The next Euro-plan, sensible or senseless?

There are rumours in the Welt am Sonntag and the Wall Street Journal of another grand plan to save the Euro. The main outlines have already been foreshadowed in recent weeks by the main players (Draghi, van Rompuy, Barosso, Juncker): a re-focus on bailouts for banks, not governments, together with stronger central fiscal institutions that will control and perhaps even mandate national reforms and budgetary choices.

One can see where they are coming from: having figured out that several governments can’t possibly balance their own books and politically cannot afford to let their banks fail, the ECB and the European political elites have woken up to the fact that the banks need to be brought into the fold. Options include these banks being bought up by the ECB, given unlimited credit by the ECB, or be subjected to European financial institutions. At the same time, the need for growth means the European elite has finally woken up to the fact that Southern Europe is simply not politically able to push through major reforms and is now proposing central institutions that will do it for them. In exchange for this loss of sovereignty, they will get more cheap loans, perhaps even Eurobonds (essentially allowing Greeks and others to borrow as much as they want whilst the rest of Europe has to pay them back).

I have called for the buy-up of banks by the ECB in the past (see this previous post, this other one, yet another one, and the links from there to outside data) so am glad they are finally starting to wake up to this issue. Yet, what appears to be on the table now is worse than ‘muddling on as usual’: from what it sounds like, it is a recipe for the break-up of the European Union.

Let us first take the whole issue of bank-buyouts. At present, European banks have lots of toxic debts. Unlike US banks though, their toxic debt is to a large extent of an institutional nature: government bonds that wont be paid back and loans to other banks and major institutions that are also unsure. Hence the solvency of banks is more an issue of governments and institutions.

The problem banks in questions, particularly in Southern Europe, are furthermore joined at the hip with their political systems: they have bonds in their government debts because the same group runs the politics as the banks. The open financial flows between those governments and their banks hence means that helping one inevitably means taking on the problems of the other too.

So what you really want is a wholesale restructuring of these banks so that they do not lend vast amounts to local and national governments and instead get more focused on loans to entrepreneurs. Yet, those banks are permeated with political networks and hence one would have to have a large number of financially skilled monitors throughout these banks to prevent financial flows to political allies.

Is the ECB or the European Commission capable of affecting such a restructuring? Not on its own: it simply does not have the tens of thousands of financially skilled employees to do all the monitoring.

Who does have the manpower? The only group that comes close is in healthy banks in the rest of Europe and the rest of the world. Hence the only way in which banks would be properly restructured is if they are taken on as a project by major for-profit foreign financial institutions whose first concern will be all these ties to local government. Furthermore, because of the open financial flows between governments and their banks in the problem countries, for-profit foreigners would probably need to have control of all the banks in a country to prevent them being unfairly treated compared to other banks in that country.

Now, that makes it a very tough and big job: one conglomerate of foreign banks would have to ‘take on’ all Spanish banks, another would have to take on all Greek banks, etc. The ECB could indeed help organise this by buying up these banks, and then simply auctioning off all these banks to conglomerates, but that in itself is a tough job.

Is this what is on the table? Not at all. The ECB has realised it doesn’t have the manpower to restructure these banks so is simply proposing to give these banks access to cheap loans whilst having a small but supposedly powerful financial institution monitor those banks.

Let us be clear about such a plan: it is ludicrous and naive. These banks are going to run rings round those few monitors and in a hundred and one ways are going to remain tied at the hip with their local politicians. Surplus money will flow (via bonds and loans) to those local politicians who will use it to prevent making tough choices and to pay off their own supporters.

The banking aspect of the plan will thus only further strengthen the political and economic paralysis of the problem countries, making the eventual crash even more spectacular. And financial markets will see it coming (though it might take them a few weeks to figure out what is really going on) and will continue the preparations for a financial collapse of Southern Europe.

Then the political aspect of the plan, which is to impose fiscal restraint and structural reforms on non-reforming countries via more stringent central institutions.

