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."

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.

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