Tag Archives: balance of payments

Measuring Global Production And Competitiveness

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Imagine a firm F1 in the United States 🇺🇸, which sells, say, toys. The firm is solely American, insofar as the employees of this firm and factory location are concerned. But the firm also exports toys and this contributes to the United States’ exports. For simplicity, assume that raw materials aren’t imported from abroad. Let’s say sales is $120 million of which exports are $100 million.

Now, imagine the firm has offshored significant part of its production to, say, Taiwan 🇹🇼. In other words, there’s a firm F2 in Taiwan owned by significantly by F1. This gives a cost advantage to F1 and let’s say the sales are $200 million outside the U.S. and $40 million in the US.

The way the system of national accounts and balance of payments guide, i.e., the 2008 SNA and BPM6 treat these two cases are different.

Exports of the United States is $100 million in the first case but not $200 million in the second.

This is because—and I am simplifying here—the toys are manufactured by F2, which is a resident of Taiwan and the goods sold in the rest of the world (rest in relation to the United States) is between a resident unit of Taiwan and the rest of the world.

In addition, there’s a significant transfer of resources from F1 to F2 and this is captured using the concept of transfer pricing.

Of course, this doesn’t mean that these sales don’t affect the United States’ balance of payments. Remember how the current, capital and financial accounts look:

source: IMF, BPM6

In the first case, only the goods line in exports is affected in the current account.

In the second case, goods and services (transfer of resources from F1 to F2), distributed income of corporations and retained earnings are all affected.

Goods, because of transfer of some goods from F1 to F2. Also because consumers inside the United States may buy the toys.

Services, because of use of intellectual property of F1 by F2. 

Distributed income of corporations and retained earnings because F1 is a direct investor in F2.

So in our example, in the second case, the sale of toys to the the world affects exports, imports and primary income in the balance of payments.

So what was $100 million of exports could be $30 million of exports when production is offshored, whereas $200 million is more intuitive.

In other words, the goods and services balance (or the trade surplus, or the negative of the trade deficit) is changed.

So the change in the U.S. goods and services balance of payments is attributable to three things:

  1. Change in competitiveness of American firms,
  2. Changes in accounting treatment because of offshoring,
  3. Transfer pricing.

The UN 🇺🇳 guide, Guide To Measuring Global Production is a good reference for this.

It explains complications because of transfer pricing:

Transfer pricing

3.40 The Organisation for Economic Co-operation and Development (OECD) (2010) guidance on transfer pricing13 introduced a series of guidelines that may assist MNEs and national tax authorities in using transfer prices to value intra-firm transactions and to evaluate their appropriateness for taxation purposes. The guidelines insist that intra-firm transactions are priced, as far as possible, like arm’s length transactions between unrelated third parties. The guidelines give recommendations on how these intra-firm transactions can be analyzed to determine if they meet these requirements. These recommendations cover comparable measures of profits or comparable measures of costs to be used in assessing transactions between firms.

3.41 In this context recent developments at OECD have resulted in a series of steps to be followed by member countries to limit the impact of Base Erosion and Profit Shifting (BEPS)14. These steps will require transparency, exchange of information between taxation authorities and general cooperation to ensure the arm’s length principle is followed in transactions between entities in an MNE group.

3.42 Nevertheless, distortions in the use of the arm’s length principle are not always tax driven. The 2008 SNA (paragraph 3.133) explains that the exchange of goods between affiliated enterprises may often be one that does not occur between independent parties (for example, specialized components that are usable only when incorporated in a finished product). Similarly, the exchange of services, such as management services and technical know-how, may have no near equivalents in the types of transactions in services that usually take place between independent parties. Thus, for transactions between affiliated parties, the determination of values comparable to market values may be difficult, and compilers may have no choice other than to accept valuations based on explicit costs incurred in production or any other values assigned by the enterprise.

3.43 The 2008 SNA explains that replacing book values based on transfer pricing with market value equivalents is perhaps desirable in principle but is an exercise calling for cautious and informed judgment. One would expect such adjustments to be enforced in the first place by the tax authorities.