In the optimal scenario, Southern European politicians would be implementing true structural reforms to make their economies more competitive and thus have some hope of growth in the medium term. This includes allowing firms to more easily fire workers. It includes a massive reduction in the promised pensions (which are unaffordable). It includes the breaking up of a zillion local cartels, including those of the lawyers, the taxi drivers, the pharmacists, the teachers, the accountants, the medics, etc. It includes an opening up of the local financial markets to true foreign competition. It includes a radical trimming of the bureaucracy. It includes a reform of all the infrastructure and property institutions which are rife will corruption.

This kind of reform is not so much costly from a financial point of view, but takes an awful lot of political will. It needs an invigorated civil service and a sense of national crisis on the part of the populations. It needs the old guard to give the young and idealistically ambitious the power and the opportunity to reorganise things.

You should by now realise why this is not happening: the young and ambitious have fled Southern Europe and are now in the US, Australia, Northern Europe, or even in former colonies. The civil service in these countries is demoralised as their wages have been reduced and their pension prospects look bleaker, so the remaining civil servants (those who couldn’t get a decent job elsewhere) are mainly hanging on to what they have and in no way are prepared for the daring deep reforms needed. Similarly, those with remaining jobs and positions are those dependent on their political connections. Paralysis is deepening, not reducing.

And how is the new Europlan proposing to break this deadlock? By having a bunch of snot-nosed German, French, English, and other European civil servants come and tell the Southern Europeans what reforms to instigate, how much to cut pensions, etc.?

Why is this an act of utter lunacy? Well, just imagine what these local Southern European politicians are going to do the second after they have agreed to such a plan and hence got access to more cheap loans? They are going to complain and sabotage all those deeply unpopular reforms. And their populations will lap it up, becoming highly Euro-sceptic in a matter of months. They will quickly grasp onto the way out of such a self-esteem trap: take the money and simply not implement any real changes (there are hundred and one ways for national politicians to not actually implement laws or frustrate them), literally forcing the European institutions to realise that they cannot actually dictate anything, putting them the stark choice of either to keep bailing out or to be seen to stop the money tap.

Eventually, the money tap will indeed by stopped by which time the antipathy between the European countries will have become so high that most countries will simply take the hit, default, reintroduce their own currencies, and effectively leave the European Union.

As a passionate believer in the European project, it is simply heart-wrenching to see it destroyed by such political incompetency. It is not quite Versailles all over again, but one gets the same feeling of having to watch politicians make a complete balls-up of the situation. I can only hope that the usual inability to agree on anything in Europe will torpedo this plan.

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JC
JC
9 years ago

Paul, if you or others like the EU etc, the latest plan set out by Germany could work, as long as the ECB eases up on monetary policy. There was some okish news that came out during the weekend. Ireland voted yes to austerity by 60%. The Spanish government government reported that the local governments are going to see balanced budgets this year and are at balance right now. Portugal reported that they’ve met the austerity guidelines as agreed to and the economic downturn , although continuing, looks like it may have hit close to bottom.

The big problem is Greece and we’ll see what happens there.

Look, in my opinion the Euro was a really stupid idea, but now it’s there it would be hugely costly to give it up- even for Germany. The EU absorbs 70% of the Germany’s exports so they certainly aren’t out of the woods either if the region collapses.

As for the recent Master Plan, we have been hearing about since the weekend, it’s really just an affirmation of the Maastricht Treaty with teeth and the ability to float bonds through some means that avoids the constitutionality issue for Germany.
It could work.

I’m not as pessimistic about the current state of the banking system in southern Europe as you seem to be, especially after the stress testing that will be done by the end of the month in Spain. That will help determine the state of play there. The Italian banks are not as badly off as Italy didn’t experience a land boom like Spain etc.
The big problem going forward is the bank run and whether it can be stopped.

