The ECB and policy "blackmail"

Süddeutsche Zeitung has conducted a fun interview with French ECB Executive Board member Benoît Cœuré and two radical activists. Central bankers should sit down with people who think capitalism is doomed more often.

One of the activists recalled (slightly inaccurately) an incident from August of 2011.  At the time, interest rates on Italian and Spanish bonds were spiking, amid fears of a self-fulfilling prophecy about the sustainability of their debts.

Source: 10-year bond benchmark from Datastream; SMP purchases laboriously hand-compiled from ECB statements

On August 5th, ECB then-president Trichet sent secret letters to Italian PM Berlusconi and Spanish PM Zapatero with a list of measures that should be urgently adopted to “restore the confidence of investors.” The letters were immediately understood as specifying preconditions for the ECB intervening to buy bonds. The activist referred to this as "blackmail," as the ECB was threatening to ignore the bond market panic if the measures were not adopted.  Cœuré replied:

The ECB does not blackmail anyone. The case you have mentioned refers to the purchase of government bonds under the Securities Markets Programme (SMP). What the ECB wanted to make clear was that our monetary policy can only be effective if governments themselves carry out reforms that address the root causes of the crisis. No monetary policy measure can have the desired effect if that is not given.

Yes, well, if you believe that, I'm sure Monsieur Cœuré would welcome your expression of interest in purchasing the Pont d'Avignon. 

On July 11th 2011, Mario Draghi (who cosigned Trichet's letter to Berlusconi), praised a just-passed Italian austerity package and called for a push to balance the Italian budget by 2014.  Just over three weeks later, Trichet and Draghi, in their secret letter, called for the budget to be balanced by 2013. Would Cœuré care to argue that there was some change in the "root causes of the crisis" that required this acceleration? 

If the ECB had wanted to, it could have thrown its weight behind the measures Italy had already adopted. Trichet could have said that the bond markets were displaying "fear and irrationality" about the bonds of the country with the highest primary surplus in the Eurozone, and pledged to put a floor under bond prices. 

Instead, the ECB tried to use the panic to maximize its influence. The chart above--which shows aggregated ECB bond purchases for all countries--suggests quite strongly that the ECB stopped trying very hard to change prices when Berlusconi proved unable to get the measures in the letter through Parliament (for this argument, see Irwin's The Alchemists.) Blackmail is not an unreasonable term for this.  

Market 'discipline' and game theory

Hot off the presses at the APSR, a new article from Kelemen and Teo:

...we argue that balanced budget rules work by coordinating decentralized punishment of sovereigns by bond markets, rather than by posing a credible threat of judicial enforcement. Therefore, the clarity of the focal point provided by the rule, rather than the strength of its judicial enforcement mechanisms, determines its effectiveness.

Ok, so: bond markets are all about herd behaviour (focal points allow bond investors to guess what everyone else will do, and do the same thing).  Properly structured institutions are those that use herd behaviour to enforce balanced budgets, by having a well defined trigger for firing off a "stampede now" flare.

The authors judge the Eurozone's fiscal compact by this standard and find it wanting because its rules on budget deficits are insufficiently clear, due to its effort to make room for counter-cyclical policy by referring only to a "structural" budget deficit. In addition, the possibility of bailouts via the ESM reduces incentives to maintain balanced budgets. But all hope is not lost:

Nevertheless, because of the remaining uncertainty about the availability of bailouts for any given state and the extent of “private sector involvement” (including losses imposed on bondholders), bond markets can still play a constructive role in restraining excessive state borrowing. However, this will only be the case where bond markets are presented with sufficiently clear focal points.

As the authors recognize, their argument is structurally identical to the Hadfield-Weingast argument about the coordinating role of law. Like Hadfield and Weingast, they similarly dismiss the prospect of successful judicial enforcement a priori, implicitly suggesting that they are better informed about political realities than the leaders who haggled over enforcement rules vigorously.

More striking, however, is the way this framing of the issue slides into normative assertions. The equilibrium outcome (states follow budget rules because otherwise bond holders fall into a panic) is invested with a positive normative status that is not questioned. Despite quite explicitly conceptualising bond markets as driven by herd mentality, the only question they ask is the circumstances under which bond markets can be "constructive;" that is, how this herd mentality can successfully be turned into a doomsday machine to enforce budget rules. They simply don't consider the possibility that having doomsday machines around might not be the height of wisdom, nor the political implications of using markets as an enforcement mechanism to override democracy.

