Markus Brunnermeier, Harold James and Jean-Pierre Landau have just published a fascinating book, The Euro and the Battle of Ideas, in which they bring together their respective skills in economic theory, economic history and economic policy to bear on one of the most important macroeconomic problems of our times—the rules versus discretion debate. Anyone who has studied this debate—and that’s just about anyone who has taken a course in economics—would benefit from reading this book.
The book focuses on the role of government in the economy and how conflicting ideas about this role affect economic policy in Europe and beyond, including at the International Monetary Fund. But most of the economic policy ideas revolve around the rules versus discretion debate, and include policy credibility, accountability, time inconsistency, policy flexibility, moral hazard, and fiscal consolidation versus stimulus. All of these issues have been extensively researched, and views differ. Many economists (including me) are of the view that rules-based policies are more effective, while others (including Larry Summers) argue against rules.
The fascinating hypothesis—and the organizing principle—of the book is the authors’ view that ideas differ by country. In particular, they argue that in Europe the battle of ideas is largely between Germany, on the side of rules, and France, on the side of discretion. They note related differences in other parts of the world: in Italy they see a regional split in which “great liberals…come from the North, whereas the pioneers of practical Keynesianism…are Southerners.” And I can think of other examples where opinions appear to differ by group. In the United States, for example, there have been schools of thought—Cambridge versus Chicago, Samuelson versus Friedman—distinguished by positions in the rules versus discretion debate. Ulrike Malmendier and her colleagues show that the degree to which Fed policy makers are rules-based appears to be related to whether they personally experienced the great inflation or not.
But this book is mainly about France versus Germany, and in portraying the battle of ideas this way the book provides novel explanations of why certain policies are chosen. Rather than a question of good policy versus bad policy, it is a question of who is up or down politically, and the relative power of France versus Germany.
The authors consider key debates within the rules versus discretion framework: quantitative easing, bailouts, fiscal stimulus. Within Europe they argue, for example, that “Starting from the negotiations for the Maastricht Treaty and the SGP, fiscal policy rules following the traditional German rigorist approach clashed with the deeply ingrained Keynesian instincts in France.”
I particularly liked the book’s discussion of the IMF’s decision to break the rules of its exceptional access framework when it lent to Greece. This framework was put in place in 2002, and it led to a stop in financial crises emanating from emerging market countries which had been raging before then. Unfortunately, these rules were broken in 2010 when the IMF made a large loan to Greece which eventually led to a bailout of private creditors. Many realized it was a mistake, but the U.S. Treasury objected to restoring the rules arguing the case that discretion was needed. With the IMF management, staff and other countries in favor of restoration, a shift in the U.S position was all that was needed to make the needed changes. When the U.S. Treasury finally agreed to remove its objection, the Congress supported the reform, which then passed. I was involved in the restoration effort and saw how the battle of ideas had both a country basis and an intellectual basis, much as the book tells the story.
While many of the chapters conclude with a sensible set of policy recommendations, the book provides more of a “positive approach” rather than “normative approach” to policy. This perspective is useful in helping to identify barriers to better policy, and possible compromises. It is not, of course, a replacement for traditional analytical research which has the power to change views based on ideas rather than national differences.
In this regard, it is promising that the authors show that national views change over time. Indeed, France and Germany switched sides: Early in the book the authors show that the current French-German dichotomy is relatively new. Before World War II, they argue that Germany was more statist and discretionary (they give the example of Friedrich List criticizing free trade), while France was more laissez faire and rules-based (they give the examples of the classical liberal economists Jean-Baptiste Say and Frederic Bastiat). But the experiences of the World War II, they argue, caused a counter reaction and a switch with Germany now more rules-based and France more discretionary. Maurice Allais, who they classify as a classical liberal and who was writing in France during and after World War II, is an exception.