic policy driving out good ideas and the way I've sort of been thinking about it, is the morality of debt but also the rush to expansionary austerity, the household analogy about the government needing to tighten its belt in recessions, right? So, I think, yeah, back to your point about Europe, there is an aspect of the European Crisis which is a tragedy to some extent, that the Euro Crisis kind of backup right to the global crisis. And the European financial crisis isn't one financial crisis. As you said, in Spain, in Ireland, these were very much tied to global capital and real estate booms and they weren't sovereign debt crises.

Copelovitch: But Greece happened first and everybody looks at the Euro Crisis through the lens of Greece, which is much more classic balance of payment, sovereign debt crisis and that gets imposed over the proposals about policy solutions. But I think the morality of debt view, the ideas and the narrative that evolved around the Euro Crisis were very much the Greeks are corrupt and lazy, they don't pay enough taxes, they borrow too much, it was their problem. And all of the southern periphery, Italy, Spain, Portugal, Greece, that's what the crisis is about, right?

Copelovitch: And it's very different in Italy, it's very different in Spain. And those sorts of ideas, I think, cover how we think about the policy responses. And yeah, in the US and the UK, what I talk about in the paper, is the rush to austerity and the media really, constantly talking about debt instead of unemployment and shifting in the middle of the Crisis in 2011.

Copelovitch: And I talk and show a few figures about how coverage shifted. And so all of the public discussion about policy responses is we need to balance the books, we need to roll back the stimulus, we need to tighten things, we need more austerity because the debt is so high. And we stopped talking about unemployment. And look, I'm a card-carrying rationalist, materialist to a great extent, but I think these sort of ideational factors really played a key role in shaping where we are over the last decade.

Beckworth: Yeah, I agree. I think the importance of narratives can't be understated for the past decade, how you shape the narrative publicly becomes important. You mentioned Greece. Greece definitely helped shape the narrative, not only for Europe, but also for the US. You mentioned the concerns about austerity. 90% debt-to-GDP ratio threshold from the Rogoff-Reinhart.

Copelovitch: Right.

Beckworth: Paper. I mean, that concern was motivated by what happened in Greece. And to be clear, I want to be nuanced here, yeah, there is a time where you should be worried about debt-to-GDP. But not right after a deep, sharp recession because that's almost entirely driven by business cycle forces, not by some long term, structural problem with policy.

Copelovitch: Right, right.

Beckworth: But narratives are important and I'm going to pull out and put on my monitor set, you probably know I'm much more of a money guy than a fiscal guy.

Copelovitch: Yeah.

Beckworth: But I really, again, going back, I really think this whole levels versus rate thing is hugely consequential. I look at the Eurozone Crisis, for example, and we'll come back to this in a little bit more detail when we talk about your Eurozone paper, but I think of all the mistakes the ECB made over there, they actually increased rates in 2008. They increased them twice in 2011. So, they're just getting back to recovering and the ECB tightens. I mean, some of the debt crisis itself can be tied to bad monetary policy and again, why did they do that? Well, this ongoing concern about inflation, which as you mentioned, has barely reached 2%.

Copelovitch: Yeah, and this is, when I think about the Eurozone, I think about also the power politics in European institutions. And if you think about the influence of German views or German and sort of northern European views in the ECB governing council, they really carry the day. And to some extent, that's by design, right? If you think about the trade offs involved in the design of the Euro, the great fear of the Germans as we're giving up the Deutsche Mark, right? This stable, low inflation currency, which is the anchor and we're going to get something that looks like the franc or, God forbid, the lira.

Beckworth: Yeah.

Copelovitch: And so the trade off is yeah, we're going to bind ourselves to Italy and Portugal and Greece, but we're going to have a Bundesbank at the heart of that, right? And so we're going to get, unlike the Fed, we're going to get a single mandate and it's going to be about price stability, and we're going to structure the voting and the governing council to make sure that we're not going to get Italian or Portuguese or Greek monetary policy. And so I think you're right, that the output of that is this rush to tighten, right? In 2011, 2012, 2013, and look, you know, it makes sense for the largest surplus country where unemployment is low and this is a...

Beckworth: Exactly.

Copelovitch: This is a fundamental problem with the Eurozone, is you have one monetary policy for countries experiencing Great Depressions and countries experiencing extremely low unemployment and very low inflation. But the monetary policy should be geared to the median of the Eurozone, and it's been geared to the largest surplus countries with the lowest unemployment for the last decade.

Beckworth: That's a great point. And you frame it in terms of surpluses, and also you can frame it in terms of creditor versus debtor.

Copelovitch: Right.

Beckworth: Again, I like your framing it in terms of what you just did, the monetary policy, one size fits all. In this case, one size does not fit all with the ECB.

