I was intrigued by Munchau’s editorial on central bank independence, that appeared on today’s FT. Munchau argues that central banks’ choices are increasingly political in nature, especially if their mandate is broad, as is the case for example of the Fed. His argument is that a broad mandate implies tradeoffs, and as such it does not go well with central bank independence.
I must say I am unconvinced to say the least, on at least two levels.
First, I do not see how a strict mandate would make central bank choices less political in nature. It makes them more opaque, but by no means less political. I wrote about this in a paper on ECB action during the crisis, and more succinctly in an op-ed for Social Europe co-written with Yan Islam back in 2015. Let me quote a few excerpts from that piece:
A dual mandate requiring the central bank to pursue two, sometimes conflicting, objectives forces the institution to make inherently political choices. Far from being a shortcoming, this allows for a more flexible and unbiased monetary policy. A central bank following a dual mandate will always be able to take an aggressive stance on inflation, if it deems this necessary. Appropriate choice of the weights given to employment and inflation would allow incorporation of any combination of the two objectives. […]
Inflation-targeting central banks, such as the ECB, de facto also target growth but timidly and without explicitly saying so. This leads to low reactivity and opaque communication, hampering in turn the capacity of central banks to manage expectations and effectively steer the economy. A good case in point is the ECB that – compared to the Fed – did “too little and too late” from 2009, amid a constant debate on whether the inflation-targeting mandate was being violated. […]
ECB opacity is intrinsically linked to the confusion between its mandate and its activities in the real world, and as such it cannot lead to any meaningful discussion but only to legalistic disputes on the definition of price stability, of how medium is the medium term and the like.
The main merit of a dual mandate is in fact that it lets the political nature of monetary policy emerge without ambiguities. It is indeed true that monetary policy with a dual mandate requires hard choices, just like those debated these days, and hence is political by its very nature. The point is, so is monetary policy with a simple inflation-targeting objective. The level of inflation targeted, and the choice of the instruments to attain it, is anything but neutral in terms of its consequences on the economy. Thus, an inflation-targeting central bank is as political in its actions as a bank following a dual mandate, the only difference being that In the former case the political nature of monetary policy is concealed behind a technocratic curtain.
In a sentence, we argued that monetary policy choices are always political, and as such they should be incorporated in the policy mix, without hiding behind what Yan and I called a technocratic illusion.
Munchau’s link between the broadness of the mandate and its political nature, is simplistic and in my opinion strongly misleading. In fact, we concluded back in 2015 that it is linked to a specific intellectual framework
The profound justification of an exclusive focus on price stability can only lie in the acceptance of a neoclassical view in which virtually powerless governments need to make little or no choices. Once we dismiss that platonic view, monetary policy acquires a political role, regardless of the mandate it is given.
The second reason why Munchau’s argument is unconvincing is the conclusion, somewhat implicit in his piece, that a central bank making political choices needs to be a “government agency”. Why is it so, exactly? I fail to see it. What matters is not that the central bank is controlled by the finance ministry, but that it is accountable, like any other actor doing policy, in a system of well functioning checks and balances.
Once we recognize that a central bank has a political role, we need to make sure first, that its mandate is not falsely perceived as technocratic; and second, that its actions are properly embedded in a balanced policy mix, in which there is coordination with, not subordination to, the other branches of government. It seems to me that the US institutional system comes pretty close to this. The same cannot be said for the eurozone.
A couple of days ago I had an interesting debate hosted by France 24, on Trumponomics. Interesting because there was an overall agreement between me and Dan Mitchell from Cato Institute, even if from totally opposite points of view, on the fact that Trumponomics does not exist. The Donald is pushing forward a number of inconsistent measures, whose final effect is impossible to forecast (except that it is a safe bet to say that it will not end well).
Mitchell argued of course that the only good policies imply the downsizing of the government. As one can easily imagine I would tend to disagree. And over and over again, during the 40 or so minutes of discussion, came back the reference to the golden era of Ronald Reagan. Trump needs to cut taxes, as Reagan did, and downsize government, as Reagan did. And growth and unemployment will return, as under Reagan
When I said that the problem of the US was not the lack of jobs per se, but rather the increasingly unequal distribution of income, that started precisely under Reagan, Mitchell replied that this was false (I officially spread fake truths!), claiming that median income under Reagan increased. Well, think again. An old post by Paul Krugman had already dispelled the mith, and I had written on it myself. I copy the figure from that post (updated) here:
So, while it is true that median income increased under Reagan-Bush (Mitchell is formally right), it is hard to define it an era or decreasing inequality I My conclusion back then was that growth does not lift all boats, and trickle-down economics does not exist. And Reagan did not do that well in terms of growth either. And did I mention twin deficits?