Another problem with this framing is that they evaluate fiscal rules only from the point of view of their enforceability, rather than whether or not they are a good idea for other reasons. Thus, they attack a budget rule making space for anti-cyclical spending for being unenforceable by bond markets, but never defend the idea that pro-cyclical economic policy is a good thing.  Enforceability is not a useful evaluative stance in any event, because it doesn't discriminate very well among different rules: "your budget deficit must never exceed 50% of GDP, wherever you are in the business cycle" would be brilliantly clear and thus enforceable, but presumably the authors wouldn't like it very much.

The fiscal compact as an obsolescing bargain?

Raymond Vernon coined the term "obsolescing bargain" in the context of interactions between multinational corporations and host countries. When MNCs are deciding where to invest, they have a lot of options and thus a lot of bargaining power. Host countries therefore offer attractive tax and other concessions in order to get investment. However, once investments are made, the threat of expropriation gives more bargaining power to the host country. At this point, there may be an effort to renegotiate the terms of the initial deal, which has "obsolesced" due to shifts in bargaining power.

This sort of problem can potentially affect all sorts of bargains. For instance, a party that has agreed to buy, say, coal may be reluctant to abide by the terms of the deal if the price of coal drops. The coal seller has less bargaining power, and the coal buyer more, than at the time the agreement was concluded. If a contract was signed, the buyer may seek to get out of it via legal loopholes: for instance, declaring force majeure.

This pathway from an obsolescing bargain to a search for legal loopholes now appears to be unfolding in the Eurozone.

Late in 2011, European leaders agreed on a fiscal compact designed to make it much more difficult for countries to run fiscal deficits. Inter alia, it called for constitutional or similar changes limiting budget deficits and instituting automatic correction procedures to address them.

The bargaining situation surrounding this agreement was fundamentally shaped by panic on the bond markets. As I argued the other day (see Weidmann, for one, misses our bond market overlords) the threat of the ECB to sit on the sidelines and let the panic rage gave the ECB's leaders a lot of political influence. In late November 2011, Mario Draghi deployed this influence on behalf of the fiscal compact, hinting transparently that whether the ECB would intervene against the panic would depend on its adoption.  On 9 December, the fiscal compact was agreed; on 14 December, Draghi announced a large injection of liquidity into banks, which they could use to buy sovereign bonds.  His satisfaction at the adoption of the fiscal compact was evident.  (UPDATE: Draghi actually announced the decision on 8 December; my confusion arose from the fact that the details were finalised on 14 December.)

With Eurozone bond prices back to low levels, the bargaining situation has changed. The fiscal compact now appears a very high price for security against a self-fulfilling bond market panic that has faded to a distant prospect.  And it's not surprising that opposition to the terms of the fiscal compact is mobilising. Gabriel's proposal to change the rules on how deficits are counted is an example of the loophole-seeking that is one way the bargain might be revised. (For more on the art of creative fiscal accounting as a way around budget commitments, see Joachim Wehner.)

The most charitable thing that can be said about the pro-austerity case used to justify the fiscal compact is that it's controversial (actually, the evidence against it is overwhelming and mounts all the time). Using a transient situation of market panic to bludgeon elected leaders into accepting constitutional mandates of a policy both controversial and massively consequential displays a contempt for democracy. And if the result is a contempt for constitutional and treaty rules, the architects of those rules have only themselves to blame.

P.S.  There's been a lot of scepticism (here's some from Germans and some from Italians) about whether the fiscal pact will in fact be very binding.  Personally, I hope there are loopholes large enough to drive many, many stimulus-laden trucks through, but I doubt it.  The fact that Renzi is bothering to mobilise formal opposition suggests as much.

Sigmar Gabriel and the German model fallacy

(Background: Germany's government is a coalition between the conservative Christian Democrats (CDU/CSU), led by Angela Merkel, and the moderately left-wing Social Democratic Party of Germany (SPD), led by Sigmar Gabriel. The CDU/CSU is very much the senior partner, and was almost able to form a government by itself.)

