Two articles on today’s Financial Times puzzle me. The first (Weidmann warns of currency war risk) offers yet another example of how economic analysis sometimes leaves the way to ideological beliefs. The Bundesbank’s president argues (as he already did in the past) that giving up inflation targeting hampers central bank independence. How? Why? He does not bother explaining.
What I think he has in mind is that once the objective of the central bank goes beyond strict inflation targeting, monetary policy needs an arbitrage between often conflicting objectives (typically unemployment and inflation). It is the essence of the dual mandate. This of course moves monetary policy out of the realm of technocratic choice, and makes it a political institution (Stephen King explains it nicely). I would argue that this is normal once we abandon the ideal-type of frictionless neoclassical economics, and we accept that we may have a tradeoff between inflation and unemployment. But this is not the issue here. The issue, and the puzzle, is why transforming the choice from technocratic to political, should necessarily lead to giving up independence. Read more
Countries like the United States, Japan or the United Kingdom can finance their debt at zero or negative real interest rates. This in spite of debt levels higher than those of the euro area, and growth forecasts that are not necessarily better. Meanwhile, the eurozone peripheral countries have to deal on a daily basis with the mood of markets, and to pay interests on debt at the limit of sustainability.
The reasons for this state of affairs are clear, and have been repeatedly mentioned. Eurozone countries are forced to borrow in a currency that they do not issue: the euro is in effect a foreign currency. To quote Paul de Grauwe,
In a nutshell the difference in the nature of sovereign debt between members and non-members of a monetary union boils down to the following. Members of a monetary union issue debt in a currency over which they have no control. It follows that financial markets acquire the power to force default on these countries. This is not the case in countries that are no part of a monetary union, and have kept control over the currency in which they issue debt. These countries cannot easily be forced into default by financial markets.
In other words, peripheral eurozone countries are in the same situation of Latin America in the eighties: they are forced to pay high risk premia to markets fearing the risk of default, induced by the vicious circle austerity-recession-debt burden.