Just a final remark. The downsizing of government under Reagan is also a myth (which is rather good news, by the way): Look at OECD data:
I rest my case. People at Cato should pick their role models more carefully.
Just a very quick and unstructured note on Greece. There is lots of confusion under the sky, and it seems to me that creditors are today advancing in sparse order.
Yesterday something rather upsetting happened, as the Eurogroup suspended bailout payments because Greece engaged in some extra expenditures. These are mostly targeted to pensioneers and to the Greek islands that had to endure unexpected costs linked to the refugee crisis. Unexpectedly, the Commission is siding with Greece, with Pierre Moscovici arguing that the country is on target, and that its effort has been remarkable so far. In fact, I have understood, Greece is doing so well that it overshot the target of structural surplus for 2016, and it it these extra resources that it is engaging in order to soft the impact of austerity.
And then there is the IMF, accused by Greece of pushing for more austerity, is also under attack from EU institutions (Eurogroup and Commission) for its refusal to join the bailout package. The Fund has hit back, in a somewhat irritual blog post signed by Maurice Obstfeld and Poul Thomsen (not just any two staffers) and seems not to be available to play the scapegoat for a program that in their opinion was born flawed. In fact, I think that more than to Greece, Obstfeld and Thomsen have written with the other creditors in mind.
I have two considerations, one on the economics of all this, one on the politics.
- I think I will side with the IMF on this. At least with the recent IMF. Since the very beginning The IMF has dubbed as irrealistic the bailout package agreed after the referendum of 2015 . The effort demanded to Greece (the infamous 3.5% structural surplus to be reached by 2018) was recognized to be self-defeating, and the IMF asked for more emphasis on reform, with in exchange a more lenient and realistic approach to fiscal policy: debt relief and much lower required suprluses (1.5% of GDP). In other words, the IMF seems to have learnt from the self-defeating austerity disaster of 2010-2014, and to have finally an eye to the macroeconomic consistency of the reform package. I still believe that the bailout should have been unconditional, and require reforms once the economy had recovered (sequencing, sequencing, and sequencing again). But still, at least the IMF now has a coherent position. Moscovici’s FT piece linked above also seems to go in the same direction, arguing that nothing more can be asked to Greece. It falls short of acknowledging that the package is unrealistic, but at least it avoids blaming the country. And then there is the Eurogroup, actually, Mr Dijsselbloem and Schauble (let’s name names), that did not move an inch since 2010, and fail to see that their demands are slowly (?) choking the Greek economy, stifling any effort to soften the hardship of the adjustment.
- The political consideration is that the hawks still give the cards, as they dominate the eurogroup. But they are more isolated now. Evidence is piling that the eurozone crisis has been mismanaged to an extent that is impossible to hide, and that the austerity-reforms package that the Berlin View has imposed to the whole eurozone is a big part of the explanation for the political disgregation that we see across the continent. The more nuanced position of the Commission, the IMF challenge to the policies dictated by the hawks, therefore represent an opportunity. There is a clear political space for an alternative to the Berlin View and to the disastrous policies followed so far. The question is which government will be willing (and able) to rise to the occasion. I am afraid I know the anwser.
Update (1/7/2016): The whole paper is now available on Repec.
I have recently written a text on EMU governance and the implementation of a Golden Rule of public finances. I will provide the link as soon as it comes out. The last section of that paper can be read stand alone (with some editing). A bit long, I warn you, but here it is:
Because of its depth, and of its length, the crisis has triggered an interesting discussion among economists about whether the advanced economies will eventually return to the growth rates they experienced in the second half of the twentieth century.
One view, put forward by Robert Gordon focuses on supply-side factors. Gordon argues that each successive technological revolution has lower potential impact, and that in this particular moment, “Slower growth in potential output from the supply side, emanating not just from slow productivity growth but from slower population growth and declining labor-force participation, reduces the need for capital formation, and this in turn subtracts from aggregate demand and reinforces the decline in productivity growth.”
