Mario Draghi is a Lonely Man
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.
The job of a central banker is extremely hard nowadays, and it is becoming more and more hard to justify why the task of stabilizing the European economy must be left on the shoulders of the ECB alone.
When arguing in favour of fiscal policy over monetary policy, Keynes had in mind precisely a liquidity trap situation like the current one, with excessive hoarding by the private sector, and broken transmission mechanisms from interest rates and liquidity to real activity. In these cases,monetary policy loses traction, and the witness has to be taken by fiscal policy until private spending resumes.
But the situation Keynes describes is a piece of cake compared to what Mario Draghi is facing. On top of the liquidity trap, SuperMario needs to deal with a suffering banking sector, with the effects of asset price inflation that Nicolò highlighted, and last but most important, with a monetary union that is both incomplete and non optimal: diverging economic performances, very limited automatic rebalancing forces, schizophrenic institutions; (think of the banking non-union compromise). The ECB has a couple of instruments, and faces half a dozen objectives at least. No wonder Draghi has a hard time sharing Barroso’s upbeat mood.
In the past month the discussion on austerity and on fiscal policy in general has disappeared from the public debate. And yet, we are confronted, more than ever, with the absurdity of a mix of rules and ideology (the latter shaping the former) that prevents the implementation of a commonsensical policy mix: differentiated and coordinated fiscal policies (consolidation in the periphery accompanied by expansion in the core), and a sharing of tasks with the ECB. Bold action should be taken to put fiscal policy at the centre of the scene, from a revision/repeal of the fiscal compact, to a common management of public debt. But no, eurozone governments are inert, happy with themselves, and cheering at the dead cat bounce effect. Tout va très bien, Madame la Marquise…
Mario Draghi today is more lonely than ever.