Monday, 9 June 2014

Incoherence in Frankfurt: Draghi's not pointing the money hose where his own arguments say he ought to

I've been musing on something Draghi said in Friday's press conference, when he answered a question on the danger of deflation.  For background, here's some data on price changes:

2009 2010 2011 2012 2013 2014 (my est.)
Euro area 0.9% 2.2% 2.7% 2.2% 0.8% 0.7%
Germany 0.8% 1.9% 2.3% 2.0% 1.2% 1.0%
Ireland -2.6% -0.2% 1.4% 1.7% 0.4% 0.2%
Greece 2.6% 5.2% 2.2% 0.3% -1.8% -1.3%
Spain 0.9% 2.9% 2.4% 3.0% 0.3% 0.0%
Italy 1.1% 2.1% 3.7% 2.6% 0.7% 0.5%
Portugal -0.1% 2.4% 3.5% 2.1% 0.2% -0.1%

  • Notes for the pedantic: these are year-end versus year-end rates, which are more volatile than the comparisons of annual price averages you usually see reported, but make the recent trend show up more clearly; my estimate is for 2014 is made mechanically on the basis of the data for the year so far and similar to the ECB's, at least for the Euro area as the whole; I don't know whether they have country estimates. Source.
Draghi cited four causes for low inflation/deflation, including world prices for food and energy, the strengthening euro, and "to some extent, the persistent weak demand." But it's the fourth that I want to focus on:
The other cause [is] ... the relative price adjustment that was needed and is needed in some countries, the idea being that relative price adjustment is a once-and-for-all phenomenon. It stops and then inflation goes back. Now the longer the inflation doesn't go back, without denying the need for the relative price adjustment, which is essential to restore competitiveness and growth and job creation in these countries, but the longer the inflation doesn't go back, the more the Governing Council is in a, say, watchful position.
The table above lists the countries he's got primarily in mind, the so-called PIIGS; 2013 was the first time all of them had lower inflation rates than Germany at the same time.

To the extent that he's worried about an excessively long period of stagnant/falling prices in the PIIGS, and he thinks that further relative price adjustment is needed, what would be the right policy? It should be to increase inflation in Germany and the Eurozone as a whole, so that relative prices can shift without requiring deflation, as Krugman and others have been pointing out as a long time.

But this is not what the ECB did. Only one of the measures announced Friday is likely to have a regional component: the TLTROs, which is a plan to offer banks €400 billion in very cheap loans conditional on expanding lending to the real sector. To the extent that these loans are taken up at all (see ECB string-pushing) they're going to be taken up by banks in the PIIGS. In fact, although the allocation formula is region-neutral, this geographical impact seems to have been precisely the point, as the ECB has been worried (PDF) about the failure of its low interest rates to pass through to countries like Italy and Spain.

So the TLTRO policy amounts to sending cheap credit to those countries where you'd like to see relative prices fall, and not to those where you'd like to see relative prices rise. Seems backward, doesn't it?  On Draghi's own logic (relative price adjustment good, deflation bad) he should have pointed the money hose at Germany.

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