In a famous speech at the IMF in 2013, later developed in a number of other contributions, Larry Summers revived a term from the 1930s, “secular stagnation”, to describe a dilemma facing advanced economies. Summers develops some of Gordon’s arguments to argue that lower technical progress, slower population growth, the drifting of firms away from debt-financed investment, all contributed to shifting the investment schedule to the left. At the same time, the debt hangover, accumulation of reserves (public and private) induced by financial instability, increasing income inequality (on that, I came first!), tend to push the savings schedule to the right. The resulting natural interest rate is close to zero if not outright negative, thus leading to a structural excess of savings over investment.
Summers argues that most of the factors exerting a downward pressure on the natural interest rate are not cyclical but structural, so that the current situation of excess savings is bound to persist in the medium-to-long run, and the natural interest rate may remain negative even after the current cyclical downturn. The conclusion is not particularly reassuring, as policy makers in the next several years will have to navigate between the Scylla of accepting permanent excess savings and low growth (insufficient to dent unemployment), and the and Charybdis of trying to fight secular stagnation by fuelling bubbles that eliminate excess savings, at the price of increased instability and risks of violent financial crises like the one we recently experienced.
The former IMF chief economist Olivier Blanchard has elaborated on the meaning of Summers’ conjecture for macroeconomic policy. If interest rates will remain at (or close to) zero even once the crisis will be over, monetary policy will continuously face the Scylla and Charybdis. The recent crisis is a good case study of this dilemma, with the two major central banks of the world under fire from some quarters, for opposiite reasons: the Fed for having kept interest rates too low, contributing to the housing bubble and the ECB for having done too little and too late during the Eurozone crisis.
Drifting away from the Consensus that he contributed to consolidate, Blanchard concludes that exclusive reliance on monetary policy for macroeconomic stabilization should be reassessed. With low interest rates that make debt sustainability a non-issue; with financial markets deregulation that risks yielding more variance in GDP and economic activity; and with monetary policy (almost) constantly at the Zero Lower Bound, fiscal policy should regain a prominent role among the instruments for macroeconomic regulation, beyond the cycle. This is a very important methodological advance.
Nevertheless, in his plea for fiscal policy, Blanchard falls short of a conclusion that naturally stems from his own reading of secular stagnation: If the economy is bound to remain stuck in a semi-permanent situation of excessive savings, and if monetary policy is incapable of reabsorbing the imbalance, then a new role for fiscal policy may appear, that goes beyond the short-term stabilization that Blanchard (and Summers) envision. In fact, there are two ways to avoid that the ex ante excess savings results in a depressed economy: either one runs semi-permanent negative external savings (i.e. a current account surplus), or one runs semi-permanent government negative savings. The first option, the export-led growth model that Germany is succeeding to generalize at the EMU level, is not viable, except for an individual country implementing non cooperative strategies, because aggregate current account balances need to be zero. The second option, a semi-permanent government deficit, needs to be further investigated, especially in its implication for EMU macroeconomic governance
There are a number of ways, not necessarily politically feasible, to allow EMU countries to run semi-permanent government deficits. A first one could be to restore complete national budget sovereignty, (scrapping the Stability Pact). This would mean relying on market discipline alone for maintaining fiscal responsibility. As an alternative, at the opposite side of the spectrum, countries could create a federal expenditure capacity (which would imply the creation of an EMU finance minister with capacity to spend, the issuance of Eurobonds, etc.). Such an option is as unrealistic as the previous one. In an ideal world, the crisis and deflation would be dealt with by means of a vast European investment program, financed by the European budget and through Eurobonds. Infrastructures, green growth, the digital economy, are just some of the areas for which the optimal scale of investment is European, and for which a long-term coordinated plan would necessary. The increasing mistrust among European countries exhausted by the crisis, and the fierce opposition of Germany and other northern countries to any hypothesis of debt mutualisation, make this strategy virtually impossible. The solution must therefore be found at national level, without giving up European-wide coordination, which would guarantee effective and fiscally sustainable investment programs.
