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How Countries’ Different Attitudes towards Inflation can thwart the European Dream

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  • Lucian Croitoru

Abstract

In this paper I show that countries’ commitment to maintain a fixed exchange rate is unsustainable if their attitudes towards inflation differ. This means that, if these attitudes are different, two of the solutions to the macroeconomic policy trilemma (those involving the fixed exchange rate) are unsustainable. Countries’ different attitudes towards inflation are an expression of different attitudes vis-à -vis competitiveness and reflect diverse national preferences regarding the objectives of economic growth, solidarity and sustainability, which are parameterised in the economic policies of nation-states. If countries commit themselves to maintaining fixed exchange rates and open capital accounts or they set up a monetary union, the segregation of their attitudes towards inflation engenders a mechanism that generates and perpetuates major current account imbalances across countries. The mechanism systematically places the adjustment burden on countries with a deficit, through wage and/or price deflation in countries with preferences for relatively high inflation rates, and leads to a lower effectiveness of fiscal policy or even to the loss of this policy as public debts as a share in GDP increase and come to exceed relatively elevated levels. At the end of the day, the commitment to a fixed exchange rate or to the currency area vanishes, showing that – if countries’ attitudes towards inflation differ – nation-states are incompatible with monetary integration, contradicting in this case one assertion of the political trilemma of the world economy described by Rodrik (2000). Keeping the commitment in place in a sustainable manner calls for giving up nation-states and for their democratic federalisation. In light of the above, the “executive federalism†(Habermas, 2011) instituted after 2008 in the euro area is not a solution for the survival of the currency union. It can prove useful only if it has been used in order to buy time for creating genuine demand from the public for a democratic federalisation of the euro area.

Suggested Citation

  • Lucian Croitoru, 2018. "How Countries’ Different Attitudes towards Inflation can thwart the European Dream," Romanian Economic Journal, Department of International Business and Economics from the Academy of Economic Studies Bucharest, vol. 21(70), pages 2-41, December.
    • Handle: RePEc:rej:journl:v:21:y:2018:i:70:p:2-41
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    References listed on IDEAS

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    More about this item

    Keywords

    exchange rate; inflation; macroeconomic policy trilemma; euro zone; nation-states; policy trilemma of the world economy;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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