I still think it doesn’t fall apart, but I’m not 100% certain, as the ECB is a very stupid central bank.

john walker
john walker
9 years ago

There is provably a bit of real estate debt hangover in Italy ( and Spain?)
In late 2007 we were staying in a pretty good restaurant in Sansepolcro ( a town on the not so fashionable eastern fringe of Tuscany). Got talking with a English couple who were looking at buying a holiday villa in the area , it was cheaper than the main part of Tuscany- The going price for a ruin was 2 million pounds.

Paul Frijters
Paul Frijters
9 years ago

JC,

Eurobonds cant work and I doubt the Germans would go for them in disguise. A more democratic ECB money-helicopter drop under the slogan “print money for the population, not the bankers” would be far preferable and doesn’t require a major political coalition.

Yes, I am also increasingly coming to the position that the ECB lacks political nous at the top. When they were doing nothing but a bit of money printing and insisting on fiscal restraint, I though they were doing ok, but now?

The option they might take and that I am hoping for as a second best to population-money-printing is for the ECB to nullify the financial effect of a Greek collapse on the banks outside Greece, i.e. to replace any defaulted Greek bonds with euros. That would have to be carefully planned and kept secret though because the moment you would announce something like this outsider speculators will buy up the Greek bonds inside Greece. If you do it in the open you would have to rely on some kind of grandfathering rule in terms of ownership in the past, but that’s tricky.

Tel
Tel
9 years ago
Reply to  Paul Frijters

“print money for the population, not the bankers”

It would require a renegotiation of the treaty, and since the EU only exists because of treaties, those are the only thing that provide the EU (and also ECB) with any authority whatsoever. Breaking a treaty without due process would effectively make the EU an illegal organization, which I doubt would assist European stability.

Paul Frijters
Paul Frijters
9 years ago

john,

yes, the main problem in Spain was the property market collapse, which might not even be over yet. Yet, from a longer-term perspective the preceding boom was only possible because of overly cheap loans courtesy of being in the Euro.

john walker
john walker
9 years ago
Reply to  Paul Frijters

careless loans obviously .
There was a lot of funny money sloshing around the UK ,some UK fiance types celebrated the end of 07 in a London restaurant, with some grand cru at 12,000 pounds a bottle….

john walker
john walker
9 years ago

Jacques the link stuff does not seem to work properly

http://youtu.be/4X0LOD8mOiA?t=25s

john walker
john walker
9 years ago
Reply to  john walker

well there you go:)

JC
JC
9 years ago

Paul:

I’m not as pessimistic about this whole thing, even the debt level. EU wide/Euro debt is just above 80%. Japan’s is 230% and they’re able to finance at around .90%. Leaving aside Germany’s rate at the moment as I don’t see that as a decent indicator, the problem in the EU is the way it’s structurally set up and with a central bank that is part of the problem rather than the solution.

If the can put a stop to the bank drain, have the central bank do some serious QEing to the point where they can change inflation exceptions, make financing more EU wide, they can stop the crisis I think.

They are basically dealing with 3 problems and each one makes the others worse to some degree.

A bank run in the periphery
Slow growth
Sovereign debt.

The bank run can be dealt with through a Euro-wide insurance plan for deposits.

Slow growth can be dealt with by changing inflation exceptions

and Sovereign debt can be dealt with by centralizing the fiscal side.

Look, I don’t necessarily support these measures, but there are ways out of this stuff.

JC
JC
9 years ago

There was a lot of funny money sloshing around the UK ,some UK fiance types celebrated the end of 07 in a London restaurant, with some grand cru at 12,000 pounds a bottle….

You know, back in 07 when the GFC was just about to get into gear, I had a hunch, a trader’s hunch only, that the major central banks were too tight. They had gone way over what was needed.

I didn’t think much past that until I started reading Scott Sumner’s blog, who put more of a scholarly tone to this idea.

The ECB was not loose even in the early part of the decade and the same applied to the Fed. Both central bank’s basically adhered to the their inflation targets. So on that basis they really didn’t err on the side of ease as people seem to think they were.