On Monday, while Angela Merkel was enjoying the perks of being Prime Minister, her Economics Minister Sigmar Gabriel said something in France that has made some noise: namely, that in exchange for implementing structural reforms, countries ought to get more time to reduce their budget deficits, for instance by not having the costs of reforms count against treaty budget limits.  Thus, he appeared to be backing Italy's Renzi and France's Hollande.

The resulting hubbub in Germany shows just how mistaken it would be to take this as a harbinger of a German paradigm shift on austerity.  Merkel and CDU Finance Minister Schäuble denied that there was any split in the government and insisted that all were agreed that no changes in Europe's fiscal compact regulating budget deficits were needed. Schäuble took the occasion to stress the need to learn the lessons of the successful experience of the countries who reformed under supervision of the EU-ECB-IMF "Troika." (Really, I kid you not.  He said: "Wir hatten ja die Erfolge in den Ländern, die unter Programm waren, weil sie die Strukturreformen auch durch die Vereinbarung im Zusammenhang mit Hilfsprogrammen und durch eine Überwachung durch die Troika durchgesetzt haben, deswegen haben sie die Erfolge. Die Lehren müssen alle ziehen in Europa...")   The man has an interesting definition of success.

But Schäuble is a hopeless austerity fanatic. What's really depressing is the other side of the political spectrum: Gabriel of the SPD. In defending his suggestion to allow slower budget consolidation in exchange for structural reforms, he repeated a one-sided account of the origins of Germany’s euro-era economic success.

Germany, he said, did exactly the same thing in 2003. "Agenda 2010 [structural reforms] plus more time for deficit reduction." Germans should honestly admit this and aggressively [offensiv] offer this as the German model.

The problems with making the German experience a model for the Eurozone as a whole are well understood. Look at the chart below, which graphs unit labour costs (labour costs for unit of output) for Germany and other Eurozone countries. As is evident, one of these things is not like the others. Up to the crisis, Germany held the share of wages and other labour costs in output very stable, while they were rising elsewhere in Europe.

German costs stayed low for two reasons. Most commonly cited are the Agenda 2010 reforms mentioned by Gabriel, pushed through by the SPD, which made it easier to create low-wage jobs. However, wage restraint in higher-paid jobs, the result of the weakening of unions and collective bargaining and the threats of employers to relocate abroad, was also very important. 

The problem with squeezing wages as a growth strategy is that workers are not just producers, they’re also consumers. The lower wages are as a share of output—the lower unit labour costs are--the less of output workers can afford, implying that some combination of investment, government spending, and exports must make up the difference

Luckily for Germany, until 2008 shortfalls in domestic demand were compensated for by the boom elsewhere in the currency block. Divergence in unit labour costs led to a surge of exports from Germany to the rest of the Eurozone—workers there had more to spend, and domestically produced goods were losing competitiveness.

For Gabriel (and the entire German political mainstream, so far as I can tell), the lesson of all this is that Germany prospered because it undertook the tough reforms needed to ensure competitiveness.  And other Eurozone countries should do likewise.  But this is a remarkably short-sighted position:

• A strategy of squeezing wages is a strategy of relying on external demand. Europe is already running record trade surpluses, but its growth is very weak. The idea that exports could be the main engine of growth for the Eurozone as a whole is not credible, leaving aside the probable reaction of the rest of the world. 
• Competitiveness is a relative concept!  Germany’s wage squeezing worked precisely because other Eurozone countries did not undertake “tough reforms” at the same time. (This is an example of the sort of “fallacy of composition” that Blyth discusses so effectively.) This is not the situation that European peripheral countries now face. 

It's clear that for Gabriel, relaxing austerity (he offered no prospect of reversing it) is simply a means to promote what is, in fact, a disastrous and unrealistic policy of extending the German model to the rest of Europe.  Alas, nothing to get excited about. 

