Confidence and the Bazooka
It seems that we finally have our Bazooka. Quantitative Easing will be put in place; its size is slightly larger than expected (€60bn a month), and Mario Draghi, once again, seems to have gotten what he wanted in his confrontation with hawks within and outside the ECB (I won’t comment on risk sharing. I am far from clear about the consequences of that).
And yet, something is just not right. I am afraid that QE will end up like LTRO and all the other liquidity injections the ECB performed in the past. What bothers me is not the shape of the program (given the political constraints, one could hardly imagine something more radical), but Draghi’s press conference. Here is a quote from the introductory statement:
Monetary policy is focused on maintaining price stability over the medium term and its accommodative stance contributes to supporting economic activity. However, in order to increase investment activity, boost job creation and raise productivity growth, other policy areas need to contribute decisively. In particular, the determined implementation of product and labour market reforms as well as actions to improve the business environment for firms needs to gain momentum in several countries. It is crucial that structural reforms be implemented swiftly, credibly and effectively as this will not only increase the future sustainable growth of the euro area, but will also raise expectations of higher incomes and encourage firms to increase investment today and bring forward the economic recovery. Fiscal policies should support the economic recovery, while ensuring debt sustainability in compliance with the Stability and Growth Pact, which remains the anchor for confidence. All countries should use the available scope for a more growth-friendly composition of fiscal policies.
And here the answer to a question, even more explicit:
What monetary policy can do is to create the basis for growth, but for growth to pick up, you need investment. For investment you need confidence, and for confidence you need structural reforms. The ECB has taken a further, very expansionary measure today, but it’s now up to the governments to implement these structural reforms, and the more they do, the more effective will be our monetary policy. That’s absolutely essential, as well as the fiscal consolidation side. So structural reforms is one thing, budget and fiscal consolidation is a different issue. It’s very important to have in place a so-called growth-friendly fiscal consolidation for confidence strengthening. This combined with a monetary policy which is very expansionary, which has been and is even more so after our decisions today, is actually the optimal combination. But for this now, we need the actions by the governments, and we need the action also by the Commission, both in its overseeing role of fiscal policies and in its implementing the investment plan, which was launched by the President of the Commission, which was certainly welcome at the time, now has to be implemented with speed. Speed is of the essence.
The message could not be any clearer: Draghi expects the QE program to impact economic activity through private spending. What we have here is the nt-th comeback of the confidence fairy: accommodative monetary policy, structural reforms and fiscal consolidation, will cause a private expenditure surge (“[..] but will also raise expectations of higher incomes and encourage firms to increase investment today and bring forward the economic recovery“). We have been told this many times since 2010.
Unfortunately, it did not work like this, and I am afraid it will not this time either. The private sector signals in all surveys available that it is not ready to resume spending. If governments are not given the possibility to spend more, most of the liquidity injected into the system will remain idle, exactly as it was the case for the (T)LTRO.
The concept of countercyclical policies is so trivial as to become commonsensical: Governments should step in when markets step out, and withdraw when markets step in again. Filling the gap will actually sustain economic activity, and crowd-in private expenditure; more so, much more so, than filling the pockets of agents with money they are not willing to spend. This is the essence of Keynes. Since 2010 in Europe governments rushed to the exit together with markets; joint deleveraging meant depressed economy. How could one be surprised that confidence does not return?
I would like to add that invoking more active fiscal policy within the limits of the Treaties has the flavour of a bad joke. Just so as we understand what we are talking about, the EMU 18 in 2014 had a deficit-to-GDP ratio of 2.6% (preliminary estimates by the Commission, Ameco database); this means that to remain within the Treaty a fiscal stimulus would have to be limited to 0.4% of GDP. How large would the multiplier have to be, for this to lift the eurozone economy out of deflation? Even the most ardent Keynesian would have a hard time claiming that!! And also, so as we don’t forget, at less than 95% of GDP EMU, Gross public debt can hardly be seen as an obstacle to a serious fiscal stimulus. Even in the short run.
The point I want to make is that QE is all very good, but European governments need to be put in condition to spend the money. It is tiring to repeat the same thing again and again: in a liquidity trap monetary policy can only be a companion to the main tool that could be used by policy makers: fiscal policy.