In general, the multiplier associated with public investment is larger than the overall expenditure multiplier. This is particularly true in times of crisis, when the economy is, like today, at the zero lower bound. With Kemal Dervis I proposed that the EMU adopts a fiscal rule similar to the one implemented in the UK by Chancellor of the Exchequer Gordon Brown in the 1990s, and applied until 2009. The new rule would require countries to balance their current budget, while financing public capital accumulation with debt. Investment expenditure, in other words, would be excluded from deficit calculation, a principle that timidly emerges also in the Juncker plan. Such a rule would stabilize the ratio of debt to GDP, it would focus efforts of public consolidation on less productive items of public spending, and would ensure intergenerational equity (future generations would be called to partially finance the stock of public capital bequeathed to them). Last, but not least, especially in the current situation, putting in place such a rule would not require treaty changes, and it is already discussed, albeit timidly, in EU policy circles.
To avoid the bias towards capital expenditure that the golden rule could trigger, we proposed that at regular intervals, for example in connection with the European budget negotiation, the Commission, the Council and the Parliament could find an agreement on the future priorities of the Union, and make a list of areas or expenditure items exempted from deficit calculation for the subsequent years.
The news of the day is that François Hollande will not seek reelection in May 2017. This is rather big news, even it if was all too logical given his approval ratings. But what went wrong with Hollande’s (almost) five years as a President?
Well, I believe that the answer is in a post I wrote back in 2014, Jean-Baptiste Hollande. There I wrote that the sharp turn towards supply side measures (coupled with austerity) to boost growth was doomed to failure, and that firms themselves showed, survey after survey, that the obstacles they faced came from insufficient demand and not from the renown French “rigidities” or from the tax burden. I was not alone, of course in calling this a huge mistake. Many others made the same point. Boosting supply during an aggregate demand crisis is useless, it is as simple as that. Allow me to quote the end of my post:
Does this mean that all is well in France? Of course not. The burden on French firms, and in particular the tax wedge, is a problem for their competitiveness. Finding ways to reduce it, in principle is a good thing. The problem is the sequencing and the priorities. French firms seem to agree with me that the top priority today is to restart demand, and that doing this “will create its own supply”. Otherwise, more competitive French firms in a context of stagnating aggregate demand will only be able to export. An adoption of the German model ten years late. I already said a few times that sequencing in reforms is almost as important as the type of reforms implemented.
I am sure Hollande could do better than this…
It turns out that we were right. A Policy Brief (in French) published by OFCE last September puts all the numbers together (look at table 1): Hollande did implement what he promised, and gave French firms around €20bn (around 1% of French GDP) in tax breaks. These were compensated, more than compensated actually, by the increase of the tax burden on households (€35bn). And as this tax increase assorted of reshuffling was not accompanied by government expenditure, it logically led to a decrease of the deficit (still too slow according to the Commission; ça va sans dire!). But, my colleagues show, this also led to a shortfall of demand and of growth. A rather important one. They estimate the negative impact of public finances on growth to be almost a point of GDP per year since 2012.
Is this really surprising? Supply side measures accompanied by demand compression, in a context of already insufficient demand, led to sluggish growth and stagnating employment (it is the short side of the market baby!). And to a 4% approval rate for Jean-Baptiste Hollande.
OFCE happens to have published, just yesterday, a report on public investment in which we of join the herd of those pleading for increased public investment in Europe, and in particular in France. Among other things, we estimate that a public investment push of 1% of GDP, would have a positive impact on French growth and would create around 200,000 jobs (it is long and it is in French, so let me help you: go look at page 72). Had it been done in 2014 (or earlier) instead of putting the scarce resources available in tax reductions, things would be very different today, and probably M. Hollande yesterday would have announced his bid for a second mandate.
In a sentence we don’t need to look too far, to understand what went wrong.
Two more remarks: first, we have now mounting evidence of what we could already expect in 2009 based on common sense. Potential growth is not independent of current economic conditions. Past and current failure to aggressively tackle the shortage of demand that has been plaguing the French – and European – economy, hampers its capacity to grow in the long run. The mismanagement of the crisis is condemning us to a state of semi-permanent sluggish growth, that will keep breeding demagogues of all sorts. The European elites do not seem to have fully grasped the danger.
Second, France is not the only large eurozone country that has taken the path of supply side measures to pull the economy out of a demand-driven slump. The failure of the Italian Jobs Act in restarting employment growth and investment can be traced to the very same bad diagnosis that led to Hollande’s failure. Hollande will be gone. Are those who stay, and those who will follow, going to change course?