13 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations: www.oecd.org/ctp/transferpricing/transfer-pricing-guidelines.htm

14 http://www.oecd.org/tax/beps.htm

The guide has 175 pages, so it’s very complicated!!

Again, distortions in transfer pricing isn’t the only thing. Even if it is captured properly, the mere act of offshoring changes the goods and services account numbers.

To summarize, there are two important issues here:

  1. Measurement issues for national accountants,
  2. Need for economists to understand the accounting behind all this.

So one could say that U.S. trade balance isn’t as bad as it seems, because a lot is captured in primary income account of balance of payments instead of the goods and services account. It might also partly explain why the U.S. primary income balance is so large. It should however be noted that there’s a cancelling effect in the current account and current account balance which is equally important.

The post was motivated by a tweet by Brad Setser.

How The Economist‘s Cover Story Is Causing Discomfort

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The recent cover story of The Economist on Germany’s trade surpluses—titled The German Problem: Why Germany’s Current-Account Surplus Is Bad For The World Economy— is the biggest concession the magazine has made to Keynesianism. Of course, it’s not as if the publication is now a full Keynesian but still, it’s a large admission.

I have two previous posts on this:

  1. The Economist On Germany’s Balance Of Payments
  2. John Maynard Keynes On Surplus Nations’ Obligations

So it was expected that The Economist‘s story was going to be opposed by other publications pandering to the establishment. For example, FT‘s Martin Sandbu who wrote a piece, Germany Bashing Falls Flat.

Handelsblatt had this response:

Sandbu’s main point is:

That means the accusation against Germany comes about five years too late. There was indeed a strong jump in the nation’s trade surplus half a decade ago, at a time when the world was still struggling to come out of recession. But that surplus has not changed much since.

He also says:

[the] claim [that Germany’s penchant for high saving … is a drag on global growth] trips up both analytically and contextually. Analytically, because the impulse from net trade on aggregate demand is the change in the external balance, rather than its level — much like the impulse from a fiscal deficit is the change in public borrowing as a share of economic output. So long as imports, exports and other macroeconomic aggregates grow at the same rate, a stable external balance goes along with the same steady growth of aggregate demand.

This claim has a pretense to be analytical but it’s hardly the case. This can be seen in stock-flow consistent models but it’s not the easiest to show that in a blog post, so here’s an attempt:

Divide the world into Germany (and other surplus countries) and the rest of the world. The rest of the world’s current account deficit means (without minor qualifications about “revaluations”) that its net international investment position is deteriorating by the amount of its current account deficit. So it’s not the case that if some aggregates grow at some rate, everything is fine because others—such as NIIP/GDP—aren’t.

There are many debt sustainability conditions and each should be used with care. One condition is that

cad(g) < g

where the lowercase cad is the ratio CAD/GDP, CAD is the current account deficit and g is the growth rate of GDP. It’s not as simple as it looks, because growth rate of GDP also affects the current account balance or deficit. The notation cad(g) is to indicate that it is so.

For high growth rates, cad(g) is larger than g.

In other words, sustainability implies that growth is restricted to be low.

Similarly, on the creditor’s side, an economy (i.e., Germany) growing at about 2.2% (nominal) and current account balance of 8.3%, that implies that its NIIP/GDP is rising fast (and hence deteriorating the ratio of others).

So Sandbu’s claim that those asking Germany to expand domestic demand aren’t analytical itself falls flat. His analysis just does a chart eyeballing of some numbers. Just because a few things aren’t worsening, doesn’t mean things are fine. Other metrics may be worsening.

Handelsblatt‘s analysis doesn’t really say much except claiming that Germany’s trade surplus just means its expenditure is less than its income and nothing more. It also errs on endorsing the claim that, “that national economies cannot be managed like large firms.”, which the crisis taught us is highly incorrect.

Public Debt And Current Account Deficits, Part 2

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This is a continuation of a recent post at this blog, Public Debt And Current Account Deficits, in which I argued that the current account balance of payments affects the public debt.