But in Europe, bad economic policy is today considered a virtue.
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Sparse Thoughts of a Gloomy European Economist 
Hi Francesco, I think most economists (outside Germany?) would agree that Mario Draghi knows full well that the ECB’s current QE can only hope to underpin activity and prop up inflation through the expectations channel and thus though what one could call “confidence effects”. When base money is kept in reserve accounts with the central bank and there is no demand for new credit, monetary policy “pushes on a string”. This is probably the best that Draghi could get from his Governing Council (and implicitly from Euro Area governments). Regarding his call for fiscal support remaining within treaty limits, I doubt that it would have been his role to speak out against these treaties… So, I guess he gave it his best shot, for all the shortcomings of the QE plan; in particular, one should regret that debt purchases are not more massive, targeted on periphery countries that are still on unsustainable debt trajectories, and with full risk mutualisation…
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“The concept of countercyclical policies is so trivial as to become commonsensical: Governments should step in when markets step out, and withdraw when markets step in again. Filling the gap will actually sustain economic activity, and crowd-in private expenditure “…
This apodictic statement shows a lack of awareness of the history of macroeconomics. For the past almost hundred years, it has been characterized by pendulum swings from recommending monetary policies to fiscal policies and back again and so on. This was pointed out as early as 1968 by Miton Friedman:
Click to access 58.1.1-17.pdf
independently of his monetary theories.
These swings occur when the prevalent policy has failed. The great moderation believed in monetary policy, as Olivier Blanchard propounded shortly before the financial crisis. Since it did not prevent it, you now believe in fiscal policy.
But fiscal policy is only possible if a country can afford it. Greece can’t. And the necessity can be different in different countries. As Otmar Issing pointed out in the FT on October 23, 2014,
“Imagine you are asked to give advice to a country on its economic policy. The country enjoys near-full employment; its growth is above, or at least at full potential. There is no under-usage of resources – what economists call an output gap – and the government’s budget is balanced, but the debt level is far above target. To top it all monetary policy is extremely loose.
This is exactly the situation in Germany. Recently forecasts for growth have been revised downwards, but so far the overall assessment is unchanged. At present there is no indication of the country heading towards recession. Inflation is low but there is no risk of deflation. From a purely national point of view Germany needs a much less expansionary monetary policy than it is getting from the European Central Bank. This is a strong argument why fiscal policy should not be expansionary, too.
Where is the economic textbook that argues that such a country should run a deficit to stimulate the economy? There is hardly a convincing argument for such advice.”
So the largest economy of the Eurozone does not need fiscal stimulus. And no country of the Eurozone is expected to bail out other countries, as the EU treaty makes clear.
Furthermore, Germans are sceptical of fiscal stimulus. The reason is that it was tried and failed in the Seventies: The then socialist minister of the economy, Prof. Karl Schiller, a convinced Keynesian (and former member of the Nazi party; as you know, the Nazis were popular for their fiscal stimulus through public works (Autobahnen) and armaments – as you say, the essence of Keynes) tried it and resigned when it failed – for the reasons explained by Milton Friedman: It usually comes too late because of delays through legal obstacles and the inefficiency of public planning.
Since French and Italian interest rates are very low, they can of course try fiscal stimulus if you think their planning is better than Germans’ (which is pretty bad, as the Berlin Airport shows). The Venice “Moses project” might help – but, unfortunately, the mayor of Venice and a number of his sidekicks have been arrested for corruption in that project – one of those legal obstacles?
Think about it.
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You should not stay in a EMU if you think in terms of maximizing national interest only, without willing to coordinate with the others.
Think about it.
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Isn’t that what Greece, Portugal, Spain and Italy did?
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Germany acted against its national interest in joining the euro and it engaged considerable amounts of money for the GIPSI countries. What more can you ask for?
And Greece and Italy faked their statistics to join the euro. They obviously did this in their national interest. So you think they ought to leave?
Perhaps a good idea. Think about it.
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@ hanno A.