Copelovitch: Right.

Beckworth: But yeah, if you go back during the boom years, right? So, Germany was sluggish, it was slowing down, so what does the ECB do? It kind of adjusts its policy to the biggest kid on the block, Germany, and rates are held lower than probably was ideal for the periphery. So, you see a boom in the periphery and then... So, it's roughly appropriate for Germany. In fact, I have a paper on this where you look at Taylor rules.

Copelovitch: Right.

Beckworth: The Taylor rules for the core were actually fairly... Let me restate that. The ECB set policy rates that were fairly consistent with Taylor rules for the core, both during the boom time and the bust. So, it's just that the periphery, they were way off. The ECB policy was way too easy during the boom years and way too tight during the bust years.

Copelovitch: Yeah, and you see German financial journalists writing about this all the time, that the ECB is massively deviating from the ideal Taylor rule. But what they're talking about is the Taylor rule for Germany, right? Not the Taylor rule for the Eurozone as a whole. And look, I mean, we do this in the US. We have a monetary union in the US and the ideal policy for Mississippi and California are not the same policy. But we have a lot of other mechanisms in terms of fiscal policy, political union and fiscal transfers through the federal government, labor mobility, et cetera to facilitate adjustment. And this is where the politics of the Euro Crisis are really difficult because it's possible to have German-style monetary policy and offset that for the Euro to survive with other types of things. But those other types of things are also politically unpopular.

Beckworth: Right. With the Germans, with the Germans…

Copelovitch: Yeah, I mean, you could have permanent bailouts of the north or the south. You could have widespread labor mobility. You could have lots of unemployed Greeks and Spaniards and Portuguese moving, and that's actually happened over the crisis. I spent 2013 to '14 in Berlin on Sabbatical and there's hundreds of thousands of Spaniards and Greeks coming to work, but they're high-skilled professionals, right? So, there's a lot of workers that are not mobile.

Beckworth: Okay.

Copelovitch: And in the US, it's a lot easier for people to move. We have fiscal transfers. One way to think about American is that New York and California have been bailing out Mississippi and Alabama for 100-some years now. And there's a lot of political reasons why that is sustainable.

Beckworth: Right.

Copelovitch: We have surplus states and deficit states, if you want to think about it that way.

Beckworth: Yeah. Now, just to flesh it out for those listeners who don't understand... I know many of our listeners understand what you're saying about the optimal currency or framework. But what you're saying, just to make a real, concrete example: If you're in Michigan and you lose your job, and the Feds decide to tighten because overall the US economy's growing rapidly, that makes no sense for you, right? It only worsens your situation. But the nice thing is, you have several buffers, several things you can fall back on. One, you can move down to Texas, which is booming maybe, or to California.

Copelovitch: Right.

Beckworth: And the nice thing is, they speak your language, the culture's very similar, you watch the same TV shows.

Copelovitch: There's a common political identity of Americans, too, right?

Beckworth: Yes, yeah, exactly.

Copelovitch: If you think about why these solutions are politically infeasible in Europe, it's... We scratch the surface in all the stereotypes about what Germans think about Greeks and what Greeks think about Germans.

Beckworth: Right.

Copelovitch: So, you don't have the common political identity. In the political science field of European integration, you talk about the common social identity. And that rock is not there for these policy solutions.

Beckworth: Yeah.

Copelovitch: it is.

Beckworth: It'd be the equivalent of us forming a currency union with Canada and Mexico.

Copelovitch: Yes.

Beckworth: And then having us think about those Mexicans coming here and taking advantage of our system or something. That's what the Germans probably feel about the Greeks, and then the Mexicans...

Copelovitch: Yeah, or the fiscally responsible Canadians thinking about bailing out the  Americans.

Beckworth: Right, right. So, it's understandable, given the history they have and the feelings, and that's maybe why, in some ways, this was a very ambitious, overly ambitious project to begin with.

Copelovitch: Yeah. I mean, the interesting thing though, is all of these things were known. Everybody knew there were lots of papers in the '90s saying, "Look, the Euro is not an optimal currency area." And again, as a political scientist, I think about this "why the Euro?" Right?

Beckworth: Right.

Copelovitch: It was close enough in terms of trade and financial ties to sort of make the case that, in spite of the fact that it's not an optimal currency area we should do it, but a lot of this was about geopolitics and this is the capstone of 50 years of successful European integration, and that we need to keep pushing European integration forward with a new project. And this one's going to be money and we know there are economic problems, but we'll kind of work those out as we go on. And no one envisioned a global crisis that would then be hit by a kind of Eurozone balance of payments crisis and make it this serious.

Beckworth: Yeah, but the warnings were there, right?

Copelovitch: Yeah.