The problem we’re in the a mess, I believe, is that they went way over the top with tightening and when the shit really hit the fan they were too slow to understand the ground had basically shifted underneath them.

Both were talking about meeting inflation expectations in 08! The lunatic ECB raised rates that year to fight inflation and a few months late was lowering interest rates like a demon.

When it’s all said and done I reckon most of this is a monumental disaster caused by the large central banks.

john walker
john walker
9 years ago
Reply to  JC

JC on the way back from Europe (late October 07) I was reading in the Economist about the collapse of a quite small wall street bank that turned out to have ‘surprise’ debts equivalent to about 20% of the US GDP… the yone of the article was .. If such a small bank could have gotten such a huge hidden debt….. what else was out there??
A lot of Bezzele ..no?

Paul Frijters
Paul Frijters
9 years ago

jc,

there is more to it than that. The Japanese have huge assets as well as huge debts, whilst the Spanish borrowed up to the hilt for their houses, the Greeks essentially lived large off other people’s money, the Irish (and yes, even the Dutch) had a property boom, the Icelanders cheated on the rest with their Icesavers schemes, etc. This credit boom was a bubble and it was not equally big in all countries, almost completely absent in germany. When the bubble burst the debt had to be unwound. Debt unwinding is always painful and cannot be so easily waved away by some central bank magic though i agree the ECB was slow in picking up what was happening.

The problem has been the economic and political paralysis that aggravated the crisis and has become an almost permanent feature since. The price adjustment that needed to be made inside uncompetitive countries are beyond those political systems.

To some extent its a crisis of Europe’s own making; yes, the Greeks cooked the books but only because the rest of Europe gave them a huge incentive to do so under the naive expectations that Greeks were really just Germans living closer to the equator. The same naivete is on display right now in the new Europlan.

Tel
Tel
9 years ago
Reply to  Paul Frijters

“… the Icelanders cheated on the rest with their Icesavers schemes, etc.”

Ha ha, all that Glitnir’s is not gold.

I’m not up on the Icelandic equivalent Pty Limited company law, but it seems to me that anyone dealing with such a company would well understand that it can go into receivership and that liability is indeed limited. It’s right there plain as day in the illegible Icelandic fine print. No one was cheated.

I believe that UK savers were backed by the Bank of England, so clearly they weren’t cheated, and if you aren’t willing to accept that the BoE is a sophisticated risk taker then who in the world would be? I mean really.

JC
JC
9 years ago

John

What “small bank” with assets of 20% of US GDP failed in 07. I don’t believe any large US bank has or had $3 trillion in assets let alone a small one.

The banking system experienced a sudden and material drop in assets values primarily real estate. It’s worth pondering what caused that.

john walker
john walker
9 years ago
Reply to  JC

illiquid (not real) assets. Bear sterns

its a while ago

JC
JC
9 years ago

Paul,

I’m more than a little convinced the sudden drop in real estate values was caused by the ECB and the Fed being too tight.

Leaving aside the Fed, the ECB was strictly adhering to its inflation targets all through the beginning of the decade.

As for the Germans.. well they were actually the first country to break the Maastricht Treaty in the earlier part of the decade.

The point being that the system is flawed which has to be redressed sooner rather than later.

Tel
Tel
9 years ago
Reply to  JC

“As for the Germans.. well they were actually the first country to break the Maastricht Treaty in the earlier part of the decade.”

Yeah, but the Greeks got caught. You can go through this discussion with the cops next time you are pulled over for speeding, and it goes nowhere at all.

Paul Frijters
Paul Frijters
9 years ago

JC,

I am not convinced at all that the tightness alone caused the bubble to pop: credit levels were out of control and the credit-funded party was coming to an end sooner or later. Like with musical chairs, the music had stopped, people were rushing to a seat, and no amount of additional noise after that would have kept it going.
You are, I gather, a trader who would have liked to keep the party going and wants to believe there would never have to be an end to such booms. Alas! We once again learned that expanding credit really is a problem for the economy, though there are precious few models out there that manage to explain why.