It is difficult to see how the formation of the Euro zone was ever in anyone’s interests. However it did not need to have become such an albatross. The Euro Zone needed a central bank with enough independence to hold to it’s price level trend target [although a NGDPL target would have been better] and it needed private lenders who would have realized that being in a currency union increases country risk, not decreases it. Instead ECB has let the price level fall farther and farther off track and borrowers in Greece, Portugal and Ireland and Spain were allowed to borrow too much. But even that pales in comparison to policies that seek to have governments reduce deficits during the recessions.
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Hello Hanno, I hope that you found the Leigh and Blanchard papers enlightening, but your comment leads me to guess you didn’t read (or understand) them… Re your post, you use a quote from Issing stating that the German economy is fine, well balanced. Do you really think that the German economy would not have a negative output gap if it wasn’t running consistently large current account surpluses? If Germany could no longer export, would domestic demand ensure full employment, a closed output gap and stable inflation of below, but close to, 2% ? … “Think about it”…
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Dear Patrick,
Dear Patrick,
Thank you for the links to my comment in
The time it took you to find them proves you think they are the most convincing ones. Actually, they are the same as put forward by P. Krugman and summarized in my former comment. L. Ball gives the technocratic justification for inflation: The central bank can manipulate interest rates more easily in a liquidity trap. But he admits that most macroeconomists assume that there were only two liquidity traps in twenty years. That means that someone who starts out with savings for his old age will have lost about 70 % of their value after twenty years – simply to give the central bank the possibility to maneuver at that time. The answer to that was given by Pieter Praet (you remember that inflation is equivalent to a tax) in
https://www.bis.org/review/r140528a.htm
“Maintaining a high tax almost all the time just for the pleasure of cutting it in a rare occurrence (and even if that rare event is going to bring sufficiently severe consequences) does not seem to pass the test of optimal intertemporal allocation of policy action. The costs of high inflation are high. But the benefits of having high inflation as a hedge against a crisis are small …”
L. Ball was aware of the weight of this argument and therefore tried to argue that there had been any number of zero lower bounds since WWII – far more than anybody else had been aware of. If you find that hard to believe, his theory falls down. In any case, it is a minority opinion (and, as I find, both factually and morally wrong).
As for Blanchard, he is aware of the harmfulness of inflation. He presents the case for inflation, but also its costs, and then says
“the question remains whether these costs are
outweighed by the potential benefits in terms of avoiding the zero interest rate bound. ”
Perhaps you might weigh these arguments for and against inflation. You know my answer.
Now you raise a new question with no connection to the former ones:
“If Germany could no longer export, would domestic demand ensure full employment, a closed output gap and stable inflation of below, but close to, 2% ? ”
Of course not, but what’s wrong with exporting? That’s a consequence of the division of labour (Adam Smith) and Krugman’s New Economic Geography.
Saraceno seems to think that it it is somehow evil to have export surpluses. But the money from those surpluses has to be invested in other countries – at least so macroeconomists including Krugman tell us. So: Was it evil of Britain to lend to the US and further their industrialization in the 19th century? Should the British have kept their money at home? The answer can only be: Are you serious?
Actually, Germany’s situation is indeed fragile, but that is the case of every economy, esp. of an exporting one because it feels downturns in its clients’ economies very strongly. Under Jospin, France’s growth was higher than Germany’s. At the beginning of the 20th century, Argentina was one of the richest countries in the world through it exports (!) of grain and meat. It is the proof that a country can lose its position – indeed ruin itself – through bad policies. Greece is just another example of that general rule. Germans are especially aware of it. “Vorsprung durch Panik”, the fear (or “angst”) of loss of competitiveness, has served them well in the crisis. But others will catch up. That’s history.
But Saraceno’s idea that Germany should actively try to be as inefficient as the PIIGS is beyond belief. What kind of economist is he? Ever heard of growth theory?
Perhaps we can agree that his blog gives you, Patrick, and me the opportunity of a nice discussion but that one should not take him seriously (of course, he makes nice graphs – better than most others).
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It is unclear that ECB’s QE will be continued and expanded until it is successful. If inflation does not pick up with 60b/m then the should try 120b and if that dose not work 240. Eventually someone will twig. But who knows if 60 i enough? Also governments should increase spending on activities that have present costs and future benefits. If they do not, this will increase the size of QE needed.