A usual objection to the connection is that the two deficits—current account deficit and the budget deficit—although connected by an identity, don’t move together and in fact move in the opposite direction frequently. This point was raised by the blog Econbrower, yesterday.

The identity in question is:

NL = DEF + CAB

where, NL is the private sector net lending, DEF is the government’s deficit and CAB is the current account balance of payments (and is to a zeroth order approximation, exports less imports).

This is not a behavioural hypothesis but still a useful tool to build a narrative. Also, the causality connecting the identities is domestic demand and output at home and abroad.

Imagine, initially that NL is a small positive relative to GDP (for example, NL/GDP = 2%), Also remember that,

NL = Private Income − Private Expenditure

Now assume that private expenditure rises relative to private income. This will lead to higher GDP, a higher national income and a rise in imports because of income effects and hence a lower CAB. It will also lead to higher taxes because of higher income and hence will reduce the budget deficit, DEF, ceteris paribus.

So if the current account balance is in deficit, it would mean that the budget deficit and the current account deficit move in opposite directions.

That’s the theoretical basis for the empirical relationship. But that in itself isn’t the whole story. This is because the other balance—net lending, NL—has a life of its own. As is the case in the United States and several western countries, it turned negative once or twice in the 1990s the 2000s, and when the private sector’s debt rose, it made a sharp U-turn into the positive territory. The blue line in this graph:

Click the graph to see it on FRED.

So, if net lending reverts to its mean of staying positive, one can then conclude that the cumulative budget deficit, or the public debt is affected by cumulative current account deficits.

At any rate, the public debt shouldn’t be the main object of study. What’s more important is the international investment position. And it’s an identity that:

NIIP = cumulative CAB + Revaluations

where, NIIP, is the net international investment position.

A nation which runs current account deficits can become indebted to the rest of the world. IIP is the position of assets and liabilities of resident sectors of a nation. So, the net debt (the negative of NIIP) is the nation’s debt.

The above linked Econbrowser post brings in the complication of revaluations to deny the relationship between CAB and NIIP. But revaluations can’t save you for long.

In short, both public debt and NIIP depend on current account deficits.

Finally a weak analogy: if you play in the rain, you might enjoy it as well. But then if you get sick, you can’t say, “I felt so good playing in rains, so playing in the rain didn’t make me sick”. Saying the two deficits (current account and budget) move in opposite directions is an argument like that.

The Economist On Germany’s Balance Of Payments

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The Economist‘s latest cover is about the German balance of payments. The subheading of its editorial says, that it “[t]he country saves too much and spends too little”.

That’s welcome, although the article claims that the German government’s policy is not mercantilist, while at the same time saying that wages have been held down to achieve more competitiveness in exports.

🤦🏻‍♂️

Anyway, it’s good that it has recognized that this is a problem for the world economy. Funnily, the editorial is still defending free trade, without realizing that the ideology is based on the assumption that market forces will resolve imbalances. If the magic of the price mechanism works, why do you need active policy?

It’s important to remember that John Maynard Keynes recognized that active policy measures are needed to resolve global imbalances. He proposed to impose a penalty on creditor nations in his plan for Bretton-Woods and also require them to take measures such as:

(a) Measures for the expansion of domestic credit and domestic demand.
(b) The appreciation of its local currency in terms of bancor, or, alternatively, the encouragement of an increase in money rates of earnings;
(c) The reduction of tariffs and other discouragements against imports.
(d) International development loans.

– page 24 of The Keynes Plan

A lot of times, people argue that the moral stand that Germany reduce its surpluses is vacuous. Germany is independent and responsible for its own decision. Who are others asking German politicians to raise domestic demand?

The answer to that is Germany makes huge gains out of its success in international trade. What if deficit nations form a union and impose high tariffs and quotas on their imports? International trade runs under a set of rules (the “rules of the game”) and other nations have a right to demand this from Germany and ask for fairer rules.

Anyway, The Economist has finally accepted what Keynes was saying 80 years ago!

Public Debt And Current Account Deficits

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Yesterday, there was an article at Vox which takes issue with a statement from Donald Trump which connects the US public debt with current account deficits.