JC
JC
9 years ago

“You are, I gather, a trader who would have liked to keep the party going and wants to believe there would never have to be an end to such booms.”

I really have no great aversion to trading either side of markets, Paul. I can just as easily go long or short a currency or stock. Although my retirement account, which is long like everyone else, took a hit then. Bear markets are good to trade because they move so quick and furious.

It’s just an observation in that I thought the CB’s were being accused of doing the wrong thing and people have it backwards. While I think they were okish in the early part of the decade people think they were far too loose. Whereas I think they were far too tight and most people haven’t given that much time.

Jock
Jock
9 years ago

Paul
It was clear from the outset that a Eurozone that included the southern countries was unsustainable. It is even clearer now. There is no point in coming up with one “plan” after another to retreive the situation as there will always be another crisis around the corner, so why bother?
What is needed is a plan to help these countries out of the Euro while keeping them in the EU. This is the plan that might have some chance of success, and this is the one you should be working on.

sdfc
sdfc
9 years ago

JC

Loose money caused the credit boom which is at the heart of the current problems. Most recessions are caused by central banks tightening money and are almost always ended when the central bank begins easing monetary conditions again.

The big difference this time around is the incredible amount of debt that was run up during the boom as a result of cheap money between 2003 and 2006. Hence the relative lack of effectiveness of monetary policy once central banks began to ease.

JC
JC
9 years ago

SDFC

Where is the evidence of loose money in Europe when the ECB was absolutely Catholic in the way it approached its inflation target. This also applies to the Fed, but we’ll leave them out for a moment.
Also, lets leave Britain out of this because they are not in the eurozone.

You need to explain that if the ECB maintained policy to keep to the target:

1) you think the ECB broke the target from a material amount of time. (they didn’t by the way)

2. The inflation target was too liberal from where it should have been causing a boom. (It wasn’t)

You’re also talking a bout most recessions and yes, recessions end when the CB has tightened a little too far. However this one was pretty big and no run of the mill recession.

SDFC, the ECB raised rates in 08 like a month or two after Bear Stern signalling to the market that it was going to be to tight. The morons did this again last year, just before the shit hit the fan. Their timing is remarkable.

“Hence the relative lack of effectiveness of monetary policy once central banks began to ease.”

There is no limit by the amount of money a central bank can supply a market in a fiat monetary system and rate levels aren’t the determining factor.

Here’s the freaking problem SDFC, which is what the market is picking up on. They do a QE or a form of QE with the LTRO and then tell the market they are going to maintain a strict inflation stance of around 2%. This is what Sumner is saying and he’s right. That’s why the QE’s are being strangled. The Fed is doing this too by the way.

sdfc
sdfc
9 years ago

JC

I agree the ECB has been an embarrassment in the way it has dogmatically stuck to its price target since the crisis blew up in late 2007. However the evidence that policy was too loose earlier in the decade is abundantly clear given the huge run up in private debt in Portugal, Spain and Ireland for instance.

Yes I know the policy problem was the ECB being too Franco-German centric however that is of little comfort to those countries now struggling with the after effects of the pre-GFC credit binge.

My argument has always been that the price target was too narrow, not that they did not adhere to it.

There is no limit to how much money the central bank can supply to the banking system that is agreed. However when the private sector is loaded with debt and asset prices have tumbled then your credit transmission mechanism is likely to be impaired as we have seen. That is when monetary policy becomes ineffective in driving growth.

We’ve discussed this before and as you know to my mind the best way out of this mess is through higher inflation, however the zealots at the Bundesbank think that would be the end of civilization as we know it.

JC
JC
9 years ago

I agree the ECB has been an embarrassment in the way it has dogmatically stuck to its price target since the crisis blew up in late 2007.

It wasn’t that they just stuck to their target, it’s the fact they weren’t in the slightest forward looking to see a freight train head their way. It’s perhaps the worst example of Western central banking the world has ever seen in the modern age.