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Hello Hanno, following your last reponse to our exchange, I was a bit at a loss over how to respond without “talking past” each other. Your answer shows that you are certainly very “economically literate”, so why wasn’t the blog posts and discussions fruitful? I thought about how to provide a simple “closed economy” type analogy of the trade and financial flows within the euro area since the creation of the euro, but I just saw that Michael Pettis has provided a presentation of the issues which is much better than anything I could have hoped to do. So, I do hope that his article, here (http://blog.mpettis.com/2015/02/syriza-and-the-french-indemnity-of-1871-73/), will allow you to better understand where the ideas put forward by economists such as F. Saraceno, S. Wren-Lewis, P. Krugman, M. Pettis and many others are coming from. Regards!
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Hello Patrick,
I just saw your latest. Let me say immediately that I hope you can do much better than M. Pettis (you can see I do not share your high opinion of him). Let me refer you to the latest comment by Herbert February 6, 2015 at 1:46 pm to his post. I know of other cases of his sloppiness with facts. His verbosity prevents one from realizing as rapidly as with Saraceno how wrong he can be. Wren-Lewis and Krugman have become political propagandists. At least Krugman is entertaining. Where their ideas come from is not hard to understand – the question is: How good are their arguments?
You are aware that my main point is inflation and the fact that a considerable number of economists seems to ignore its cost.
Imprudent lending by banks seems to me to be a side issue – they are immediately punished for that by not getting their money back. Bankruptcy laws bring varying forms of debt forgiveness, and welfare laws protect debtors from starving. The question is what to do next. That is what I want sensible answers to. Would you lend to a bankrupt?
I hope we can continue our conversation!
Best regards,
Hanno
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Hano, Clearly inflation has some cost, that’s the reason central banks don’t set an inflation target of 100% pa. But the question is what is the cost of inflation compared to operating an economy at less than it’s potential.As for banks being punished for imprudent lending, no they are not, or not much. Look at the shareholders of the banks that lent to Greece, they were largely bailed out. From: Sparse Thoughts of a Gloomy European Economist To: thutcheson2000@yahoo.com Sent: Friday, February 6, 2015 12:16 PM Subject: [New comment] Confidence and the Bazooka #yiv6821647230 a:hover {color:red;}#yiv6821647230 a {text-decoration:none;color:#0088cc;}#yiv6821647230 a.yiv6821647230primaryactionlink:link, #yiv6821647230 a.yiv6821647230primaryactionlink:visited {background-color:#2585B2;color:#fff;}#yiv6821647230 a.yiv6821647230primaryactionlink:hover, #yiv6821647230 a.yiv6821647230primaryactionlink:active {background-color:#11729E;color:#fff;}#yiv6821647230 WordPress.com |
hanno achenbach commented: “Hello Patrick,I just saw your latest. Let me say immediately that I hope you can do much better than M. Pettis (you can see I do not share your high opinion of him). Let me refer you to the latest comment by Herbert February 6, 2015 at 1:46 pm to his” | |
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Hello Patrick,
Because of your good opinion of
http://blog.mpettis.com/2015/02/syriza-and-the-french-indemnity-of-1871-73/
I took another and closer look at this rambling, indeed meandering post.
The fact is that it is totally inconclusive. It ends with the statement:
“4. I am not smart enough to say with any confidence that one side or the other is right…”
Apart from that, all he says is that there must be writedown of debt in favour of indebted countries.
Now, as Schaeuble and others have been saying, what one needs is a bankruptcy law for sovereign states. But banktruptcy laws inevitably lead to some debt forgiveness, so he and other so-called hardliners accept that as a consequence.
But if one is bankrupt, one has to give everything one has to a receiver who will then decide what to do with it (of course leaving you enough to live on, even if in reduced circumstances – if there is too little, you are reduced to welfare). That means your freedom to decide what to do with your life is reduced – that is your price for your inability to pay your debts. Of course, that means your sovereignty is reduced. But after all, you were able to enjoy the use of the money that was lent to you. And when you borrowed it, you promised and thought you would repay it.
If you now say to your creditor:
“You were stupid enough to believe that I would be able to repay you, therefore I owe you nothing”
you mustn’t wonder he considers that as barefaced effrontery, adding insult to injury.