A tension in ordoliberalism

(I'm still feeling my way regarding the implied reader for this blog.  The ideal thing would be to have background links at the beginning of each post, I suppose.  At any rate, ordoliberalism is the specifically German variety of neoliberalism, where liberal here is used in the European/social theory sense of pro-market. The big difference from the more familiar AAA [Anglo-American-Austrian] version of neoliberalism is a much more forthright embrace of the role of the state in shaping market economies. Ordoliberalism in Germany has also made its peace with an extensive welfare state and role for organised interest groups, including labour.)

Lecturing in 1979, Foucault gave a remarkably good account of ordoliberalism (especially remarkable given that he seems to have based it largely on a handful of not particularly brilliant French secondary sources). He argued that unlike classical laissez-faire liberalism, which sought to limit the state's interference in a market it saw as prior to the state, ordoliberals believed a competitive market economy could never exist without the state, and sought to deduce the proper form of the state from the requirements of such a market. Two key elements of ordoliberalism were the result:

• Commitment to the rule of law, "defined as a state in which the actions of the public authorities will have no value if they are not framed in laws that limit them in advance."(169) In particular, laws should be crafted to enable the promotion of competitive markets while forbidding interference with them.
• Promotion of the diffusion of entrepreneurial subjects who, because they can flourish in competitive markets, won't demand alteration of their outcomes. (Foucault describes this under the heading of "the policy of society.")    

It's easy to see both these aspects of ordoliberalism in the German reaction to the Eurozone crisis

• Rule of law: Germany has pushed the promulgation of all sorts of legal constraints, such as "debt brakes" in national constitutions that limit the amount of borrowing a sovereign may do, while seeking to give very sharp edges to the provisions of existing treaties and insisting they not be violated.  
• Promotion of entrepreneurial subjects: Germany has demanded that states implement structural reforms meant to ensure "competitiveness," which has become the central buzzword of German and Eurocrat discourse on the crisis.  (Sometimes I feel like Wettbewerbsfähigkeit--competitiveness--is about half the vocabulary one needs to read the German papers on the topic!) States so reorganised would presumably not need bailouts nor push to water down treaty provisions like the no-bailout rule.  

That it's so easy to read recent developments through Foucault is, to my mind, a pretty convincing demonstration of how penetrating his perception was. But what Foucault does not seem to analyse is a potential tension between these two commitments. What if what's required for the promotion of entrepreneurial subjects is case-by-case decision making not readily formulated in pre-announced rules?

And indeed there has been some interesting criticism of Eurozone policy along these lines. Changes in Eurozone practice and treaties have granted the Commission very wide discretion in requiring adjustment of domestic policies in the presence of budget deficits and other macroeconomic imbalances.  Michelle Everson and Christian Joerges argue in a great paper that

the machinery of the new  regime  with  its  individualised  measures  which  are  oriented  only  by necessarily  indeterminate  general  clauses,  is  regulatory  in  its  nature, establishing  a  ‘political  administration’  outside  the  realm  of  democratic politics and the form of accountability which the rule of law demands. 

Now, it's certainly the case that from the outset ordoliberals were not particularly enthusiastic about letting democracy get in the way of markets (see Ptak). But they were serious about the rule of law involving limited discretion, and what Everson and Joerges call "authoritarian managerialism" does not embody it.

P.S. On how Germany's ordoliberalism has shaped its reaction to the crisis, see Blyth and Dullien and Guerot.  On the authoritarian drift of Eurozone policy, Scharpf and Majone are also both very good. In different ways, both these scholars had been inclined previously to downplay the EU "democratic deficit" on the grounds that limitations of democracy were legitimate to promote good outcomes.

The rule of law and game theory

There's a powerful current in the academic study of law, represented in political science most notably by Barry Weingast, that hopes to analyse law in terms of game theory. The basic idea of the approach is to represent conformance with the law as an equilibrium outcome in a coordination game.   In a coordination game, the players all attain a better outcome if they can coordinate their moves than if they act based on the assumption of no coordination. For instance, if we're choosing what side of the road to drive on, it would be a lot safer if we all chose the same side. 

Weingast and various collaborators have posed the relevant coordination problem as a problem of coordinating on decentralised enforcement. If everyone plays their part in punishing those who breach rules, then the rules will be followed. In a recent paper, Hadfield and Weingast suggest that the key role of law is coordinating beliefs on when a breach of law requiring decentralised enforcement has taken place.  They then argue that "the normatively attractive features of the rule of law—generality, stability, impersonal application, publicity—are attributes needed to support decentralized enforcement efforts."