Trump ran his campaign on dividing people, is out to destroy health care and wants a regressive system of taxation and so should be resisted. At the same time, a blanket opposition is counterproductive, especially when it is an important matter.

Vox quotes Trump:

For many, many years the United States has suffered through massive trade deficits; that’s why we have $20 trillion in debt.

In response, Vox claims:

The US trade deficit refers to the fact that the US imports more from the world than it exports. The national debt is the result of the fact that the US government spends more revenue than it collects. There’s no direct relationship between the two.

The whole article is written to claim that there is no connection. But anyone who knows the sectoral balances identity will recognize that there is a connection.

So the sectoral balances identity is:

NL = DEF + CAB

where, NL is the private sector net lending, DEF is the government’s deficit and CAB is the current account balance of payments (and is to a zeroth order approximation, exports less imports).

Of course, this is an identity and shouldn’t be confused for any behavioural hypothesis but it’s still useful in creating a narrative around a model (such as an SFC model) with behaviour for households, firms, the financial system, the government and the rest of the world.

On an average the private sector net lending is a small positive number relative to GDP (such as 2%), although it can fluctuate a lot. So for the U.S. economy, we saw that it was negative a lot in the 2000s and then reverted to a large positive just before and during the crisis.

One should of course keep in mind the correct causality connecting the three terms. What connects them is demand and output at home and abroad.

So the government’s deficit is affected by exports and imports. If there’s a large current account deficit, there’s a fall in demand and hence output and hence income and hence taxes leading to a higher government deficit than otherwise. Deficits in turn affects the public debt.

In other words, the U.S. public debt would have been lower, ceteris paribus, had the problem of the U.S. trade imbalance would have been addressed. This would have happened because of higher national income and higher taxes.

People don’t see the connection because they are comparing different nations. So for example, Japan has been successful in international trade and yet has a high public debt. In the other extreme, Australia has had large current account deficits over the years and public debt much lower than Japan (relative to GDP). But one should do a ceteris paribus comparison.

See Part 2 here: Public Debt And Current Account Deficits, Part 2

Two Hundred Years Of Ricardian Trade Theory

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Ingrid Kvangraven has a nice article, 200 Years of Ricardian Trade Theory: How Is This Still A Thing? on the blog, Developing Economics. In that, she asks how “the observation of persistent imbalances (and recurring debt crises in the deficit countries) appears to have little impact on the popularity of Ricardo’s theory.”

It’s a nice article going into details about the assumptions of the trade theory, but let me just add another perspective. New Consensus Economics is based on the assumption about the magic of prices and market forces acting to resolve imbalances. Government “intervention” (a loaded word), supposedly spoils this magic and economists are trained to think that this is the reason for crisis. So a New Consensus economist doesn’t find this to be contradictory. “Hey government, why did you interfere with the workings of the market”, an economist is likely to say.

The role of the government in this model is mainly about law and order and is supposed to balance its books. Whenever a crisis arises, economists tend to blame “fiscal profligacy” and recommend contraction of fiscal policy and “economic reforms”.

Of course, since the financial crisis started about ten years back, economists have conceded that they have been wrong about several things. Fiscal policy is one major area where this is so. But the “learned intuition” is so deeply ingrained and ramified into every corner of their minds—borrowing words from Keynes—that it is difficult for them to escape old ideas.

It’s unfortunate that Keynes didn’t stress much about this problem, which is huge. In his GT, he did have a chapter on mercantilism and discussed how the mercantilists behaved the way they behaved because of their distrust in the role of market forces in resolving imbalances. Keynes also had a plan called the Keynes Plan, before the Bretton Woods established. Keynes proposes a fine on creditor nations as well (page 23-24):

from page 23 of IMF’s document on Keynes’ Plan

Usually one only hears of this in Post-Keynesian literature but this was not all. He also proposed other responsibilities for creditors:

from page 24 of IMF’s document on Keynes’ Plan

Of course, the idea of a Bancor sounds crazy because of its similarity to the Euro. The trouble with the Euro is that there is no central government with large fiscal powers, such as in a federation like the United States. Bancor would need a world government. Nonetheless, we can still embrace Keynes’ genius that creditors should take responsibility in the rules of the game and reject Bancor. So apart from the principle of effective demand, this is one of Keynes’ biggest contribution to the history of humankind—that creditor nations have a responsibility.