However the evidence that policy was too loose earlier in the decade is abundantly clear given the huge run up in private debt in Portugal, Spain and Ireland for instance.

That represents about what, 25% of EU GDP? The rest of the EZ wasn’t overburdened though and the target was about right. So you’re saying they should have set policy for the lower 25%? They can’t.

Yes I know the policy problem was the ECB being too Franco-German centric however that is of little comfort to those countries now struggling with the after effects of the pre-GFC credit binge.

The rest of the non German team should read the riot act to the ECB and put it in its place. And it seems to me, just reading through the lines that the Bundesbank is second guessing their every move and criticizing them like crazy both to the press anonymously and to the German government. It’s an impossible situation.

My argument has always been that the price target was too narrow, not that they did not adhere to it.

Not really. I think there are at 0 to 3% which is about average as targets go, no? However they were only happy at 0 and get concerned about the Germans beating them up if it reached the top of the target.

There is no limit to how much money the central bank can supply to the banking system that is agreed. However when the private sector is loaded with debt and asset prices have tumbled then your credit transmission mechanism is likely to be impaired as we have seen.

The south is in the middle of a serious banking run, serious recession and sovereign debt crisis. I’m not sure potential credit worthy borrowers are walking through of bank doors at the moment.

The ECB could buy unlimited amounts of assets. That’s the point. The banking system would subsequently stabilize.

That is when monetary policy becomes ineffective in driving growth.

Impossible in fiat system.

We’ve discussed this before and as you know to my mind the best way out of this mess is through higher inflation, however the zealots at the Bundesbank think that would be the end of civilization as we know it.

No, it’s not higher inflation they want. It’s what Sumner keeps saying. It’s higher GDP. They are not the same thing.

sdfc
sdfc
9 years ago
Reply to  JC

JC

Yes I know the PIIGS were a relatively minor consideration to the ECB and commented on that fact in my earlier comment.

However that does not negate the premise that the ECB ran a consistently loose monetary policy in fact we are just seeing the flip side of that now with the ECB running policy for the benefit of relatively fast growing Germany which we know is now benefitting from an undervalued exchange rate.

We also shouldn’t forget that while German private sector debt is relatively low its banking sector is highly leveraged and has significant exposure to the PIIGS courtesy of easy monetary conditions earlier in the last decade.

The comment about the price target being too narrow is not a comment on the bounds of the CPI target itself which I think is around 2.0% but rather the blinkered targeting of the CPI at the expense of everything else.

The ECB could buy unlimited amount of assets the trouble is it is not a good look for a central bank to have the currency backed by dodgy loans. Also it would do little in regard to the misaligned exchange rates that are a feature of the euro.

We know that monetary policy can be ineffective in a fiat money system, the experience of the Europeans, Poms, Japanese and
Yanks is ample evidence that high levels of private debt severely inhibit the effectiveness of monetary policy.

Higher NGDP growth implies higher inflation.

JC
JC
9 years ago
Reply to  sdfc

Yes I know the PIIGS were a relatively minor consideration to the ECB and commented on that fact in my earlier comment.

Okay.

However that does not negate the premise that the ECB ran a consistently loose monetary policy in fact we are just seeing the flip side of that now with the ECB running policy for the benefit of relatively fast growing Germany which we know is now benefitting from an undervalued exchange rate.

I think they are frightened out of their wits, expecting the anonymous Bundesbank Official to slam them on Der Spiegel online over the weekends. They are too scared to move a muscle because of the dreaded Bundesbank.

SDFC, you have to provide evidence that either their inflation target range was out of kilter or they in fact failed to adhere to it within an acceptable range. Failure to do so simply becomes an assertion without any foundation. they have a pretty low ceiling for the top of the band as you said.

In a single currency zone we often see divergence occurring between regional economies. We saw that here a few years ago with WA’s GDP growing at a whopping 16% pa, breaking all records for any developed nation region, while Tasmania was in self induced permafrost . The RBA ran effective monetary policy, not great but effective. So I don’t buy your example with the PIIGS.

