Mario Draghi is a Lonely Man

January 10, 2014 6 comments

I just read an interesting piece by Nicolò Cavalli on the ECB and deflationary risks in the eurozone. The piece is in Italian, but here is a quick summary:

  • Persisting high unemployment, coupled with inflation well below the 2% target, put deflation at the top of the list of ECB priorities.
  • Mario Draghi was adamant that monetary policy will remain loose for the foreseeable horizon.
  • As we are in a liquidity trap, the effect of quantitative easing on economic activity has been limited (in the US, UK and EMU alike).
  • Then Nicolò quotes studies on quantitative easing in the UK, and notices that, like the Bank of England, the ECB faces additional difficulties, linked to the distributive effects of accommodating monetary policy:
    • Liquidity injections inflate asset prices, thus increasing financial wealth, and the value of large public companies.
    • Higher asset prices increase the opportunity costs of lending for financial institutions, that find it more convenient to invest on stock markets. This perpetuates the credit crunch.
    • Finally, low economic activity and asset price inflation depress investment, productivity and wages, thus feeding the vicious circle of deflation.

Nicolò concludes that debt monetization seems to be the only way out for the ECB. I agree, but I don’t want to focus on this. Read more

Reduce Inequality to Fight Secular Stagnation

December 22, 2013 5 comments

Larry Summers’ IMF speech on secular stagnation partially shifted the attention from the crisis to the long run challenges facing advanced economies. I like to think of Summers’ point of as a conjectures that “in the long run we are all Keynesians”, as we face a permanent shortage of demand that may lead to a new normal made of hard choices between an unstable, debt-driven growth, and a quasi-depressed economy. A number of factors, from aging and demographics to slowing technical progress, may support the conjecture that globally we may be facing permanently higher levels of savings and lower levels of investment, leading to negative natural rates of interest. Surprisingly, another factor that had a major impact in the long-run compression of aggregate demand has been so far neglected: the steep and widespread increase of inequality. Reversing the trend towards increasing inequality would then become a crucial element in trying to escape secular stagnation.
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Competitive Structural Reforms

December 16, 2013 3 comments

Mario Draghi, in an interview to the Journal du Dimanche, offers an interesting snapshot of his mindset.  He (correctly in my opinion) dismisses euro exit and competitive devaluations as a viable policy choices:

The populist argument that, by leaving the euro, a national economy will instantly benefit from a competitive devaluation, as it did in the good old days, does not hold water. If everybody tries to devalue their currency, nobody benefits.

But in the same (short) interview, he also argues that

We remain just as determined today to ensure price stability and safeguard the integrity of the euro. But the ECB cannot do it all alone. We will not do governments’ work for them. It is up to them to undertake fundamental reforms, support innovation and manage public spending – in short, to come up with new models for growth. [...] Taking the example of German growth, that has not come from the reduction of our interest rates (although that will have helped), but rather from the reforms of previous years.

I find it fascinating: Draghi manages to omit that German increased competitiveness mostly came from wage restraint and domestic demand compression, as showed by a current account that went from a deficit to a large surplus over the past decade.  Compression of domestic demand and export-led growth, in the current non-cooperative framework, would mean taking market shares from EMU partners. This is in fact what Germany did so far, and is precisely the same mechanism we saw at work in the 1930s. Wages and prices would today take the place of exchange rates then, but the mechanism, and the likely outcome are the same. Unless…

Draghi probably has in mind a process by which all EMU countries embrace the German export-led model, and export towards the rest of the world. I have already said (here, here, and here) what I think of that.  We are not a small open economy. If we depress our economy there is only so much the rest of the world can do to lift it through exports. And it remains that the second largest economy in the world deserves better than being a parasite on the shoulders of others…

As long as German economists are like the guy I met on TV last week, there is little to be optimist about…

What is Wrong with the EU?

December 5, 2013 3 comments

Eurostat just released the 2012 figures for poverty and social exclusion in the EU. The numbers are terrifying. Let me quote the press release: “In 2012, 124.5 million people, or 24.8% of the population, in the EU were at risk of poverty or social exclusion,  compared with 24.3% in 2011 and 23.7% in 2008. This means that they were in at least one of the following three conditions: at-risk-of-poverty, severely materially deprived or living in households with very low work intensity
One may be tempted to shrug. After all, 1% in four years, is not that much. Let me put actual people behind the numbers: The number of people at risk of poverty increased of 5.5 millions between 2008 and 2012. Strikingly, always looking at Eurostat data, the number of jobs lost in the EU28 over the same period is almost exactly the same (-5.4 millions).

This is plain unacceptable. And teaches us two lessons

  • Our welfare system is not capable anymore to shield workers from the hardship of business cycles. We progressively dismantled welfare, becoming “more like the United States”. But we stubbornly refuse to accept the consequence of this, i.e. that fiscal and monetary policy need (like in the US) to be proactive and flexible, so as to dampen the cycle. Constraints to macroeconomic policy, coupled with a diminished protection from the welfare state, spell disaster, social exclusion, and the destruction of the social fabric.
  • The second lesson is that these numbers are there to stay. The economy may recover, but the loss of confidence, of capacity, of social status of those who we pushed into hardship, will stay with us for years to come. We are destroying human capital at amazing speed.

What is enraging is that none of this was inevitable. The crisis could have been shielded by less ideological leadership in European institutions and in some most European capitals. Frontloading of austerity in the periphery was a terrible mistake. Not accompanying it with fiscal expansion in the core was a crime, showing of how little solidarity counts, facing the protestant urge to “punish the sinners”.

The result is that one of the most affluent economic areas of the world barely notices that one quarter of its population lives at risk of poverty. What is wrong with us?

What is Mainstream Economics?

November 29, 2013 12 comments

Paul Krugman and Simon Wren-Lewis have been widely criticized (for example here) as defending  “mainstream” economics that spectacularly failed during the crisis (and before).

My (very short) take on this: I do believe that Krugman has a point, a very good one, when claiming that standard textbook analysis is (almost) all you need to understand the current crisis, and to implement the correct policy solutions.
The point is what we define as “textbook analysis”. Krugman refers to IS-LM models. But these, that starting in the 1980s virtually disappeared from graduate curricula because supposedly too simplistic, not grounded on optimization, not intertemporal, and so on and so forth.
I personally was exposed to these ideas in my undergraduate studies in Italy, and I still teach them (besides using them to discuss the crisis with my students). But they were nowhere to be found during my graduate studies at Columbia (certainly not a freshwater school). None of the macro I studied in graduate school (Real Business Cycle models, or their fixed-price variant proposed by New Keynesians) as interesting as it was intellectually, could give me insight on the crisis. I simply do not need to use it.

The IS-LM model with minor amendments (most notably properly accounting for expectations to deal among other things with liquidity traps) remains a powerful tool to understand current phenomena. The problem is that it is not mainstream at all. What bothers me in Krugman’s post is the word “standard”, not “textbook analysis”.