The ladder of reasoning ascending to this conclusion is missing more than a few rungs, in my view. But  the more important point is how bizarre it is to assume that only decentralised enforcement provides a stable basis for legal order.  And this really does seem to be what they think:

The [mistaken] idea that government coercion is necessary for law leads to two other mistakes: (a) the belief that legal order can be achieved by tightening up government coercion; and (b) attributing failures of legal order to failures of coercive institutions, the power of the judiciary, or the enforcement agency in particular. 

Yes, some parts of legal order look like coordination games, but many others do not.  Consider the considerations that go into deciding whether to obey the law about which side of the road to drive on...

versus deciding whether or not to exceed the speed limit:

In the speed limit case, tightening up government coercion (speed cameras, points on the licence) certainly makes a difference to a balance of considerations; in the what-side-of-the-road case government coercion almost irrelevant--this really is a coordination game.   One could multiply examples ad infinitum. Again: there are examples of law-backed order that are coordination games and there are others that are not. 

Given how smart these scholars are, it's pretty hard to understand why they don't see this. The only explanation I can offer is the impulse, all too frequent in political science, to come up with a maximally general theory.  But the assumption that there's a single answer as to why people obey rules is just wrong (and more here).

For an alternative approach to the rule of law, see here.  

Hungary and the importance of an independent currency

Speaking of Hungarian exchange rate policy, Deborah Mabbett and Waltraud Schelkle discuss it in the course of a provocative recent argument that the lack of exchange rate autonomy is not the reason the Eurozone periphery has suffered so much in the course of the crisis. This is a really important paper, since it raises the issue of what the counterfactual implied by the case for currency autonomy is--if the Eurozone peripheral countries had their own currencies, what sort of practical situation would they be in? Formal exchange rate autonomy isn't much help if you're not willing nor able to use it.  Looking at EU countries not in the Eurozone, they write:

we found little support for the proposition that a flexible exchange rate is a useful policy instrument. ...the existence of an exchange rate makes surprisingly little difference to the extent of real devaluation. This is not to say that it is easy or even preferable to achieve real devaluation by other means (basically, internal contraction) but it is hard to sustain the argument that only nominal devaluations succeed. Furthermore, advocates of nominal devaluation may underestimate the real costs imposed on actors in the domestic economy: a particularly salient issue in Hungary and Latvia, where many households and firms had taken out foreign currency-denominated loans.

I think this is too strong, at least for Hungary--I think the evidence is that nominal devaluation has been a significant advantage, even despite the foreign loans issue, and the differences in internal contraction are quite significant.  At the chart below suggests, Hungary has seen much, much less employment loss in the course of the crisis than Greece or Spain. At the end of 2012, all three countries had seen nearly equivalent changes in real exchange rate, but Hungary's was almost entirely down to nominal exchange rate changes while those in Greece and Spain were purchased at the cost of huge increases in unemployment.  Even recently, as Hungarian real exchange rates are moving up (hopefully because workers are getting paid more as employment recovers), the nominal exchange rate has played a significant buffering role. Obviously, there are other forces in play, etc., but I still think this is pretty convincing on the backdrop of clear theoretical reasons why we expect real devaluations to be costly.

These are unit-labour-cost real exchange rates versus the Eurozone, if you care--it's not much different if you use the whole world. Sources: real exchange rates, employment

Update: the graph redrawn to emphasise employment changes - see comment

Hungary's financial nationalism

There is in the heart of Europe a country that has done some exceptional things to make the financial sector bear more of the costs of the financial crisis.  For instance:

• A transactions tax was implemented
• Tax rises to balance the budget were directed at banks via a levy on their assets
• Banks were made to forgive mortgage borrowers part of their debts

A leftist triumph?  No.  These things were done by Fidesz, the odious party that has abolished democracy in Hungary in all but name.  And these measures were motivated not by leftist values, but by reference to a nativist, at times anti-Semitic ideology.  As Prime Minister Orban put it in January,

The truth is that we had had enough of the politics that is forever concerned with how we might satisfy the West, the bankers, big capital and the foreign press, and how we must put our hands up in surrender at the first word of complaint... 