I don’t agree that Germany is benefiting from an undervalued exchange rate in the same way I don’t think say WA’s exchange rate is misaligned to Victoria. You don’t those sorts of assumptions in a single currency zone. Germany is a cheap producer, which the others can follow too.

We also shouldn’t forget that while German private sector debt is relatively low its banking sector is highly leveraged and has significant exposure to the PIIGS courtesy of easy monetary conditions earlier in the last decade.

I’m not sure how you arrive at the nexus of highly leveraged banks and easy monetary policy as the two can occur under different conditions.

The comment about the price target being too narrow is not a comment on the bounds of the CPI target itself which I think is around 2.0% but rather the blinkered targeting of the CPI at the expense of everything else.

Yep, they are going to destroy themselves with that Central bank. It’s the stupidest, most stubborn, blinkered, irrational, no nothing CB in the world, although I must say the BOJ comes close.

The ECB could buy unlimited amount of assets the trouble is it is not a good look for a central bank to have the currency backed by dodgy loans

.

But that’s the point, they don’t have to buy PIIG assets! They could buy proportionaly or simply buy northern EU bonds. They could purchase private debt. There’s a host of stuff they could purchase without endangering their quality if they chose. They could even intervene in the foreign exchange market and that way sell Euro into the market and buy US dollars after which they park it in bonds.. any bonds for that matter (Australian bonds?). The point is to materially expand the balance sheet .

Also it would do little in regard to the misaligned exchange rates that are a feature of the euro.

It’s misaligned how? You think it’s too high? So do I :-)

We know that monetary policy can be ineffective in a fiat money system, the experience of the Europeans, Poms, Japanese and
Yanks is ample evidence that high levels of private debt severely inhibit the effectiveness of monetary policy.

SDFC, what is the objective of either a fiscal or monetary stimulus? It’s to rise NGDP, right? Sumner is right, monetary stimulus is far, far more effective and far cheaper. Again if the objective is to raise NGDP you get the CB to do it.

Higher NGDP growth implies higher inflation.

Actually if the signaling was done well, I would bet the inflation rate wouldn’t be higher than the long term historical average from the 90?s on which is when things began to stabilize. If the market believes the central bank will keep to its word in that it will hold NGDP at say x%, there would be little for the CB to do, is my bet, as the market would do it for them

sdfc
sdfc
9 years ago
Reply to  JC

JC

As I said the problem isn’t that they did not adhere to the target but rather the blinkered following of the target at the expense of everything else. A central bank’s prime responsibility should be the stability of the financial system as well as price stability. It is plain to see that allowing credit to grow out of control is not consistent with financial sector stability.

The RBA also ran loose monetary policy which has left our economy also vulnerable to crisis. The major difference between our situation and the US, UK and Europe is simply that unemployment has not risen to the same high levels as those economies.

Germany’s major trading partners are the other members of the EZ. Its trade balance was already in surplus to the rest of the euro countries and received a significant boost with the adoption of the euro. In a floating exchange rate regime you would expect this trade imbalance to be rectified by an appreciation of the German currency in relation to its European debtors. There is no mechanism for this in a fixed exchange rate regime.

WA runs a trade deficit with the eastern states but a surplus with the rest of the world. So no they are not the same.

If the ECB buys German debt for example then this will be of little use to the PIIGS as the deposits will end up in the German banking system.

The relationship between loose monetary policy and credit booms is well established.

Sumner is wrong, when the credit transmission mechanism is impaired monetary policy becomes relatively ineffective. We have seen this in abundance over the past four years. The answer is not ever increasing amounts of reserves.

The best thing about announcing an NGDP target is the implication that the CB will look through higher inflation. It is no magic solution however unless that higher inflation is actually generated.

JB Cairns
JB Cairns
9 years ago

Actually they want both.

They also usually go together.

