A quantitative easing policy tailored to the local needs

The EU is looking for ways to respond to the crisis caused by the pandemic, but the Eurozone is still far from becoming a fiscal union. In crisis Poland should be happy to be outside the Eurozone and to have independent central bank, said Ernest Pytlarczyk, the chief economist at Pekao Bank.
A quantitative easing policy tailored to the local needs

Ernest Pytlarczyk (© private archives)

Obserwator Finansowy: What is the difference between the EUR and the USD in the context of the optimum currency area theory?

Ernest Pytlarczyk: It is likely that neither the Eurozone nor the United States are optimal currency areas, but the US is definitely closer to meeting the criteria. There are also differences in the economic cycles between the individual states, different economic models, and fiscal transfers, which were supposed to smooth out these differences. However, in reality the states which were poor in the past are becoming even poorer, because there is a continued outflow of skilled workers.

I think that the notion of an optimal currency area is disappearing from economics, as there is no practical use for it.

What really differentiates these two blocks is the mobility of the factors of production, although it is lower than years ago. The US is a country with one language and a unified culture. Meanwhile, the Eurozone is, after all, a collection of nation-states, which hinders mobility. Business cycles are less coordinated and external shocks affect economies of individual countries in different ways, which means that the instruments available to the ECB are not suitable to accommodate these shocks.

We are experiencing a crisis caused by the pandemic, a factor independent of the economy. Could such an event, which covers almost the entire world, lead to a synchronization of economic cycles, including in the Eurozone?

At first, it seemed that we are dealing with a classic symmetric shock, which affects all countries in the same way. It turns out, however, that this is not the case. In Europe, there were different economic lockdown regimes, the intensity of the disease varies, and the individual countries are dealing differently with the effects of the epidemic. The initial reaction took place on the level of individual states and was not coordinated. In the Eurozone we can clearly see that countries, such as France, Spain and Italy, have suffered the most, while Germany has been less affected. The lockdown was introduced there but the fiscal response is larger. Meanwhile, in the countries of Central and Southeast Europe we see a much less extensive spread of the disease, reaching a much smaller part of the population.

However, finally it was possible to develop a unified response at the EU level. The idea of “common debt” had gained support. A fiscal union is one of the elements of an optimal currency area — could this be a breakthrough moment for the Eurozone?

First of all, it is still does not come up to the idea of Eurobonds or joint liability for the issued debt. Instead, we will have a new fund, where it is strictly defined who is responsible for what part of the debt — as was the case with the cohesion funds. There will be net contributors and net beneficiaries. This is very important from the point of view of stimulating the economy, something that is supposed to happen in Europe. But this is not a fiscal union in which each country is jointly responsible for the whole debt.

This is certainly a step forward, because we have a response to the economic situation, but it does not change the mechanics of the Eurozone and the EU.

What would change if joint liability for the debt were adopted?

The Eurozone would transform from a group of countries that agree on something into a state-like entity, where the common or federal budget is superior and is financed from taxes. To take the example of Poland — it isn’t written down what part of the budget is covered by the Mazowieckie voivodeship. It’s simply the case that those who are doing better contribute more.

Would a European government be able to collect taxes without asking for the consent of the Member States?

These could be funds from pan-European taxes — for example, there was an idea to tax the Big Tech companies. In such a case we do not have the direct taxation of citizens — it would be some intermediate solution. But this would mean that there is a tax, or some portion of a tax, which is transferred to the EU budget. At present such a mechanism exists in a very limited form — the EU budget is financed by the contributions from the member states, part of the VAT and customs duties.

Apart from institutional change, would a fiscal union help improving the competitiveness of the Eurozone — or more broadly, the European Union — in relation to other world powers, such as the United States and China?

There are reasons why a fiscal union hasn’t been established so far. The European nations simply aren’t ready for it. What we see now is a discussion on who will pay more and who will pay less, which is typical for the EU. This is a discussion that is not seen at the level of nation-states — beside the issue of the solidarity payments, which is just a minor side topic, people in Poland don’t think about which region pays more into the budget. Meanwhile, at the EU level the issue of which country contributes how much money is still important. This alone shows that there is still no such thing as a common European identity.

More than 200 years ago some people were also asking similar questions in America: why should Virginia pay for the debts of New York? Then, however, the newly created United States decided to issue federal debt.

But in the US there was something that connected the individual states — the culture, the language, the struggle for independence. Even so, the mutualization of debt took many years. In Europe, we can try to speed this process up, but there is a risk that this will strengthen populism. A fiscal union is a political problem. The EU is integrated in terms of the economy — and this is a great value. But forcing the idea of a political federation is risky. Since 2010 we have got a bit wiser on this subject due to the developments in countries such as Italy, Greece, and even France.

Do you probably stand by your proposal described in your book “The euro paradox” that convergence in the EU is not the result of fiscal transfers?

Exactly. Such transfers are ineffective in the long run. They did not accelerate convergence in the East Germany. What is more, these transfers resulted in a disproportionate increase in wages, which lowered the competitiveness of these regions. This is a problem of internal devaluation, which is all the more difficult to carry out within a single state.

The Europeans are not able to embrace the American model, in which — as it happened, for example, in Detroit — people are simply leaving regions with high unemployment and look for work elsewhere.

To some extend this is happening anyway, but it’s not desirable. As a result, such countries are becoming even weaker and require more and more support. In such conditions economic convergence is not possible. In Europe, people will never agree to a division of labor where in one country there are only summer cottages, and in another there are factories.

You argued that one of the main advantages Poland derives from remaining outside the Eurozone is the possibility of devaluing the PLN during a crisis. Meanwhile — and this has also been pointed out in the official press releases of the Monetary Policy Council — despite the undertaken monetary policy and fiscal policy measures, the PLN hasn’t depreciated in a meaningful way. Does it mean that this argument is no longer valid?

No, no, no. This mechanism is still very important. For Poland, staying outside of the Eurozone, and the fact that we have a floating exchange rate and an independent central bank, is still one of the biggest benefits. We have the option (the option of currency devaluation), and having options is always valuable.

So why hasn’t the PLN depreciated?

We would like to have the shortest possible recession, and to be affected by the crisis as little as possible, but at the same time we would like to get an additional “boost” from the PLN. The Monetary Policy Council has cut the interest rates on the expectation that the PLN would weaken, but the truth is that interest rates in the Eurozone are even lower, and the scale of quantitative easing is enormous. Investors saw that Poland’s has surplus in its current account and will probably have one of the shortest recessions, the spread of the virus is relatively low, and the share of tourism in the economy is low compared with the countries of the South europe. As a result, they have decided to take advantage of these prospects. And that is why the demand for Polish assets is high.

We may be disappointed that we don’t have additional stimulus from the currency channel, but we don’t have it because our situation is relatively a better one.

However, Poland is not benefiting from the broad stream of funds available to the ECB.

Just so we don’t narrow down everything to the sole issue of the exchange rate — it is very important that we have an independent central bank. We didn’t have to wait to see what the ECB does, and whether that program will be suitable for our situation.

In Poland we have our central bank, which has tailored the support program to the Polish reality and has introduced quantitative easing. Additionally, there is a “hotline” between NBP and the institutions that run the anti-crisis fund. We are hardly likely to have a program so closely tailored to our needs if we were in the Eurozone.

This confirms that remaining outside the Eurozone is beneficial to Poland during a crisis. I wouldn’t focus on the exchange rate of the PLN, but on the freedom enjoyed by NBP.

Ernest Pytlarczyk, PhD, is the chief economist at Pekao Bank (the second biggest bank in Poland).

Ernest Pytlarczyk (© private archives)