Beckworth: Going back to your earlier point, in part, the severity of the crisis is tied to the very fact that this is not an optimal currency area. You have reasons that are quite excessive amounts of debts, some that are just living beyond their means on an unsustainable basis, and that is the result of the design of the Eurozone, right? The one size fits all, the capital flows.

Copelovitch: Yeah, they're…

Beckworth: So, it shouldn't be a surprise, although you mentioned this political momentum, this desire to further integrate, avoid future war. Have you been surprised though that it has persisted so long? Because 2010, we're having this conversation as well and I was convinced, "Man, this is over. The Eurozone is done." Here we are, eight years later, and we're still talking about it. So, are you surprised it's still ongoing?

Copelovitch: So, I'm not surprised the Euro hasn't collapsed, right? Because it is... At the end of the day, you can see this. My colleague, Stefanie Walter in Zurich, who's one of the coauthors on the Eurozone paper that we're talking about, she's done polling in Greece and you still have majorities in favor of staying in the Euro, in spite of the fact that people are living through a Great Depression. There really is a fear in Greece and elsewhere that, if we leave the Eurozone and this thing which is supposed to be permanent, that we're somehow going to get kicked out of the EU as well, right? And that it's not just a monetary union. Again, it also is something that started as the Coal and Steel Community in the '50s, and then became the Common Market and then the European Union in the '90s.

Copelovitch: And there's a Monetary Union of 19, but we've got 28 countries and if we leave the Monetary Union, somehow we're going to get kicked out of the EU, right? And so that's been the backstop, right? The puzzling question is "why are people in Italy willing to live through literally two decades of no economic growth?" And in Greece, they're living through something which is now worse than the Great Depression, and I think that's why, right? So, I'm not surprised that the Eurozone hasn't collapsed. What I'm surprised about is that we haven't gotten to talk about something like comprehensive debt reduction, right? So, one way that I do this, and I think because I'm a Jeff Frieden student I think about the Latin American Debt Crisis and we muddled along in the Latin American Debt Crisis with bailouts in '82 and a second round in kind of '85 and '86.

Copelovitch: But we eventually got a comprehensive Brady plan where people really realized, "Look, these debts are unsustainable and we're going to solve, for a group of countries, the problem." And we still haven't done that, right? So, the solution is basically permanent austerity and some hope that these debts are going to go away. But Italy's had this debt overhang since the 1980s and Greece's debts, the IMF and everybody else has been saying, "Look, it's unsustainable. We need comprehensive debt relief." And you understand why you wouldn't get that for one country?

Beckworth: Yeah.

Copelovitch: But the fact that the Eurozone hasn't come together and said, "Look, we need all of these new reforms," and there's lots of stuff going on with all of these proposals about what, in the future, are we going to do? But that's sort of after you solve the current debt crisis. And so I've been surprised that we haven't seen more on comprehensive debt relief before we talk about things like banking union and deposit insurance and fiscal integration and things like that.

Beckworth: That's interesting. I want to go back to the point you just made about the support the Euro has among the residents. You're calling... past professor, Jeff Frieden, had an article titled "A Plan to Save the Euro." And he presents some data on this point and he says, "Even in the most heavily affected debtor nations, support for the Monetary Union never fell below 50% of the population. It was typically closer to 70%," which is just striking, right? So, imagine you're in Greece, you're not getting fed, you've got to work, you're rioting, you're mad as all get out, and yet you're like, "I want to stay in the Eurozone!" It just seems incongruent. Now, he does...

Copelovitch: If you think about Greece and Italy though, I think there's a really strong sense of "Europe has saved us from our terrible domestic politics," right? So, Greece only becomes a democracy in the 1980s and then they get into the "rich democracies' country club." They get into the European Union and a lot of the stereotypes about people not paying their taxes and corruption, there's enough sort of real world evidence about Greek governments to kind of... You understand why maybe someone would say, "Yeah, there's a terrible recession here, but we're better off in the European Union with the Germans and the Dutch and the French than we are on our own."

Copelovitch: And I think Italy is very much the same way. I mean, Italian politics, I think they've had 65, 66 governments since World War II and so you think about all of the debt they accumulated in the '70s and '80s. They've been in the Eurozone now and Italy actually, I was looking at some slides from this morning on a talk that he just gave. And Italy actually has basically been the model of fiscal rectitude and primary surpluses since the 1990s, and you think about it all of these officials that are European technocrats.

Copelovitch: Being in Europe has been good for Italy economically, but there's a sort of massive inequality, right? You have the north, which is Germany. You have the south, which looks like Greece economically. But I think there's some sense of "if Italy was somehow not in the Eurozone or it somehow left the EU, things would be even worse than they already are." And so there's a floor for how much political support. And it's just hard as an American, I think, for us to get our heads around. If things were that bad in the US, would people support the status quo? Almost certainly not, right?

