Box 2.14 Poland’s successful weathering of the crisis

10 This is known as the economic “trilemma” or, if extended to include open trade, the “inconsistent quartet”. 11 Padoa-Schioppa (1982) made a similar argument, extending it to include open trade. He argued that it was impossible for a group of countries like the EU to simultaneously aim at free trade, capital mobility, independent domestic monetary policies, and fixed exchange rates. This was coined the “inconsistent quartet”. 12 The European Commission made these arguments in its 1990 publication “One Market, One Money.” European

Union Commission, 1990; see for a reassessment by one of the authors Gros, 2017. 13 Mario Draghi (ECB President since 2011) summarizes these two decades in his speech “Europe and the euro 20 years on”. https://www.ecb.europa.eu/press/key/date/2018/html/ecb.sp181215.en.html 14 Buiter et al., 1993 were critical of the Maastricht criteria as they did not address the substance of unstable (public sector) debt dynamics. In addition, they did not address private sector debt vulnerability, ultimately a major contributing factor to the crisis in the euro area periphery. 15 Inflation would be measured as the 12-month average of year-on-year rates of the Harmonized Index of Consumer Prices. EU member states with rates significantly below the comparators will not be included in the three-country benchmark. 16 The deficit is the annual general government deficit. GDP is measured at market prices. Deficit can be slightly above the limit if it is on a continuously declining trend or if it is temporary in nature due to exceptional circumstances.

These would include an economic recession of over 2 percent of GDP, as later agreed. A recession between 0.75 and 2 percent would need to be discussed and agreed on between the ministers of finance of the member states. 17 Debt is the gross government debt. If the ratio is exceeded, it should be coming closer to the ceiling at a satisfactory pace. 18 The long-term interest rate will be measured as the average yield of 10-year government bonds in the last year.

EU member states with long-term interest rates significantly above the comparators will not be included in the three-country benchmark. 19 While the arithmetic was evident, the economics was less convincing and strongly contested, for instance by Buiter et al. 1993. Buiter et al. guessed that the criteria were derived at as follows. The debt ratio was close to the EC’s average in 1991; long-run growth of 3 percent seemed feasible; inflation at 2 percent seemed a stretch, according to Buiter; and a 3 percent deficit would be compatible with a debt-to-GDP ratio of 60 percent in the long run. The 3 percent deficit was equal to the EC’s public investment-to-GDP ratio (1974–1991), suggesting that deficits should finance public investments only, and not recurrent expenditures—this was called the “golden rule of public finance” in EC documents. Buiter et al. argued, for instance, that, first, this assumed that inflation would be zero (higher inflation would be compatible with higher debt ratios; p. 63), second, that education expenditures would not be seen as investment, while, third, public investment would always yield a positive financial return to government. 20 See for instance, Djankov (2014). 21 De Grauwe, 2009. 22 EC Convergence Report, 2018. 23 Kaldor, 1978. Kaldor had already warned of this in 1971 in his critique of the Werner Report of 1970. He argued that the monetary union could actually prevent the emergence of a political union because of the economic conflicts it created. 24 Kenen, 1969. 25 Blanchard and Giavazzi, 2002. 26 De Grauwe and Yi, 2012. 27 EC, 2008. 28 Investment decoupled from local savings. This went against the phenomenon uncovered by Feldstein and

Horioka (1980). They demonstrated (for OECD countries, between 1960 and 1974) a close correlation between domestic savings and local investments. They took this to indicate a low degree of integration of capital markets across countries. 29 In the wake of the crisis, financial market integration fell back towards its level of the early 2000s (ECB 2017,

Integration Report). 30 This “overshooting” of the real interest rates (nominal interest rates converged more quickly than inflation) created situations in which the real interest rates in countries such as Spain, Ireland or Portugal were substantially lower than in Germany, boosting investments in these economies as a consequence. 31 Baldwin and Giavazzi, 2015. 32 Italy, Portugal and Spain, in particular. 33 Baldwin and Giavazzi, 2015. 34 One exception confirmed the rule: Greece had had very large fiscal imbalances before the crisis, but it had hidden these from the EU.