Tuesday, 10 June 2014

Weidmann, for one, misses our bond market overlords

(See how cleverly I worked a meme into the title? This blogging thing is easy!)

In a recent speech, Jens Weidmann, head of the Bundesbank, member of the ECB's governing council, and devotee of ordoliberalism, had this to say:
Capital markets have an important disciplining function, especially as regards fiscal policy. ... The institutional framework of the currency union should be shaped to enable the disciplinary role of capital markets to function. [Pedantry]
And for a brief, shining period after the financial crisis dispelled investor complacency, that's just the way it was. Weidmann was quite pleased, for instance, that bond market panic helped eject Berlusconi.

So poor Jens appears rather distressed that interest rates for sovereign borrowers in the Eurozone periphery have fallen so far since OMT was announced in September 2012.  All he can do is warn (paywalled) that the bond market vigilantes are still out there, over the horizon, demanding reforms.
Because of monetary policy decisions, the markets are already running ahead of the adjustment progress [Anpassungsfortschritten] in the crisis countries. ... This means the pressure for action on fiscal policy shrinks, and at the same time, however, the potential for a backlash on the markets goes up. Politicians should be conscious of this and consistently implement the necessary reforms. [German]
Look, the bond markets could care less about structural reforms and fiscal consolidation. What the bond markets want is to guess what everybody else is thinking about the future course of bond prices. When the average guess changes, huge price swings ensue with no discernible relationship to economic policy.

What the recent experience demonstrates, yet again, is that when a central bank is available there's no reason to put up with this sort of crisis. Central bank action can and has created a focal point that let market participants coordinate on a different set of guesses about prices.

Whether or not he realises it, when Weidmann says the Eurozone should be organised to put the financial markets in charge, he's being disingenuous. He doesn't really want to empower the forces of blind market panic, and even less those of blind market optimism. He wants to empower the gatekeepers of the panic fighting armoury, namely, the technocrats of the ECB and the wielders of the German veto. Threatening to let the panic rage enables these actors (not markets) to dictate policy.

Karl Polanyi wrote "The financial market governs by panic." That was in the gold standard era, where there was no way for states to stand up to financial markets (without abandoning the gold standard itself). Today's version should read "The technocrat governs by the threat of financial market panic."

Note: Actually, what he said was "Kapitalmärkte haben eine wichtige Disziplinierungsfunktion, insbesondere im Hinblick auf die Fiskalpolitik. ... Der institutionelle Rahmen der Währungsunion sollte so gestaltet werden, dass die disziplinierende Rolle der Kapitalmärkte funktionieren kann." My German  is very much a work in progress, so if you want to help with translations, please do!

Here's the whole exchange:
[Newspaper:] Vor dem Hintergrund neuer starker Tendenzen in der Eurozone, die Sparpolitik zu lockern: Ist das EZB-Maßnahmenpaket nicht eine Einladung für die Politik, nun noch weniger Energie auf die Umsetzung der Konsolidierung und von Reformen aufzuwenden?
[Weidmann:] Klar ist, die Geldpolitik kann die eigentlichen Ursachen der Krise nicht beheben. Gerade angesichts der Reformmüdigkeit, die sich mancherorts breitmacht, sollte das Maßnahmenpaket daher ein Weckruf sein: Die Geldpolitik hat ihren Beitrag geleistet. Aber Sie haben recht, die Märkte sind den Anpassungsfortschritten der Krisenländer bereits vor der geldpolitischen Entscheidung vorausgeeilt. Dies wird jetzt noch verstärkt. Damit sinkt der fiskalpolitische Handlungsdruck, gleichzeitig erhöht sich aber auch das Rückschlagpotenzial an den Märkten. Dessen sollte sich die Politik bewusst sein und die notwendigen Reformen konsequent umsetzen.

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