Over the past four years we have overcome that kowtowing mentality, which was a subservient mentality. We once again have self-esteem and we have self-respect and we have self-confidence. Meaning Hungary will not succumb again!

I learned all this from a fantastic new paper by the political scientists Juliet Johnson and Andrew Barnes. They describe Fidesz's general "financial nationalism," which involved not only the above-described pressure on banks, largely foreign-owned, but also significant resistance to the efforts of the IMF and EU to shape economic policy through conditionality agreements.

Johnson and Barnes argue that Fidesz was able successfully to pursue this agenda for two reasons. First, on the backdrop of disastrous economic conditions, Fidesz came into power in April 2010 with a parliamentary supermajority. As a result, the party was in a position to use legislative and constitutional changes to consolidate nearly complete internal policy autonomy (eliminating "checks and balances"), which they used to pursue a policy of austerity the costs of which were largely borne either by foreigners or their domestic political enemies. Second, international private lenders were sufficiently impressed by the resulting successes in reducing budget deficits (and sufficiently unconcerned about anything else) to enable Hungary to access credit on acceptable terms and maintain intransigence in dealing with the EU and the IMF.

One interesting (to me, anyway!) aspect of the Hungarian story is the role of foreign-denominated debt. Over the course of the 2000s, many Hungarians took out mortgage loans in denominated in foreign currency, as these were offered with lower interest rates. As a result, when the value of the forint began dropping in late 2008, they experienced significant financial distress. Compared to Southern Europe, Hungary had the advantage of having its own currency, but these trans-currency loans somewhat constrained its ability to make use of this advantage. (Though see the next post; for related issues in Argentina and Russia, see here.) Financial nationalism as a political ideology went hand-in-hand with attempting to regain effective use of the exchange rate as a policy instrument.

There are some notable parallels here with the aftermath of financial crisis in Russia and Argentina. In all three of these cases, it was nationalism that provided the language of backlash after a period of constrained autonomy due to austerity under international conditionality and financial integration that made exchange rate devaluation costly.  Leftists and even small-d democrats who think that signing on to austerity is the responsible thing to do ought to consider this. It shouldn't only be nativists who have the brass to stand up to the international financial establishment.

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."

A Weberian view on money as an economic institution

The good people at Warwick have put up a video of a recent talk of mine on Weber and money.

The talk will make more sense if you follow along with the slides.

For more of the conference this was from, see here.



For more on the ideas in this talk, see

Woodruff, David M. 2013. Monetary surrogates and money’s dual nature. In Financial Crises and the Nature of Capitalist Money: Mutual Developments From the Work of Geoffrey Ingham, Jocelyn Pixley and G. C. Harcourt, 101-123. Houndmills: Palgrave Macmillan

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.

Rogoff and The Handmaid's Tale

So Rogoff wrote an epic piece of concern trolling about the call for central banks to raise their inflation target:

After two decades of telling the public that 2% inflation is Nirvana, central bankers would baffle people were they to announce that they had changed their minds – and not in some minor way, but completely. Just recall the market’s “taper tantrums” in May 2013, when then-Fed Chairman Ben Bernanke suggested a far more modest turn in monetary policy. People might well ask why, if central bankers can change their long-term target from 2% to 4%, they could not later decide that it should be 5% or 6%?

Because of course if the history of the last few decades teaches us anything, it's that the world is filled with central bankers dreaming of raising inflation targets.  (And let's not forget that the "taper tantrum" was about the prospect that the Fed was going to return to type and run a more restrictive monetary policy.)

No, there's just no practical way to raise the inflation target. (I can't hear you, Wren-Lewis.) Clearly, what needs to be done is Rogoff's much more practical plan of 

• Eliminating all paper cash money in favour of electronic money
• Empowering the central bank to charge negative interest rates on this electronic money, stimulating spending and overcoming deflation whenever the need arises.  (Not a new idea: Irving Fisher offered a low-tech version 80 years ago.)

Yeah, that's the ticket. Because people will be so thrilled about a plan that says we need to make all your money electronic precisely because we may need to threaten to confiscate it piecemeal. Certainly much more likely to happen than raising the inflation target.

