On 8 December 2011, in the midst of the European sovereign debt crisis, the economist Thomas J. Sargent (Pasadena, California, 1943) gave a speech of acceptance for the Nobel Prize, awarded by the Swedish Royal Academy for his “empirical research into cause and effect in macroeconomics”. The timing could not have been more apposite. That very week, on 8 and 9 December, Angela Merkel and Nicolas Sarkozy tabled a Fiscal Compact at the European Council, a proposal that was vetoed by David Cameron of the United Kingdom. The 17 members of the Eurozone and six candidate countries agreed a new intergovernmental treaty with strict public spending and debt limits. Italian spreads at the time were more than 500 basis points above the bund and interest rates on public debt were nudging 3.7% in France, had already reached 7% in Italy and Spain, 15% in Ireland, Portugal and Cyprus, and exceeded 35% in Greece. Silvio Berlusconi had just resigned and been replaced by the technocrat Mario Monti. In September 2011, Jürgen Stark had become the second German, following Axel Weber, to resign from the Executive Board of the European Central Bank (ECB) in one year, a sign of the internal tensions over the direction of monetary policy.
Sargent did not deal with abstract history in his speech: he spoke directly about a constitutional crisis unfolding in real time. Notably however he did not prescribe a solution: he set out two American experiences (from the 1790s and 1840s) and left his audience to draw their own conclusions. But the implicit message was devastating for the EU architecture: a monetary union in the absence of a fiscal union is inherently unstable, precisely the problem implicit in the Articles of Confederation prior to Alexander Hamilton.
As analysts pointed out at the time, Sargent’s investigations into the connections between monetary and fiscal policy had a direct bearing on understanding the European situation, since they demonstrate that monetary and fiscal policy are interconnected: a government can finance itself with taxes, debt or the printing of money, and these three pathways are not independent.
Just seven months later, on 26 July 2012, Mario Draghi uttered his three most famous words (“whatever it takes”) when he stated: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”. The irony was exquisite, because what Draghi did was exactly what the “unpleasant arithmetic” of Thomas Sargent and Neil Wallace (1981) predicted. Monetary policy had to shoulder the entire burden because the other elements of a sustainable monetary union – above all a central fiscal capacity for dealing with asymmetrical shocks – were absent and not even seriously considered for a long time. Draghi had to deploy the ECB’s full powers to save the euro. The ECB stepped in with the fiscal capacity the European Union (EU) lacked, precisely because of the opaque coordination between fiscal and monetary policy that Sargent highlighted as a source of uncertainty.
The institutional response to the speech was limited. Sargent was invited to deliver the same speech at Banque de France on 1 March 2012. The European debate was dominated by two opposing viewpoints that Sargent’s speech encapsulated perfectly: one side emphasised fiscal discipline as the solution (the response that typified the 1840s), while the other pointed to the systemic roots of the financial turbulence. The European political response of December 2011 (the Fiscal Pact) clearly favoured the interpretation of the 1840s (discipline, rules, sanctions) without considering the interpretations of the 1790s (joint fiscal capacity, common revenues). Sargent would have pointed out that one viewpoint without the other was incomplete.
There were no direct public references from European politicians to the Nobel acceptance speech – the leaders were too preoccupied with the crises that bedevilled every Council meeting – but Sargent’s analytical framework set the tone for the academic and institutional debate in succeeding months. In June 2012, the European Council unveiled the so-called “Four Presidents’ Report” (by the presidents of the Council, the Commission, the Eurogroup and Draghi himself), which represented a moment of truth by opening the door to a banking, fiscal and political union. This report was essentially an institutional response to the diagnosis that Sargent had set out in Stockholm six months previously: in the absence of any form of fiscal union, the monetary union could not survive. The European tragedy is that, 13 years later, this fiscal union remains unfinished.
Image: Headquarters of the European Central Bank, in Frankfurt. Photo: Jurjen (CC BY-NC-ND 2.0).