Beckworth: Right.

Copelovitch: But I think in Greece and in Italy, to some extent, you kind of understand what is going on there, along with the longer history of... With all of the problems of the last decade, the European Union has been this enormous success. I mean, this is a group of countries that spent centuries fighting wars with each other and then we have two World Wars and the Euro Crisis is small potatoes, politically and economically, compared to the enormous success of the EU as a whole from 1951 up until now.

Beckworth: That is a fair point. That's actually very refreshing. Put things in perspective, right? The lost decade, the crisis in Europe is small compared to the loss of World War I, World War II.

Copelovitch: Right.

Beckworth: So, I guess in the grand scheme of history, it is still an accomplishment and it's easy for me at least to get caught up in the here and now, and lose sight of the bigger picture.

Copelovitch: Yeah. Yeah, and I think a lot of people do and I think part of this is me spending a fair amount of time over in Europe. And when you talk to Europeans, they very clearly articulate this, too. And the Germans also, who are ardently opposed to lots of policies that you and I might think would be good economic policies, they're coming to it from a place of "that is the foundation." The EU has been essential to Germany transforming itself over the last 50, 60 years and as much as it has problems, kind of throwing out the EU or throwing out the Eurozone, it wouldn't even possibly cross our mind as something that we would want to do.

Copelovitch: And so you see it, I think, both in the surplus countries and in the deficit countries. But the politics, the thorny politics as Jeff talks about, is about finding agreement on policies that would work because you do start to worry the longer this goes on, right? You have started to see decline in the support in the polls and maybe that view that, in the long run, the EU and the Eurozone are good things has gotten us through 10 years. But it's really hard for me to imagine that if this continues for another 10 years or 20 years, that you're asking generations of people to live through permanent depressions and that's not politically sustainable.

Beckworth: Okay. So, we've kind of made it this far, kind of kicking and dragging, screaming on the ground, being pulled along. But going forward, you don't think it's sustainable to keep up at this pace? We need to see reforms made that will bring about more robust growth and integration?

Copelovitch: Yeah, I mean, that's my concern broadly and sort of why I wrote this something of a polemic of a paper for this conference. If this continues, if you had German-style monetary policy for the Eurozone, no comprehensive debt relief, and what seems politically infeasible right now, which is the kind of fiscal and political union that would make the Monetary Union ultimately sustainable, it's hard to see it lasting forever.

Copelovitch: When I talk about the Eurozone, I end with Hamilton and Jefferson in the assumption debate. And the sort of we're asking the same questions, which is does a Monetary Union need a fiscal and political union? And it's possible that it could continue without it if we had looser monetary policy. If you had permanent financing of the south by the north. If you had more labor mobility. If you had comprehensive debt restructuring. But if we're not going to get any of those things, and then we're not going to get the fiscal and political union, and now it's kosher to talk about exit, right? This is something that is a permanent Monetary Union but now every time there's a crisis, it has been talked about by European policymakers as a feasible option that Greece might exit or Italy might exit.

Copelovitch: So, then you start to wonder, "Well, is this really just a glorified fixed exchange rate union? Or kind of old style European monetary system?" And politically, are countries going to decide if this means permanent depression, are we going to eventually leave, right? So, that's sort of where I sit, is there are lots of possible policy solutions and I don't think you need a United States of Europe to have the Monetary Union work. But you need some set of policies and right now, politically, none of the policies that would make this thing sustainable in the long run are politically acceptable.

Beckworth: Okay.

Copelovitch: So, that makes me a long term pessimist.

Beckworth: Short term optimist, long term pessimist?

Copelovitch: Yeah.

Beckworth: Well, along those lines, I want to go back to the Germans because they're very influential in allowing any future reforms to come to fruition. You mentioned the Brady bonds and so there is a case with the United States in the '80s where there were a lot of Latin countries that were indebted to the US and, at some point, we became aware it was better to forgive the debt, to write some of it off.

Copelovitch: Yeah.

Beckworth: And move forward. My question then, to take that as an analogy and apply it to Germany, you mentioned you were in Germany and the Germans would say, "Hey, we're doing great. The ECB's following the Taylor rule," which suggests a lack of awareness. But given this has gone on as long as it has, almost a decade, do you get a sense that Germans are becoming more aware that they've got to look beyond themselves, they've got to compromise, they've got to think more about the distribution of the adjustment costs?

Copelovitch: Yeah. Not really. I mean, I think one of the ways in that it's different from the Brady plan was the debt is no longer held by the German and French banks.

Beckworth: That's a good point.

