Tag Archives: ECB

Introducing The Latin Euro

By Peter Boone and Simon Johnson

The verdict is now in:  traditional German values lost and the Latin perspective won.  Germany fought hard over many years to include “no bailout” clauses in the Maastricht Treaty (the founding document of the euro currency area), and to limit the rights of the European Central Bank (ECB) to lend directly to national governments.  Last week, the ECB governing council – over German objections – authorized purchasing unlimited quantities of short-term national debts and effectively erased any traditional Germanic restrictions on its operations.  (The finding this week by the German Constitutional Court — that intra-European financial rescue funds are consistent with German law — is just icing on this cake, as far as those who support bailouts are concerned.)

With this critical defeat at the ECB, Germany is forced to concede two points.  First, without the possibility of large-scale central bank purchases of government debt for countries such as Spain and Italy, the euro area was set to collapse.  And second, that “one nation, one vote” really does rule at the ECB; Germany has around ¼ of the population of the euro area (81 million out of a total around 333 million), but only one vote out of 17 on the ECB governing council – and apparently no veto.  The balance of power and decision-making has shifted towards the troubled periphery of Europe.  The “soft money” wing of the euro area is in the ascendancy. Continue reading

Is Europe On The Verge Of Another Great Depression – Or A Great Inflation?

By Simon Johnson

The news from Europe, particularly from within the eurozone, seems all bad.  Interest rates on Italian government debt continue to rise.  Attempts to put together a “rescue package” at the pan-European level repeatedly fall behind events.  And the lack of leadership from Germany and France is palpable – where is the vision or the clarity of thought we would have had from Charles de Gaulle or Konrad Adenauer?

In addition, the pessimists argue, because the troubled countries are locked into the euro, there are no good options.  Gentle or even dramatic depreciation of the exchange rate for Greece or Portugal or Italy is not in the cards.  As a result, it is hard to lower real wages so as to restore competitiveness and boost trade.  This means that the debt burdens for these countries are likely to seem insurmountable for a long time.  Hence there will likely be default and resulting global financial chaos.

According to the September 2011 edition of the IMF’s Fiscal Monitor, 44.4 percent of Italian general government debt is held by nonresidents, i.e., presumably foreigners (Statistical Table 9).  The equivalent number for Greece is 57.4 percent, while for Portugal it is 60.5 percent.  And if you want to get really negative and think the problems could spread from Italy to France, keep in mind that 62.5 percent of French government debt is held by nonresidents.  If Europe has a serious meltdown of sovereign debt values, there is no way that the problems will be confined just to that continent.

All of this is a serious possibility – and the lack of understanding at top European levels is a serious concern.  No one has listened to the warnings of the past three years.  Almost all the time since the collapse of Lehman Brothers has been wasted, in the sense that nothing was done to put government finances on a more sustainable footing.

But perhaps the pendulum of sentiment has swung too far, for one simple and perhaps not very comfortable reason. Continue reading

Six Questions For Axel Weber

By Simon Johnson

Given recent maneuverings around European Central Bank (ECB) appointments and the obvious discomfort of Mario Draghi – he carries the Goldman Sachs connection now like other people carry albatrosses – the German financial-industrial complex seems to regard Axel Weber as a “done deal” to become the new ECB president.

Such an assumption is premature.  Mr. Weber, as long standing head of the Bundesbank and general German economic maestro (including, quietly, on fiscal issues), is due to face his own round of questioning – if you listen carefully, you can hear southern Europeans sharpening their arguments, and with good reason.

There are six important and difficult subject areas for Mr. Weber. Continue reading

Waiting for the European Central Bank, And Waiting

The European Central Bank is widely expected to cut interest rates, perhaps by 50 basis points (half of a percentage point), this week. They could, of course, follow the lead of the Bank of England or the Swiss National Bank and go for a much larger cut (150 basis points and 100 basis points respectively on their most recent rounds). But they probably won’t and not because the economic outlook in the eurozone looks so different from those other parts of Europe or because the the ECB’s Governing Council knows something we don’t or because their interest rates are already low (actually, at 3.25%, they are definitely on the high side.)