But maybe there's a hidden agenda. Margaret Atwood told us about it in the Handmaid's Tale:

All those women having jobs: hard to imagine, now, but thousands of them had jobs, millions. It was considered the normal thing. Now it's like remembering the paper money, when they still had that. My mother kept some of it, pasted into her scrapbook along with the early photos. It was obsolete by then, you couldn't buy anything with it.

Pieces of paper, thickish, greasy to the touch, green-colored, with pictures on each side, some old man in a wig and on the other side a pyramid with an eye above it. It said In God We Trust. My mother said people used to have signs beside their cash registers, for a joke: In God We Trust, All Others Pay Cash. That would be blasphemy now. 

You had to take those pieces of paper with you when you went shopping, though by the time I was nine or ten most people used plastic cards. Not for the groceries though, that came later. It seems so primitive, totemistic even, like cowry shells. I must have used that kind of money myself, a little, before everything went on the Compubank.
I guess that's how they were able to do it, in the way they did, all at once, without anyone knowing beforehand. If there had still been portable money, it would have been more difficult.

Come the revolution, and our heroine's Compunumber doesn't work any more:

...she said, Tried getting anything on your Compucard today?
Yes, I said. I told her about that too.
They've frozen them, she said. Mine too. The collective's too. Any account with an F on it instead of an M. All they needed to do is push a few buttons. We're cut off.

I'm onto you, Rogoff.

ECB string-pushing

In my recent commentary on the ECB's deflation-fighting measures, I wrote:

There's no way to push money into the economy unless businesses and consumers are ready to borrow it to invest and spend.

This is a classical argument from Keynesian macroeconomics, usually associated with the phrase "pushing on a string."  Draghi actually got asked about this issue in his press conference yesterday in the context of a new plan to funnel ECB money through banks to real sector businesses:

Question: I think most would agree that the European Central Bank has been very good in providing the Eurozone financial system with cheap and plentiful supply of liquidity. So what is it exactly about this targeted LTRO that makes you think that you'll get a lot of demand from the banks for the liquidity you're putting on offer here given that we have seen a reduction in excess liquidity [ie, banks are paying down loans to the ECB rather than lending out money]. ...

Draghi: ... Now what is in this LTRO, in this TLTRO that makes it different? Several things; The cost, obviously it's very low. The term maturity is four years. And the determination that this money not be spent on sovereigns and on sectors that are already experiencing or are just coming out of a bubbly-ish situation. So that's what is in it.

I find this more than a bit thin. It's not as if it's plausible that banks had been looking at potential sources of funds for their lending and saying, well, this money is just too expensive or too likely dry up. As Adair Turner puts it

The ECB’s latest Monthly Bulletin ... [cites] multiple indicators of improved credit availability and pricing. Nonetheless, the rate of decline in private-sector loans has accelerated over the last year – from -0.6% to -2% – and low demand is acknowledged to be the main driver of depressed credit growth. Simultaneous private deleveraging and fiscal consolidation are restricting eurozone growth far more than remaining restrictions on credit supply.

Simon Wren-Lewis and Francesco Saraceno also make the point that stimulative fiscal policy is needed.

Two recent commentaries on the ECB

As it happens, I've managed to publish commentaries on both the most recent ECB meetings.

Draghi needs to realize ECB's gas pedal is already on the floor

The ECB should focus on the threat of deflation rather than maintaining austerity

Welcome to my blog

My name is David Woodruff.  I am an associate professor of comparative politics at the London School of Economics and Political Science. I teach on the MSc in Comparative Politics. You can find out more about my academic work here.

By training, I am a political scientist, and the part of political science I work in is known as "comparative political economy." Although the term political economy is used in many senses in the social sciences, my particular interests lie in how key capitalist institutions--things like money, property, and private law, and the various organizations and state agencies that manage them--emerge, change, and affect economic policy. For me, the best form of evidence on these matters tends to be well-documented narratives about particular historical episodes.

My aim in this blog to present views on current events and intellectual controversies, links to interesting reading, as well as some of my research in progress.  Although I started my career as a Russia specialist, lately I've been focussing on the Eurozone crisis and a lot of the commentary will probably be about that. I welcome your feedback.