Unfortunately, the world is still stuck with Ricardo’s ideas!

Dean Baker On US Manufacturing And International Trade

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The U.S. manufacturing deficit was $831 billion in 2015. The 2016 number might be out in a few days. Dean Baker has an excellent article, Painful Nonsense on Trade on his blog in which he debunks the claims of most economists that the US trade imbalance didn’t lead to job losses. He says:

… Note that the level of manufacturing employment, while it has cyclical ups and downs, is nearly constant from 1970 to 2000 at around 17 million. It plunged in the early years of the last decade as the trade deficit exploded. Most of the fall in employment was before the collapse of the housing bubble in 2008. This is what happens when a trade deficit increases from around 1.5 percent of GDP, the mid-1990s level, to almost 6.0 percent of GDP at its peak in 2005–2006 (over $1.1 trillion in today’s economy).

and also that the comparison to Germany is misleading:

DeLong also does a bit of sleight of hand in telling us that the loss of manufacturing employment is the same everywhere, pointing out that even Germany, the big success story, saw employment in manufacturing fall from about 40 percent of the labor force in 1971 to 20 percent at present. This is true, and if the United States had the same share of its workforce employed in manufacturing as Germany, we would have another 15 million manufacturing jobs.

A similar point was made by Wynne Godley in 1995! In A Critical Imbalance In U.S. Trade, The U.S. Balance Of Payments, International Indebtedness, And Economic Policy he said:

It is sometimes said that manufacturing has lost its importance and that countries in balance of payments difficulties should look to trade in services to put things right. However, while it is still true that manufacturing output has declined substantially as a share of GDP, the figures quoted above show that the share of manufacturing imports has risen substantially. The importance of manufacturing does not reside in the quantity of domestic output and employment it generates, still less in any intrinsic superiority that production of goods has over provision of services; it resides, rather, in the potential that manufactures have for expansion in international trade.

Euro Area NCBs’ TARGET2 Balance As Cumulative Accommodating Item In The Balance Of Payments

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There’s a discussion on Nick Rowe’s blog about the interpretation of TARGET2 balances of the NCBs in the Euro Area’s Eurosystem. How do we interpret this? My answer is the headline.

TARGET2 balances arise because of cross-border payment flows within Euro Area countries. Instead of going through how these arise, I assume the reader knows them. I have covered it many times in my blog and many others have written it.

Let’s work here in the approximation that the Euro Area is the world and there’s no economic activity outside it. Since cross-border flows within the Euro Area banking system and the Eurosystem are transactions between resident economic units and non-resident units, these flows will give rise to entries in the balance of payments of each nation within the Euro Area.

In the new balance of payments terminology, such as as in the sixth edition of the Balance Of Payments And International Investment Position Manual, (BPM6), there’s an identity:

current account balance + capital account balance = net lending (financial account balance).

For terminologies see this table from the guide:

balance-of-payments-overview

This is an identity but suggestive of some behaviour. The question is what is the residual in this. The current account consists of things such as exports, imports, interest payments between resident and non-resident units and so on. The capital account consists of acquisitions and disposals of non-produced non-financial assets and capital transfers. The financial account consists of things such as direct investment flows, portfolio investment flows and so on. Other than that, there’s also “reserve assets” and “other investment”.

There is a nice 1991 article by the BIS Capital flows in the 1980s: a survey of major trends. The author quotes James Meade who makes this distinction between autonomous flows and accommodative flows:

[accommodative capital flows] take place only because the other items in the balance of payments are such as to leave a gap of this size to be filled … [while] autonomous payments … take place regardless of other items in the balance of payments.

Strictly, this distinction makes sense in fixed exchange rate regimes. In floating exchange rate system, the two—accommodative and autonomous—can’t be clearly be separated.

