Trust and the Future of the Euro

Last week I attended the Future of the Euro conference at UC Berkeley. The conference was cosponsored by the Institute of European Studies, the EU Center of Excellence, the Austrian Marshall Plan Foundation, and the Austrian National Bank. The conference was structured around four panels on political, banking, fiscal, and monetary union. On each panel, several panelists--mostly economic historians-- gave brief presentations of about 20 minutes. In each case, I wished I could hear longer presentations to get more details. This was particularly true of the presentation by Lars Jonung from the monetary union panel, in part because he gave a critique of modern macro which I hadn't heard before.

Jonung is a senior professor in economics at Lund University, Chairman of the Swedish Fiscal Policy Council, and Research Adviser at DG ECFIN at the European Commission. Jonung says that when applying macroeconomic models, we need to keep in mind economic political culture, which he claims can be summarized as “trust.” The indirect cause of the euro crisis, he argues, was lack of trust by the public in the political system in certain parts of the Eurozone, especially Greece, Spain, and Cyprus. He describes the “vicious trust circle” in those areas, whereby weak performance leads to low trust, which leads to more weak performance, and so on. In other parts of the Eurozone, such as Germany and the Nordic countries, a “virtuous trust circle” is in place.

Jonung uses the Eurobarometer dataset as an indicator of trust. He says that the Eurobarometer ought to be a gold mine for researchers, but is rarely used because modern macro models include no role for trust. From his own analysis of the Eurobarometer, he finds that trust in national governments, the European Parliament, and the European Central Bank have fallen over the 1999-2012 period, but support for the euro has not. Jonung remarked, “People trust the euro, but they don’t trust the institution behind the euro.”

His proposed long-run cure for the euro area is to foster trust in national governments and the EU system via decentralized fiscal policy. For starters, this would entail fiscal policy councils in every member country, as well as Eurostat offices in every member country. (See a paper by Jenny E. Ligthart and Peter van Oudheusden on the role of fiscal decentralization on trust in government.) If the recovery continues to be slow, so that trust cannot be restored across the Eurozone, he thinks that one possibility is to have a “high trust monetary union” in the North and a “low trust monetary union” in the South, with flexible exchange rate between the two. Then, when trust is equalized, they could fix the exchange rate.

As I mentioned, I wished Jonung’s talk could have been longer, because it left a lot of missing details. First, I would have liked to hear more about his high trust and low trust monetary unions idea, particularly, how trust would eventually be equalized between the two unions. Much more fundamentally, I’m not sure exactly how Jonung interprets the concept of trust. The Eurobarometer survey asks respondents a large number of questions about their trust in, and support for, the euro and various institutions. But what do respondents mean when they say that they trust a currency or institution? Does trust in a government mean confidence that the government is not corrupt? Does it mean approval of government’s policies toward people in their situation, or in all situations? Does it mean optimism that the government will be successful in preventing hyperinflation or recession? Does it imply that the government is credible, or something else? What about trust in the euro? Does it simply measure the subjective probability that the euro will persist? Is it a sense of European identity? On the one hand, I am sympathetic to the argument that macroeconomic models do not incorporate political cultural factors like trust. On the other hand, depending on what exactly is meant by trust, it may be reflected in interest rates, exchange rates, and other features of the asset market which are to some degree built into macro models.

Jonung's recent working paper with Felix Roth and Felicitas Nowak-Lehmann D. notes that when respondents are asked about "trust" in the euro, "It seems reasonable to interpret 'trust' in the euro as `trust' in the purchasing power of this type of money," but this is not what the authors mean by trust. Instead they focus on the question about "support" for the euro, which "would then mean support for the idea of a single European currency while not necessarily meaning that the respondent expects the euro to deliver a stable purchasing power." This is more what the authors mean by trust. 

The first figure below comes from the Roth, Jonung, and Nowak-Lehmann's paper showing support for the euro in the EA-12 countries (where support is their indicator for trust.) I made the second figure at the Eurobarometer website (European Commission Public Opinion). It shows, for Greece only, the percent of respondents that tend to trust or not trust in the European Union. You can see trust in the EU fall drastically around crisis time. But I'm not sure exactly what this tells us, since respondents could interpret the question about trust in a variety of ways that would all show a decline in trust following a crisis. The fact that trust continues to fall, and hasn't leveled off, does seem interesting.

You can play around on the Eurobarometer site and see how trust in the EU and ECB changes in different countries with different country-specific or Europe-wide events. Roth, Jonung, and Nowak-Lehmann "interpret the fall in trust in the ECB to imply that citizens blame the ECB for not preventing the economic, financial and political turmoil during the crisis and suspect that the crisis measures taken by the ECB and other European institutions have had an inflationary effect," while at the same time, "respondents support the euro as their currency and...do not blame the euro for the crisis."