This post is nothing new. It is just a reminder for non European readers (or for distracted European readers), about the way things work in the EMU. The German Bundesbank President Weidmann violently attacked the European Commission for failing to enforce fiscal discipline within the Stability Pact.
What is wrong with this? Is this not just another confirmation of the old cliché that Germans are obsessed with respecting the rules?
Well, think again. Everybody knows that EU countries need to curb their public deficit to be below 3% of GDP, and need to aim to structural balance. But it is less known, especially outside Europe, that since 2011, as a part of the so-called “six-pack”, the EU introduced the Macroeconomic Imbalances Procedure (MIP), “which aims to identify, prevent and address the emergence of potentially harmful macroeconomic imbalances that could adversely affect economic stability in a particular Member State, the euro area, or the EU as a whole”.
This procedure builds on a scoreboard of 14 indicators, among which we can read the following:
- 3-year backward moving average of the current account balance as percent of GDP, with thresholds of +6% and -4%;
Yeah, that is right, at the very first place. And guess what, Germany’s current account surplus, since the MIP came into force has been above 6% every single year. (it is expected to be 9% in 2016).
And yet, no corrective action has been imposed, and of course no sanctions. I understand that Germany has no problems with not being sanctioned. But maybe it would be wise to keep a low profile regarding others’ violations..
So, for once, I agree with Jens Weidmann: the Commission should be harsher on those who do not respect the rules. And of course, it will, but just with some. Among the many problems European governance has, this is not the least: all animals are equal, but some animals are more equal than others.
A sentence from Donald Trump’s victory speech retained a good deal of attention:
We are going to fix our inner cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals. We’re going to rebuild our infrastructure, which will become, by the way, second to none. And we will put millions of our people to work as we rebuild it.
This was widely quoted in the social media, together with the following from an FT article about the Fed:
In particular, some members of his economic advisory team are convinced that central banks such as the US Federal Reserve have exhausted their use of super-loose monetary policy. Instead, in the coming months they hope to announce a wave of measures such as infrastructure spending, tax reform and deregulation to boost growth — and combat years of economic stagnation.
In spite of its vagueness, the idea of an infrastructure push has sent markets
to beyond the roof. In short, a simple (and rather generic) speech on election night has dispelled all the anxiety about the long phase of uncertainty that we face. So long for efficient markets…
But this is not what I care about here. The point I want to make is that Trump’s announcement has triggered a strange reaction. Something going like: “See? Trump managed to break the establishment’s hostility to Keynes and to finally implement the stimulus policies we need. Forget the sexism and the p-word, the attacks on minorities, the incompetence. Enter Trump, exit neo-liberalism”. I see this especially (but not only) among Italian internauts, who tend to project the European situation in other contexts.
Well, I have some reservations on this claim. Where to start? Maybe with the “Contract with the American Voter“, that together with the (generic, once more) promise of new investment, promised a massive withdrawal of the State from the economy? Or from the fact that “Establishment Obama” made Congress vote, a month into his presidency, a “Recovery Act (ARRA)” worth 7% of GDP, that successfully stopped the free-fall and helped restore growth? Or from the fact that the “anti-establishment” Tea Party forced austerity since 2011, climaxing in the sequester saga of 2013?
Critics of current austerity policies in Europe should not be delusional. Trump is not the John Maynard Keynes of 2016. His agenda is, broadly speaking, an agenda of deregulation, tax cuts for the rich, and retreat of the State from the economy. Not to mention the strong chance of a more hawkish Fed in the future. To sum up, Trump is, in the best case scenario a new Reagan, substituting military Keynesianism with bridges’ Keynesianism. And we all (should) know that Reaganomics does shine much less than usually claimed.
Those progressives looking for a Trump Keynesian agenda should probably have looked more carefully at the plan proposed by “establishment-Clinton”: A significant infrastructure push (in fact, the emphasis on infrastructures was the only point in common between the two candidates), with the ambition to crowd-in private investment. And what is more important, such an expansionary fiscal policy was framed within a more active role of the government in key sectors like education, health care, and with increased progressivity of the tax system.
Would we have had Hilary Rodham Keynes? Unfortunately we’ll never know…