Copelovitch: I've always talked to my German political science and economist friends and said, "Look, every borrower has a lender, right? So, maybe the Greeks over borrowed but the German and French banks over lent." But the thing is now, the European policies have bailed out the German and French banks, and all the debt is now held by European institutions.

Beckworth: Right.

Copelovitch: So, on the one hand, in many ways the reason we got the Brady plan is people realized, "Look, Mexico and Brazil and Venezuela are insolvent, but so are Citibank and Bank of America."

Beckworth: I see.

Copelovitch: And this is going to solve the problem for the creditors and the debtors in 1989, 1990. So, on the one hand, it's easier, right? You could write down all of the European debt by having the European Central Bank print a trillion dollars of Euros and write off the debt that's on the book of European institutions and have a little bit of inflation. But on the other hand, I think people, politically, in Germany, in the Netherlands, in Finland, and elsewhere, they don't see the problem as much because the northern banks aren't on the hook anymore for the Greek and Portuguese and Spanish debt.

Beckworth: That's very interesting. They don't have the incentive that we have to do the Brady plan, is what you're saying. Since we still have the debt, the big banks in New York still have the debt, but the Germans don't anymore so they can kind of wipe their hands clean. And again, they're kind of going back to that position, that default position. "Hey, the Taylor rule's perfect for us. What are you guys doing wrong?"

Copelovitch: Yeah, and the policy discussion, if you think about these German, French proposals that are on the table, that Jeff was responding to, the big proposal that just came out and others about what are the forward looking reforms. In Germany, they sort of talk about the crisis is over and we need to think about how to prevent the next one from happening, right? And if you think about the average German voter on the street doesn't see the crisis. You're in Berlin and the economy's booming and people worry about rising inflation, unemployment's low, but the crisis isn't over in Greece. There's still a Great Depression in Greece.

Copelovitch: And so the people don't, I think, see what's going on in the other part of the Eurozone. And we had this in the US, too, with the Great Recession and the financial crisis are over in California and in New York and here in Madison, right? But if you go out to other parts of the country, the problems haven't gone away, right? And I was telling you about growing up in Pottstown, Pennsylvania. I mean, we're 40 years into places like Pottstown not recovering from the industrialization and globalization and then you're hit from a financial crisis and people are talking about "everything's fine again, let's just kind of get back to normal business." And so you see that in the Eurozone as well, right? Sort of "let's get back to normal,” in Germany." For the Eurozone as a whole, it's not normal times.

Beckworth: Yeah, and the difference being, of course, we have these shock absorbers, these buffers here that allow someone in a situation like that to respond in a better way. They can move.

Copelovitch: Yeah.

Beckworth: They can get unemployment insurance benefits. And there's a number of things they can do which isn't possible in Europe, so...

Copelovitch: And that's happened for highly educated professionals in the southern countries, right? So, all of my professional colleagues who are Spanish and Greek and Italian academics are elsewhere. They're in the US.

Beckworth: Really?

Copelovitch: They're in UK, they're in Germany. So, you also get brain drain and exacerbating inequality and it makes it even more difficult if all of the young, highly educated people in Greece and Spain are leaving. That makes it harder to sort of have economic recovery. But they are mobile within the EU in a way that lower skilled workers, older workers, I think, are not.

Beckworth: Okay.

Copelovitch: And that exacerbates the adjustment problems. And we see that in the US. I mean, one thing people have written about in the US is actually labor mobility is a lot harder now, and people move less than they used to.

Beckworth: That's right.

Copelovitch: It's harder to sell your house, people are moving less, and so true, conceptually it's easier to move from Michigan to Texas as we're talking about. But not that many people do it, right? Not that many people from rural Wisconsin are relocating to California. And so we do have shock absorbers, but they're also incomplete.

Beckworth: Yeah, this is an entirely different conversation we could have a whole hour on as well. But we've had... We've discussed this on this show, the decline in labor mobility, decline in US dynamism, a number of structural problems in the US economy as well.

Copelovitch: Yeah.

Beckworth: Let me talk...

Copelovitch: But it's a relative thing, right?

Beckworth: Go ahead.

Copelovitch: So, compared to Europe, we're sort of in a good situation.

Beckworth: Right. So, relatively speaking, we're very fortunate. Let me move to some of the proposals. Now, you gave a nice one earlier, debt forgiveness, fairly straightforward, fairly simple idea. It would create a clean slate. My question is this, let's say you do the debt forgiveness, don't we still have the same issues in the system though? At some point, you would still see balances build up because the way the Eurozone is designed, monetary policy's inappropriate for the periphery, it might lead to too much debt accumulation, and then lead to another crisis. So, is debt forgiveness enough, I guess is my question?

Copelovitch: No. It's not, right? So, I think about this as it is a balance of payments problem, as much as it's a banking and financial crisis. And you're going to have surplus and deficit countries.

