Thursday, 4 April 2013

What does the ECB think it is doing?

Or rather, why isn’t it doing something? Consumer price inflation is currently 1.7%. The OECD expects 1.6% as a whole for 2013, and 1.2% for 2014. The ECB sees downside risks due to the impact from lower activity, which it acknowledges is falling but which it hopes will recover soon. The OECD expects GDP to be flat this year, and increase by 1.3% next - is that what is meant by a recovery? On activity the ECB sees downside risks, but does not mention any upside risks. On the prices side they see upside risks from administered prices, VAT and oil, but for all three it is questionable whether it should react to these type of shocks at all.

In fact, if you look at other measures of inflation, the inactivity is even more puzzling. Annual increases in the GDP deflator have been at or below 1.2% since 2009, and the OECD expect a rise of only 1% in 2014. Wage increases (compensation per employee) have been below 2% since 2009, and are expected by the OECD to be around 1.5% this year and next. (Wages should normally increase by more than price inflation because of underlying productivity growth.)

With this in mind I read Draghi’s statement today, where he announced no change in the 0.75% interest rate, looking for some justification for why nothing was being done despite falling activity and below target inflation. After listing all the reasons that would normally suggest cutting interest rates, there was this: “Against this overall background our monetary policy stance will remain accommodative for as long as needed.”

I’m sorry, but this does not compute. The Eurozone is suffering from a large negative demand shock due to many things: partly austerity, but also the kind of balance sheet adjustment that we have seen elsewhere. (See, for example,  Reza Moghadam of the IMF here.)  In macroeconomic terms, we have a large leftward shift in the IS curve. What monetary policy is meant to do in these circumstances is to cut real interest rates to restore demand. In macroeconomics speak, to move down the IS curve until demand is restored. Moving a bit along the IS curve, and saying ‘look, we are helping’, is not good enough. Policy needs to respond to the size of the shock. Now monetary policy is difficult when signals and forecasts conflict. But when everything is pointing in the same direction, it is really easy.

The other interpretation of what the ECB is doing is that they do understand basic macroeconomics, but consumer price inflation of 1.7% prompts no action (because its close to 2%), and they expect (in contrast to the OECD) inflation to stay at this level. But is this plausible? One word that does not feature in Draghi’s statement is unemployment. The OECD expects unemployment to rise to 12% this year and next, which is 2% higher than in any year from 2000 to 2010. So how does this square with consumer price inflation stabilising at just below 2%? The answer is it does not. The ECB staff forecasts for consumer price inflation for 2014 are “between 0.6% and 2.0%” - exactly in line with the OECD.

So something is very wrong here. Even if you assume that the ECB are focused on hitting consumer price inflation alone, and care nothing for activity, unemployment or other inflation measures, they are doing nothing about future inflation falling well below 2%. So however you write the job description, they are not doing their job. What happens in this situation? Does anyone have ultimate control over the ECB? Or was the possibility that the ECB would not do their job properly never imagined?


  1. The Economist's correspondent believes the ECB is consciously undermining the economic recovery in order to pressure the GIIPS to reform:

    I have a theory, completely speculative, that the ECB is preparing some kind of big action for after Merkel's re-election, but they want to sit tight until then, even if it means another 6 months of collapsing economic activity in Europe.

  2. As I understand the ECB's mandate, "price stability" does not mean quite what it does elsewhere. They are mandated to prevent inflation rising above 2% - not to stop it falling below. Therefore falling inflation does not demand action.

    Furthermore, the evident divergence of real interest rates between core and periphery suggests that there is still a serious transmission problem despite OMT. I would guess that Draghi is concerned that cutting interest rates and/or doing QE would increase inflationary pressure in core countries - particularly Germany - without necessarily doing anything to ease monetary conditions in the periphery. As Germany is very dominant in Eurozone metrics, increased inflation in Germany translates into increased inflation for the whole Eurozone even if the periphery is deflating like a pricked balloon.