The least you can decently do is to make an effort. Now there may be differences of opinion on what a sufficient effort is. That is worth discussing. But if others have managed to get their act together, what’s wrong with asking the same of you? (“You” is Greece of course.)
A creditor will be willing to help if he can be convinced that it will bring back a sufficient amount of his claim. That is why central banks and the IMF lend to illiquid debtors – not to insolvent ones since that would mean throwing good money after bad.
And that brings me back to my central subject: inflation. Why should countries with citizens or banks that have lost money to citizens or banks of other countries punish their own poor, pensioners or middling paid workers – that is what inflation amounts to – to help those other countries? Help yes, but not impoverishment.
I would like to know your answer. But please, Patrick, think for yourself! Don’t appeal to “eminent economists” – we’re not in the Middle Ages when it was sufficient to cite an authority (“argumentum ad Aristotelem”). And I am willing to be proved wrong – all I want is to learn.
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thutcheson2:
A bank never gets as much in a bailout as from a reliable debtor. The private creditors (i.e. banks) had to agree to a 50 % haircut on their claims against Greece.
A government has to bail out its banks because its citizens’ money is in their hands. but governments try to do that as cheaply as possible. That is one of the reasons for the maximum limits on deposit insurance.
Just ask a banker.
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I don’t really disagree but I do think that banks lending to Greece should simply have had to live with default. They confused no currency risk with no country risk. From: Sparse Thoughts of a Gloomy European Economist To: thutcheson2000@yahoo.com Sent: Friday, February 6, 2015 2:08 PM Subject: [New comment] Confidence and the Bazooka #yiv9594810890 a:hover {color:red;}#yiv9594810890 a {text-decoration:none;color:#0088cc;}#yiv9594810890 a.yiv9594810890primaryactionlink:link, #yiv9594810890 a.yiv9594810890primaryactionlink:visited {background-color:#2585B2;color:#fff;}#yiv9594810890 a.yiv9594810890primaryactionlink:hover, #yiv9594810890 a.yiv9594810890primaryactionlink:active {background-color:#11729E;color:#fff;}#yiv9594810890 WordPress.com hanno achenbach commented: “thutcheson2:A bank never gets as much in a bailout as from a reliable debtor. The private creditors (i.e. banks) had to agree to a 50 % haircut on their claims against Greece.A government has to bail out its banks because its citizens’ money is in” | |
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thutcheson2 February 7, 2015 at 12:25 am:
Governments would be only too glad to let banks bear their own losses. But that is only possible if banks’ capital is sufficient, otherwise the banks would default on the money of their depositors, for instance you and me.The damage would go far beyond anything the banks -or the bankers who made the mess- can pay. That is why governments bail them out. That is a consequence of the system of banking in Western economies as it has existed for a long time. If you want to change it, that would be going far beyond the problems caused by Greece. You want to weigh the costs and benefits of such a change. In any case, it will not change the problems of the past.
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That’s true enough about systemic risk a la the US in 2008, but did not apply to the banks that should have lost from their lending to Greece. And even for systemic risk, I think it would have been preferable to let legacy shareholders loose everything (the failed to prevent managers from taking excessive risks), recapitalize the banks and sell them off again. From: Sparse Thoughts of a Gloomy European Economist To: thutcheson2000@yahoo.com Sent: Saturday, February 7, 2015 6:16 AM Subject: [New comment] Confidence and the Bazooka #yiv3451183178 a:hover {color:red;}#yiv3451183178 a {text-decoration:none;color:#0088cc;}#yiv3451183178 a.yiv3451183178primaryactionlink:link, #yiv3451183178 a.yiv3451183178primaryactionlink:visited {background-color:#2585B2;color:#fff;}#yiv3451183178 a.yiv3451183178primaryactionlink:hover, #yiv3451183178 a.yiv3451183178primaryactionlink:active {background-color:#11729E;color:#fff;}#yiv3451183178 WordPress.com hanno achenbach commented: “thutcheson2 February 7, 2015 at 12:25 am:Governments would be only too glad to let banks bear their own losses. But that is only possible if banks’ capital is sufficient, otherwise the banks would default on the money of their depositors, for instance” | |
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