Beckworth: Uh-huh.

Copelovitch: So, I think these forward looking reforms about how are we going to fix the Growth and Stability Pact and have clearer rules, it's important and it's useful. But for political reasons, it's kind of insufficient. You're not going to design a technocratic solution. And you can think about this with the history of the Eurozone. So, we have this criteria, right? 3%, 60% debt-to-GDP. We know now that the Greeks lied about the numbers to get in, but most countries we had that convergence on inflation and budget deficits and debt at the beginning.

Copelovitch: But then you get imbalances go about when you have countries violating the Growth and Stability Pact. And the first countries that do it, of course, in '99 to 2003 are Germany and France. And there's effectively no political punishment for that. And so the lesson that's learned is these rules, while they're there on the books, politically you can deviate from them without punishment. So, I think about a lot of these forward looking rules of what can we do to make sure that we're not going to build up imbalances in the future?

Copelovitch: How are you going to enforce them politically? You're not going to be able to design a technocratic solution unless there's some punishment, right? Are you going to suspend ECB voting rights if the budget deficit is too high, or the debt-to-GDP ratio is too high? And again, sort of like we talked about with the inflation, that would have to be symmetric, right? So, if the Germans or the French do it, they would have to be punished just as much as the Greeks or the Spanish. And politically, the historical evidence suggests that's not going to happen. So, one of the... The Euro Crisis paper that we're talking about was part of a special journal issue that we co-edited. And one of the papers, with my coauthor, Mark and Nicole wrote a paper looking at whether you were sanctioned in European institutions for violating the Stability and Growth Pact since the creation of the Euro. And it turns out, the more powerful countries don't get sanctioned and this is where the politics...

Beckworth: Unsurprisingly.

Copelovitch: Unsurprisingly. But that's, again, I'm a political scientist so I think about the idea that there's going to be a technocratic set of rules that's going to prevent payments imbalances from building up in a Monetary Union. It seems unlikely to me.

Beckworth: Okay.

Copelovitch: If not impossible. So, then the question, as Jeff talks about, is about the politics of adjustment, right? When these imbalances build up, who's going to bear the burden of the adjustment? Creditor versus debtor countries and then within countries, the distributional consequences of policies as well.

Beckworth: Yeah. So, one way is debt forgiveness, as you mentioned, would be one way to deal with the... one adjustment. Another one you also referred to earlier would be simply to run inflation hot for a little bit, and a little money illusion thrown in there, it might be a little bit easier of an adjustment. But there are many paths to that destination. I guess neither are very tolerable in Germany?

Copelovitch: No, I mean, if you think about the one thing that you hear a lot in Germany is "we went through painful reforms after reunification and we adjusted and we tightened our belt and we did these things in the decade after unification." And that's true, but that was true in a global environment where monetary policy, where inflation was much higher and monetary policy was more forgiving. And it's hard to sort of have internal adjustment and austerity when inflation is really low and growth is really low. It really means a sort of grinding, permanent type of depression for Italy and Greece.

Beckworth: Right.

Copelovitch: So, if the Eurozone had, on average, 3% inflation instead of 0.5% to 1% inflation, it would be easier for Greece and Italy to adjust and work down their debt burdens. But again, politically it's hard to imagine that we're going to get to that point. But that's the feasible outcome.

Beckworth: Yeah. I want to kind of go back to maybe a bigger point about our conversation today, and that is the importance of avoiding these crises, these imbalances that build up and cause crises, and that's the long term effect it has on the world, the rise of populism.

Copelovitch: Mm-hmm (affirmative).

Beckworth: There was a paper that came out recently by Manuel Funke, I'm not saying his name right, some coauthors. But it was in the European Economic Review and the title was "Going to Extremes: Politics After Financial Crisis, 1870 to 2014." They have this nice data set, they look over 20 countries since 1870, 800 general elections. And what they find is that after financial crises, not just run-of-the-mill, garden variety of recessions, but actual financial crises.

Beckworth: That there's a typical pattern of the governments taking a hard right, governing becoming more difficult, kind of like the erosion of liberal values that emerge. And so it's important that the Eurozone gets this right to avoid that and we can take that and segue into what is actually happening right now, and this is a great time to talk about Italy.

Copelovitch: Yeah.

Beckworth: And they've had a recent election. Tell us about what's going on in Italy and why you might see the Italian elections as kind of a consequence of the failings of the Eurozone?