    1. I think in 2003 the ECB Governing Council clarified their objective as "maintain inflation rates below, but close to, 2% over the medium term". I don't think 1.3% is close to 2% on anyone's definition.

      You are right that many have speculated that the ECB might be biased towards focusing on German inflation, but that is not what they are supposed to do, so it counts as not doing their job. I am also a little suspicious of the German bias idea - after all, the decision makers include representatives from all 17 central banks.

      So I remain genuinely mystified. Faced with an inflation outturn and forecast like this, MPC members would vote for additional stimulus. I wonder whether the difference is that MPC members are much more accountable than ECB decision makers. Another problem with the Euro architecture?

  3. One problem is that although the MRO rate is at 0.75%, market rates are very close to the ZLB with OIS rates below 0.1% for up to 12 months tenors:

    As a result, the main issue is the problematic monetary transmission mechanism for Southern countries rather than the general interest rate stance of the ECB.

    Regarding the low inflation question one obvious answer is that inflationary developments are the result of not just wage inflation but also corporate profit margins increases. One could argue that the ECB is just trying to make sure that corporations are able to take a larger part of a shrinking income pie at the expense of labor.

    @Coppola. The ECB is supposed to keep inflation below *but close* to the 2% target.

    1. I agree about the transmission mechanism. But this is knock down argument for implementing some form of QE, as Ryan Avent suggests here:

    2. Most certainly yes. Since government securities constitute a large part of banks balance sheet and an even larger part of collateral used in repo lending (37% plus 10% in public agencies/sub-national governments securities), a correctly targeted QE program would be much more effective than the Fed's (where there's no segmentation in the government securities market).

      There are a few problems though:
      1) The ECB does not implement a policy of rolling over its portfolio such as the Fed. That makes it an 'investor' rather than a creditor (and given the Greek experience, a preferred investor).
      2) Unlike the Fed, it does not remit its profits to the issuing Treasury but rather to the individual NCBs. As a result, interest payments on its asset portfolio do not improve debt susstainability.
      3) Its sterilization mechanism is 7-day term deposits which are a non marketable asset. If it were to issue a marketable short-term debt certificate it would be able to transform 'risky' long-term government securities to risk-free short-term titles thus enhancing the Euro money market functionality.

    3. Hi Kostas,

      A lot of analysts clearly miss your point 1):preferred status of the ECB.

      This makes QE in the EZ even more ineffective as it already is at the moment in general terms. The combination that QE would be in pretty dodgy sov debt and mass purchases thereof creates a situation that:
      -on one side yields are reduced (by excess demand of the CB);
      -on the other side however as a huge preferred creditor the rest of the debt becomes more risky (more junior if you like) requiring for that part higher yields. And that other side part was the thing you tried to influence.
      The programm therefor works by far best if no actual purchases are required.

      A problem they donot have in the US:
      -first of all US sov debt is basically still considered riskfree (defined riskfree for the modells used), PIIGS debt is clearly not;
      -the FED doesnot claim senior status. First of all it won't need it (see before and consensus opinion). Second it simply doesnot. The ECB however does it and probably needs to do it simply for legal reasons (to avoid the forbidden state finance par., at least that is their legal interpretation thereof (sounds a bit dodgy anyway)).

      Simply doubtful therefor if the ECB can give up the seniority. It has been discussed several months ago, but we haven't seen anything since. Most likley they will not open the discussion again unless forced to do so (try to keep away from the legal hot patato).

      Re your point 2). It can relatively easily be solved by distributing the profit (formally known as sov debt interest) as dividend. However some of the more prudent CBs have created a reserve/provision for PIIGS debt which makes that (dividend distribution considerably more difficult, like with the Buba). Have a look at how the Dutch have 'solved' that problem (another example of creative bookkeeping). Basically the state guarantees (OBS) the Greek debt, so the bookkeeping profits (basically the artificial rise in bookvalue of Greek bonds from purchase (at around 2x the current market value) to nominal (keep to maturity trick). So the Dutch CB did not have to keep a provision for this and the artificial increase in value could be distributed as dividend.
      They kept internationally a low profile on this for obvious reasons, but locally it was discussed in their parliament (where they obviously as well didnot have a clue what was happening).
      Another issue is that economic ownership is largely not with the original bondissuing countries. So a large part goes to other countries. Which would have to transfer it via say a bail out package. But that means you need a bail out package as well be inplace (simply opening another can of worms).