They need higher growth to reduce debt and higher inflation ,in Germany, to increase competitiveness.

It is not only the ECB but Merkel is absolutely hopeless. She simply has no understnding of the great depression.

Jc
Jc
9 years ago

Oops

The second last sentence should read.. It’s higher NGDP.

john walker
john walker
9 years ago

this is not the actual article but its near enough

The credit squeeze
Abandon ship
Investors sail into a credit storm amid worries about the debt markets

Aug 2nd 2007 | from the print edition

The problems at Bear Stearns triggered the current market decline. Investors were surprised by the scale of the losses and the time it took for them to emerge. And attempts by Merrill Lynch, one of the prime brokers to the Bear Stearns funds, to sell some of their assets showed how illiquid the market for such securities had become. The security in credit derivatives, it seems, is not so certain after all

Then there are the banks themselves. In theory, the derivatives markets have strengthened the financial system, by allowing risk to be dispersed away from the banks. But banks still have two vulnerable points. The first is the period between their agreement to launch a deal and its subsequent sale to investors. The fees for arranging deals, particularly the LBOs beloved by private-equity firms, are highly attractive. So banks have used their capital to underwrite such deals (see article). Suddenly, they have found they do bear the risk after all.

http://www.economist.com/node/9587542

aidan
aidan
9 years ago

Is there a crisis for which the answer is not micro-economic liberalisation?

john walker
john walker
9 years ago

It is trust that has been badly damaged . Trust is essential to society and all business.

Paul Frijters
Paul Frijters
9 years ago

Aidan,

yes: Syria, the Health Service, Global Warming, Ocean over-fishing, Patent law, Africa, etc..
And dont forget that I above call for a “helicopter” currency drop by the ECB. That’s not micro-reform at all.

john walker
john walker
9 years ago

“….. the usual inability to agree on anything in Europe will torpedo this plan.”
What are likely end scenarios if they do nothing ?

Paul Frijters
Paul Frijters
9 years ago

John,
you ask what will happen if this latest plan indeed gets scuppered? I had a go at that question last December and thought it likely that eventually the ECB had to come to the table and print money in return for vague promises by Southern Europe to be more restrained in future. That has since happened (the ECB gave banks cheap loan, effectively printing money on their behalf, and new stability pacts have been signed), but contrary to my calculations then, it is now clear that that will not be enough. The political paralysis is worse than thought.

Some of the paralysis is simply posturing. The new French for instance has nominally reversed the pension age increases that Sarkozy managed to push through against tremendous opposition. But Hollande has done it on the sly so that there is no real reversion: if you start at age 18 you may retire at 60, which of course is not a whole lot of people given the increased years in education!
Still, the Southern European countries are in deep trouble, aging rapidly with huge debts, powerful vested interests and little economic dynamism. One way or another, they are heading for a big ‘price correction’ to their wages, pensions, etc.

My best guess is that, eventually, the ECB and Northern Europe will let some of the Southern Europeans declare bankruptcy whilst printing large amounts of money to soften the impact. Also, eventually, they will realise that countries within the EU have to be responsible for their own fiscal positions and thus build formal mechanisms to deal with bankruptcies in the future. Central deposit and bank guarantees can be part of that, but only if they are properly paid for.

john walker
john walker
9 years ago
Reply to  Paul Frijters

Going off the Spaniards that we met intuitively, I think Spain has a much better chance than Italy.
We flew out of Rome (in Rome JAL, used Alitalias Business lounge) nobody in the terminal could tell us were Alitalias lounge was.

JB Cairns
JB Cairns
9 years ago

I missed this.

good to see <a href "http://krugman.blogs.nytimes.com/2011/01/18/european-inflation-targets/"Krugman supporting my view

JB Cairns
JB Cairns
9 years ago

should be Krugman suppoting my view.

john walker
john walker
9 years ago
Reply to  JB Cairns

how would you do it…4% in germany and none in Spain ? … wouldn’t it need Spain to not use or eat anything much German?