Anyway, coming back to the Euro Area, before the crisis started, the banking system was working fine. So there would be flows in both the current account and the financial account. The goods and services balance in the current account depends on domestic demand and output at home and abroad and relative competitiveness. There’s no reason for this to be zero. Economic units engaged in the financial markets would buy and sell securities and these affect the financial account of the balance of payments of the two nations involved in the transaction. There’s no reason for balance of things such direct investment, portfolio investment (and financial derivative flows) to balance or to equal the current account balance. Since flows typically are via TARGET2, this affects banks’ balances at their NCBs. So it’s possible toward the end of the day for banks in Spain 🇪🇸 as a whole to find themselves in need for reserves (or settlement balances) and banks in say Germany 🇩🇪 to be in a situation where they have excess funds. So banks in Spain will likely contact banks in Germany to borrow funds, either for one day or more. This is because they will get a cheaper interest rate. If they borrowed from their NCB, the interest rate is slightly higher.

These borrowings and lendings give rise to other investment in balance of payments of the two nations. So in Meade’s language, this is an accomodative flow. Not all other investment items are accommodative flows and similarly, not all accommodative items are other investment items.

But as the financial crisis began in 2007, the interbank system froze. Banks didn’t lend each other much. Hence the residual was balances between the NCBs. This would arise automatically. So these flows can be said to be accommodating. The counterpart of this is banks borrowing from their NCBs.

There’s a technicality: somewhere around mid-2000s, the system was changed so that the bilateral balances of NCBs were assigned to the ECB on a daily basis.

Since the TARGET2 balance of NCBs is a stock and not a flow, they can be hence thought of as the cumulative accommodative item. Since the crisis, a lot of things have happened. The European Central Bank has taken various steps, so that banks have sufficient liquidity. Banks have been given facilities to borrow huge amounts from their NCBs for collateral at cheap rates. Later the ECB also started its asset purchase program in which it bought government bonds, ABS and covered bonds. Some of these were already in existence when the interbank markets froze. So even as interbank markets opened, they didn’t feel the need to borrow funds from banks abroad.

The IMF’s guide BPM6 says in Appendix 3 that these intra-Eurosystem claims (the TARGET2 balances) are to be recorded in Other Investment:

Intra-CUNCBs and CUCB balances

A3.46 Transactions and positions corresponding to claims and liabilities among CUNCBs and the CUCB (including those arising from settlement and clearing arrangements) are to be recorded for the central bank under other investment, currency and deposits or loans (depending on the nature of the claim) in the balance of payments and IIP of member economies. If changes in these intra-CU claims and liabilities do not arise from transactions, relevant entries are to be made under the “other adjustment” column of the IIP. Remuneration of these claims and liabilities is to be recorded in the balance of payments of CU member economies as income on a gross basis under investment income, other investment.

where CUCB and CUNCB are abbreviations for currency union central bank and currency union national central bank, respectively.

There is some similarity with “reserve assets” in the financial account of the balance of payments and the international investment position when comparing all this to a fix exchange rate regime. In the latter, when autonomous flows aren’t sufficient, the central bank may sell gold or foreign reserves in the markets. It may also engage in borrowing funds in foreign currency. These are also accommodative flows. In the Euro Area case however, the inter-NCB claims (and the assignment to the ECB) happens automatically. Also “reserve assets” don’t go below zero, while TARGET2 balances can be negative in the sense that they are in liabilities of some NCBs instead of being in assets.

The conclusion of all this is that TARGET2 is a sort of a residual finance to a whole nation which arises automatically. Some have interpreted this to conclude that this is unlimited. This is however not the case. Since the counterpart to these are banks’ borrowing from their NCBs, this is limited to how much collateral banks can provide the Eurosystem, with or without the help of their government.