Copelovitch: Yeah, I mean, I think this is... The focus of the paper is one of the most important papers that has come out on the political economy of financial crises. And it informs a lot of my thinking, and in many ways what it is, is this sort of confirmation of what we were talking about earlier, that what we saw in the 1920s and 1930s is replaying itself, right? That when you get really serious financial crises and subsequent recessions, and they drag on, that the middle, politically, gets hollowed out. So, it's the hard right turn but it's also, if you look around the advanced industrialized world, it's the decimation of the center-left, right? Which is exactly what happened in European countries in the Great Depression, too, is the so-called "democrats" got hammered.

Copelovitch: And so I think it's a good way to understand what's going on in Italy, right? So, you have this sort of populist nightmare coalition of the Five Star and the Northern League. And so it's anti-EU, it's anti-immigrant, it's in the north, it's in the south. But it's of a piece of what we've seen with the rise of far-right parties across Europe. The center-left has been decimated. I mean, if you look at democratic losses at the state and federal level over the last decade, if you look at the SPD and how bad, politically, for them, being in the Grand Coalition has been, if you've looked at the rise of Macron and the destruction of the socialists in France, and now Renzi.

Copelovitch: So, you see this pattern across the industrialized world of center-left parties and centrist coalitions are punished, and people are moving to the extremes. And Italy, in many ways, is a special case because they've been a mess forever politically. But I think there's also this sort of more general pattern of "this is a symptom of 20 years in Italy, of the economy not recovering." I mean, you're running 20 years of primary surpluses and austerity, and the debt problems are still there but people are saying, "Being in the Eurozone hasn't been good for the economy, it hasn't fixed the internal, regional inequalities in Italy.

Copelovitch: The governments come and go, and none of the regular politicians solve the problem. We tried Berlusconi, that didn't solve the problem. We tried Renzi, that didn't solve the problem. We tried technocrats like Mario Monti, that didn't solve the problem. So, why not vote for these other people, right? And again, I think that's a more general pattern about the rise of populism. And part of what motivated me to sort of write the paper about this time should've been different is, people are looking now at a decade of politicians not fixing the economy and they're starting to say, "Well, what do we have to lose?"

Copelovitch: You can think about Italy, you can think about the Brexit vote, voting for Nigel Farage and UKIP in the European Parliament Elections a few years ago. People are saying, "Why not try somebody else?" Because the mainstream parties, the mainstream politicians haven't got the job done. And you don't want to overplay the kind of Weimar Germany analogy, but there is something to that, right? Which is you have hyperinflation and then the Great Depression. And you have the social democrats and the Christian democrats are not solving Germany's economic problems. And in Germany and Italy and elsewhere in the 1930s, you see moves to the extremes. So, one of the interesting things about the hard right turns paper, is they find that pattern across countries over 130-some years. I think it's really interesting. There's a lesson there.

Beckworth: Yeah, and the developments in Italy just reconfirm that. And I just want to mention a few points about this movement. So, as you mentioned, it's two parties, the Five Star Movement and then Northern League party and then the anti-immigrant, far-right league. But one of the interesting things that they're talking about doing, is issuing a parallel currency, these mini-BOTs, that's their name. I'm not sure how they got that name, but a parallel currency to the Euro, they're talking about it.

Beckworth: They're also talking about massively increasing fiscal policies. How they're loosening fiscal policy, bigger deficits, offering a basic income. And again, as you mentioned, this is all a response of the pain they've endured for so long. But if they go down this path, it could really blow up the Eurozone even more. Olivier Blanchard had a recent piece out that says, "How worried should we be about the Italian debt crisis?" And he goes on to say "very worried." So, if they issue a parallel currency, then there's going to be questions about banks.

Beckworth: If I'm an Italian and I see the government issue another currency and I still have my Euro, well, I'm naturally going to get suspicious because I'm going to think, "One weekend, the Italian government's going to forcibly convert my Euro holdings into this weaker, cheaper, lira or mini-BOTs, whatever they might use." And so I might have a run on the bank. So, there's all kinds of problems that could emerge. And I guess for Italy, what's such a big deal, it's a much larger country than Greece, right? And the consequences will be larger.

Copelovitch: Right. Yeah, I mean, Greece, I used to talk about Greece as sort of the size of Rhode Island, relative to the US economy. And Italy is one of the big core countries. Also, politically, one of the original six in the European Coal and Steel Community and the European Economic Community. So, there's no European Union or European Monetary Union without Italy. But yeah, I mean, I agree with you. Look, so if what we're talking about is Italexit or parallel currencies, things like that are feasible policy options, then in the long run, again, those are reasons to be skeptical of the future of the Euro because this was supposed to be something permanent. And if exit is an option, if parallel currencies are an option, then you're right. You do worry and that's when you see with bond spreads, right? That we start to think Italian bonds and German bonds are no longer the same thing.

Beckworth: Yeah, they're quite a bit higher than German bonds right now, so...