The difference really lies in two factors: extreme views about inflation, and the nature of decision-making within the ECB.  Belief that a resurgence of inflation is always imminent is, of course, Germanic but not limited to Germany.  Within the 15 central banks represented on the ECB’s Governing Council, there will always be at least one or two who see unions as looking for an excuse to push up wages.  We can debate whether or not this view is correct under today’s circumstances, but that is irrelevant – these inflation hawks still appear to strongly hold such beliefs.

Of course, there are inflation hawks among all groups that make monetary policy.  But the consensus-seeking process at the ECB is such that even just a few such people can serve as an effective brake on rapid action.  The existence of such views has plainly not prevented the ECB from taking dramatic action on some fronts (e.g., in terms of liquidity provision the ECB arguably moved farther and faster than the Fed last year), but for core monetary policy issues – i.e., when the price stability “mission” is at stake - a couple of outliers can really slow things down (particularly if one or more are members of the Executive Board.)

if the ECB puts through a fairly standard interest rate cut, then it is Business As Usual in the eurozone.  Combined with the rather anemic (or largely smoke and mirrrors) fiscal stimulus in the EU, on top of Europe’s well-known labor market inflexibility (i.e., it is hard to reduce your wage costs, even if business turns down sharply), then the eurozone is in for a rough ride. 

If the ECB surprises the market with a dramatic interest rate cut, at least we will know they are firmly in catch-up mode.  But even then, I’m afraid it is probably too late to have much effect on the recession in 2009.  Under the best of circumstances, interest rate moves affect the real economy with a lag of at least a year.  And the current disruption in the credit market is far from helping monetary policy be effective.

While we will no doubt look back on this crisis as having its epicenter in the U.S., it’s the lack of coherent policy response (monetary, fiscal, regulatory) in Europe over the past year that has really helped turn this into a sustained global crisis.

Don’t Cry (or Cry Out) for the ECB

I would like to express some sympathy for the current predicament of the European Central Bank (ECB).  They will undoubtedly come in for a great deal of criticism in the weeks ahead, particularly following their refusal to move interest rates today – if our Baseline Scenario view continues to hold.

But you have to keep in mind that they, unlike the Fed, have a very explicit mandate focused on just one variable: inflation.  It is true that there is some scope for interpretation both broad and narrow.  The broad scope exists because, for example, if actual growth slows below what is called “potential growth” (a very elusive number), inflation will decline eventually.  So when you think about what inflation should be, you are really thinking about where growth is relative to potential – and this is what interest rates can affect (keep in mind all these effects are lagged, i.e., take between one and two years to work their way through the system).  And the narrow scope means there is some choice over exactly what inflation measure you aim for and whether you can look at other things (such as money supply).  This quickly slips into monetary theology and I’m not going there, at least today.

In any case, the ECB has a pretty clear mandate and it also has a board on which almost all countries that belong to the eurozone get to vote (there are now slightly more members than seats).  The management of the ECB comprises the best minds in the business, with impressive experience in the private sector, academia and central banking.

But the basic point comes down to this.  The ECB is in Frankfurt.  And the real deal is that it represents all that is great and good about post-1945 German monetary policy, with its emphasis on trampling on inflation at every opportunity.  This worked well for Germany for a long time and it might even be a good idea now (although I’m a bit skeptical).

The problem is that it is very unclear that this focus on fighting inflation will be appropriate for all eurozone countries.  Spain and Ireland are clearly slowing down.  The latest data, put out by the European Commission, points to recession in France and Italy.

But the ECB was given a job to do.  They have a clear mandate, and they are not supposed to be flexible (unlike the Fed).  And the German authorities are watching. The ECB will cut interest rates only when they see eurozone-wide recession definitely “in the data”.  Of course, by then it will be too late.  But they are really only doing their job.  And there is nothing in their job description about preventing the world from slipping into depression.