Can Macron reform Europe?: A mental model for thinking about the economics

Having written the last piece on the intersection of Austrian economics and Post-Keynesian economics, I was asking myself the question: so what? Yes, the punch line of the piece was that both of these schools of thought lead to a world view marked by worry. But, as my friend Marcus always asks me: how do I make money from that? Not that this is the most important question when you have a monetary union and national identities at stake. But here’s my answer anyway – and I’m going to use Emmanuel Macron as the example.


As in finance, economic models are reductionist. This helps the mind focus on a few crucial variables. So these models aren’t realistic facsimiles of the world as it actually is, nor should they be taken as such – though lots of people do. What these models do is help tease out bits and pieces that matter to help economists and investors make predictions that are hopefully better than random.

I think the models we have — while inadequate then — are close enough to the real McCoy to work 90 or 95% of the time. On economic modeling, take a look at the Atlanta Fed’s GDPNow model. It is pretty good for taking incoming data and adjusting expected GDP growth up or down for them. The final GDPNow growth number tends to be pretty close to the actual GDP growth number.

Where the Austrians and Post-Keynesians come into play here is at the margins.

Remember Minsky’s quip about stability leading to instability? No? Here’s two quotes on how he put it:

“Stability leads to instability. The more stable things become and the longer things are stable, the more unstable they will be when the crisis hits.”

“Unless we understand what it is that leads to economic and financial instability, we cannot prescribe – make policy – to modify or eliminate it. Identifying a phenomenon is not enough; we need a theory that makes instability a normal result in our economy and gives us handles to control it.”

I think these are powerful words because they go to the margins that I am discussing here. What I’m saying is that 90 to 95% of the time mainstream models are right. And so you have to question how much you want to bet against them. But Minsky is right about stability leading to instability. So, in the few times when models are wrong at economic and financial turning points, you get major breaks; they are catastrophically wrong. And so it pays to figure out just when those turning points are going to happen.

Let me give you a real world example of how this works in financial modeling. Back in August 2007, when the acute phase of the financial crisis started, Goldman Sachs CFO David Viniar said “We were seeing things that were 25 standard deviation moves, several days in a row”. What Viniar was saying was the financial destruction happening in the market was only supposed to happen once every 100,000 years, according to the firm’s models. And while Viniar took a lot of flak for that statement, it’s not clear he actually believed the models represented the real world. What he was basically saying was that events on the ground are telling me we have experienced market events for which Goldman’s models are worthless. And, of course, that’s exactly when your contrarian bets pay off – as “The Big Short” attests.

So when do we get to the next turning point?

I don’t think we are at a turning point yet. Look at the GDP numbers that came out of Europe today. Gangbusters – much better than the US or the UK, by the way. And of course, this is helpful to Emmanuel Macron in Sunday’s runoff against Marine Le Pen. I think he will win by a large margin irrespective of how he does in the debate tonight.

And if he does win, he will see his election as a mandate to reform both France’s and the EU’s institutions and economies. Let’s look at the EU first and then France.

Now Macron has said he sees the euro failing in 10 years without reform and advocates for deeper integration aka ‘more Europe’. I outlined some of the reforms that are necessary on Monday but questioned the will to undertake them in a flourishing economy. I think Macron will find it difficult to sell his idea of deeper integration to European politicians concerned about satisfying an increasingly nationalistic electorate.

And in France, the problems are equally challenging, especially without an existing party apparatus and cadre of MPs. Now, some people are calling his economic platform the ‘Nordic Model’ because the Scandinavian countries have moved successfully toward a more market-oriented economic approach. But economists who have studied the situation say really Macron’s just trying to do what Francois Hollande has failed to do – something that has made Hollande the most unpopular President in French history, by the way.

I would say that what Macron wants to do to France is essentially what Gerhard Schroeder did to Germany a decade ago (something I believe cost him the Chancellery in 2005 I might add). Ultimately, he wants to increase the ability of firms to hire and fire to bring down unemployment, cut the size of government, and increase investment. It’s New Labour, Clintonian stuff that is very supply-side oriented because the goal is to boost productivity and investment. I am very sceptical.

And of course, this has proved to be a ‘deflationary’ economic model in Germany, dependent on wage suppression and export alongside productivity growth to maintain growth. It’s not at all clear it will work in France, at least for the average wage earner.

Now, the bet on the economics here is that – over the medium-term, say 1 or 2 years, none of this matters. The standard macro models take the inputs and spit out the predictions perfectly well. But, if economists who believe that growth has been fatally wounded and the potential for economic crisis is greater are right, then it’s when the credit cycle turns down that mainstream models will fall apart.

Thus, while Macron has a very limited window to make good on his promises, the question becomes what happens when credit growth turns down. Are the credit-focused economists going to be proved right by a deeper or more protracted downturn? We’ll see.

One thing is for sure, if we get a major downturn: the economic misery in the regions that voted for Le Pen will deepen or spread or both. And then the National Front will be in a much better position to take control and end the Euro just as Macron has warned.

Bottom line: It’s not yet time to make huge contrarian bets on markets or the economics and politics in Europe. Things are doing reasonably well – and that’s enough for standard approaches to modeling to hold up, financially and economically – at least for now.

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