Neochartalists Shifting Positions

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In a three part series, Bill Mitchell, makes the case against free trade. While this is most welcome – success and failure of nations depends on success in international trade via the principle of circular and cumulative causation – it’s quite a drastic change from what Neochartalists have claimed before. From “exports are a cost and imports benefits”, they have shifted their position. Mitchell goes on to concede:

These so-called ‘free trade’ agreements are nothing more than a further destruction of the democratic freedoms that the advanced nations have enjoyed and cripple the respective states’ abilities to oversee independent policy structures that are designed to advance the well-being of the population.

[emphasis: mine]

Neochartalists have always denied – till recently – that free trade can put a constraint on fiscal policy. They interpreted such critiques as an argument against fiscal expansion, instead of realizing that it’s possible to both argue for fiscal expansion and realize that it is constrained by balance of payments. One potential solution is import controls. Mitchell concedes that it’s required sometimes. He says:

In those cases, import controls may be justified to limit the damage to the less developed nation, despite the material benefits to the more developed nation being obvious.

[boldening: mine]

In another blog post as I noticed here, Mitchell says this while making proposals on reforming the international institutional framework:

…

2. Macroeconomic stabilisation – support for national currencies in the face of problematic balance of payments.

This function recognises that all nations should maintain sovereign currencies and float them on international markets but at the same time recognising that capital flows may be problematic at certain times and that some nations require more or less permanent assistance due to their export capacities and domestic resource bases.

There have been many critiques of Neochartalism but very few touch on this or give attention. But since international trade is the most important determinant of the rise and fall of nations, and that Neochartalism claims to be some fundamental theory of human interactions, its extreme position and shifting away from it should be noticed and critiqued, although welcomed.

In short, Neochartalism which is some sort of moral superiority on fiscal policy has accepted that free trade can put constraints on it. The solution of course is beyond the scope of this post but this shift should acknowledged when Neochartalism is discussed.

The Treaty Of Rome And Balanced Trade

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Policy Research in Macroeconomics (PRIME)’s blog Prime Economics reminds us of the Treaty of Rome, to establish a European Economic Community, first signed in 1957 which has a Chapter on Balance of Payments:

CHAPTER 2

BALANCE OF PAYMENTS

ARTICLE 104

Each Member State shall pursue the economic policy needed to ensure the equilibrium of its overall balance of payments and to maintain confidence in its currency, while taking care to ensure a high level of employment and a stable level of prices.

ARTICLE 105

  1. In order to facilitate attainment of the objectives set out in Article 104, Member States shall co-ordinate their economic policies. They shall for this purpose provide for co-operation between their appropriate administrative departments and between their central banks. The Commission shall submit to the Council recommendations on how to achieve such co-operation.
  2. In order to promote co-ordination of the policies of Member States in the monetary field to the full extent needed for the functioning of the common market, a Monetary Committee with advisory status is hereby set up. It shall have the following tasks:
    – to keep under review the monetary and financial situation of the Member States and of the Community and the general payments system of the Member States and to report regularly thereon to the Council and to the Commission;
    – to deliver opinions at the request of the Council or of the Commission or on its own initiative, for submission to these institutions.

The Member States and the Commission shall each appoint two members of the Monetary Committee.

I have emphasized many times in my blog that Euro Area balance of payments and international investment position imbalances are quite important for the Euro Area. Even before I started writing this blog, I had stressed before anyone else (on other Post-Keynesian blogs) that the imbalances are large and quite important in understanding the crisis.

Of course, imbalances can be corrected by deflating demand and output as has been the case in the Euro Area since the start of the crisis by policy makers. But it’s good to know that the founders of European integration thought of coordinating policies, which implies their policies would have been expansionary. Anyway, had the original ideas not been overthrown, the Euro Area would also have had a central government. Unfortunately neoliberalism became popular in the 1980s and this led to the Maastricht Treaty which forgot the original intentions of the founders.

The Treaty’s opening also has this important line:

RECOGNISING that the removal of existing obstacles calls for concerted action in order to guarantee steady expansion, balanced trade and fair competition

I should mention however that the Euro Area has this thing called the Macroeconomic Imbalance Procedure which tries to address the issue and even thinks of current account surpluses in the balance of payments as an imbalance, but it is still far away from doing anything about it, such as a coordinated fiscal policy expansion.