Copelovitch: Right. And I mean that's, again, when I think about the politics of this and if Germany and the kind of northern surplus countries really want the Monetary Union to survive, then there needs to be movement on some of these other policies that are going to make it sustainable in the long term. Because otherwise you're going to get populist coalitions that are going to put on the table these policies, which eventually will turn this permanent Monetary Union into something which is first, a glorified European monetary system, and then not the Eurozone at all. And, you know, look, I mean there is a long term, stable equilibrium which is something that looks kind of like a two-tiered system where you had a core Monetary Union and then you had almost like a Bretton Woods-style, countries like Italy and Greece would be on fixed-but-adjustable pegs.

Beckworth: Yep.

Copelovitch: To the... You could call it the "Deutsche Mark Zone" or whatever you wanted to call it.

Beckworth: Right.

Copelovitch: The Northern Euro Zone. The problem is getting there, right? So, you think about we've got 19 mountain climbers roped together going up the mountain with the crosswinds on Everest, and one of them's going to leave and that's going to pull everybody off. So, if Greece leaves and then Italy leaves, people wonder about Portugal.

Beckworth: I'm glad you brought that up because I had a question about that proposal. And one version of it is Greece and Italy don't leave, but Germany and a few other core leave. In other words, Italy, maybe Spain, Greece, all the countries that have been on the wrong end of the German Taylor rule.

Copelovitch: Yeah.

Beckworth: They keep the Euro where Germany maybe goes back to its own currency, the Deutsche Mark or some austere currency. So, you have this austere currency union, you have the more accommodating currency union. Can you do something like that? And then also preserve the European Union?

Copelovitch: So, you could. I think it would be economically disastrous for Germany.

Beckworth: Okay.

Copelovitch: So, one way to think about the Eurozone is Germany has benefited from a wildly undervalued Deutsche Mark within the Eurozone for the last 20 years. And so whatever this new currency would be, either Germany by itself or a Franco-German Benelux, Finnish Monetary... The currency would appreciate in value and it's going to be hard to have Germany's sort of manufactured, export-led economic growth.

Beckworth: Oh, yeah.

Copelovitch: The Deutsche Mark is much... so, I think that's another reason why, politically, Germany, while they haven't been willing to move to what I think are economically feasible solutions, they also don't want to leave the Eurozone because they realized that that wouldn't be... Plus, you have global venue. We're talking about trade policy in the US and how it's bad for global value chains now. European countries have reoriented their production and value chains to be European-wide.

Beckworth: Yeah.

Copelovitch: Part of the reason, in Spain, that support for the Euro was so strong during the crisis was so many Spanish companies were now a part of multinational value chains with the French and Dutch and Belgian and German companies. And so it would be very difficult for Germany to unhook themselves from that. And yeah, you would pray you wouldn't have the sort of debt problems and the, if you want to call it, the albatross of Greece and Italy around your neck. But there would be another set of political economy problems that would crop up.

Beckworth: So, no matter how you slice it, there is no easy way out, no easy way forward. So, someone's going to have to suck it up and compromise. And honestly, it's going to have to be the Germans, right? I mean, if this project, long term, is going to survive, doesn't it really boil down to the Germans willing to change their view on these issues?

Copelovitch: I mean, there's always give and take but European integration, there's power politics within the EU like there are in all international institutions. European integration though has always been a kind of Franco-German project. So, one of the other things that's interesting about the last 10 years is now Germany, as reluctant hegemon of the European Union and the Eurozone. And part of the reason I think people were so excited about Emmanuel Macron was France is going to sort of come back and there was going to be a partnership again.

Copelovitch: But if you think about the history of European integration, it was started as a French project for lots of reasons, partly to buying Germany so we're not going to get another World War. But it wasn't politically acceptable for Germany to play the leading role for a very long time. Economically, they've been the hegemon for a long time, since the 1970s or 1980s. But politically, they're also now the leading country. I think if you think about is this going to survive the Eurozone, there's going to be some consensus between France and Germany about what the solution will be.

Copelovitch: And some sort of negotiated compromise, with France, to some extent, as the middle man between the southern countries and Germany. But again, the whole European project started as France, Germany, the Benelux countries, and Italy. So, if we're not going to find a solution that's agreeable to those countries, we're certainly not going to find a solution that's agreeable to the 19 or to the 28 in the EU. So, the Germans are going to have to give, but I think they're going to give less than they did 20, 30 years ago because, politically and economically, they're even more powerful now.

Beckworth: Okay. Well, our time is up. This has been a fascinating discussion. And France, we're looking out to you to be the middle man to solve these problems going forward. Our guest today has been Mark Copelovitch. Mark, thanks for coming on the show.

Copelovitch: Thanks so much for having me. It's been great to be here.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.