  4. I stick with the conclusion that I came up with last week, which is that the euro-zone has decided that it can only close economic divergences by means of internal deflation in the peripheral countries, and the only way it can win that battle is by removing all of organized labour's bargaining power by pushing unemployment up far enough that labour will be so desperate for employment, that it will accept any wage reductions it is offered.

    And by the way, I don't think Merkel cares too much if deflation and wage contraction hits Germany as well as the core. We think of Germany as a rich country, but individual Germans; not so much.

    If wage deflation hits Germany, it will really just be business as usual. Germany's economy got to be the way it is by imposing flat and semi-flat wage settlements until low wage/price inflation expectations became part of the German DNA.

    And is Germany afraid of flat German GDP? Not in the slightest. Germany had flat GDP from 1999 to 2002, but look at them now.

    That is the scariest thing about German policy. They just look at what worked for them in the past, with absolutely no concern for context - how the World was growing, export markets and so on - and conclude that those policies will eventually work for everyone.

    1. Agree Jon - particularly with your first paragraph, which appears to be happening here in the UK also, with a strong dose of the age old divide and conquer tactic from the Conservative party; demonising and turning public opinion against various groups - the public sector mainly, but also anyone in receipt of any form of transfer payments, regardless of their situation or if it their fault. Reflecting on history, this would be a very dangerous road to go down, both from a societal and political viewpoint.

    2. But Jon, Simon

      concerning the first paragraph, isn't it also within German DNA to conflate/confuse productive output with competitiveness? If so, any significant decrease in German competitiveness vis a vis the EZ (which still accounts for 50% of external trade)may well spark another Schroeder style compact - thus eliminating the possibility of convergence.

      But even if German competitiveness is allowed to deteriorate - convergence is going to be a long process. 2012 growth in cost of German labour (2.8%)is outpacing the other big 3( FR 1.9% ITA 1.7% ESP 1.1%) - but is this sufficiently fast pace to save the EZ?


    3. I should also add economic cycle homogeneity is clearly a problem -Germany is out of synch with periphery

    4. Agreed, but not with your last sentence: Merkel has been very vocal about the reason for Germany's policies: increased global competition. And since exports from Germany to emerging markets have risen, while they decreased in the periphery, they have evidence their model is working. There is no proof for any other solution than internal devaluation for the periphery within the eurozone.
      Read this interview with Bundesbank for the German view, and note that ECB shares this view:

      ''Should Germany do more to help weak euro-area countries? For instance, by increasing wages and exporting less – as called for by some politicians and experts generally to the left?

      This approach will not resolve the problems and in the end will help no one. The Bundesbank has carried out model calculations on this. The result of our calculations was that, if Germany reduces its competitiveness vis-à-vis other euro-area countries – for instance, by allowing wages to rise faster than productivity – then there is a danger that, while output and employment fall in Germany, no positive effect will be registered in the crisis-hit countries. Europe is not an island. The euro area needs to become more competitive as a whole within the global marketplace. ''

    5. ok, I am going to take back the last sentence and modify it. German and EZ Q4 growth converged. I should have said it was out of synch with the economies on the euro-south in the early years of monetary union


  5. 1. Strictly according to wording it is 'pricestability' they should be mainly concerned about. Easily summarised/translated for us mere mortals as inflation, but it is strictly something else. Or better can be something else.
    Just looking at the wording probably even zero inflation looks a more logical explanation than 'your' inflation.

    Anyway cutting interest with a few 1/4%s hardly will help, in the South the bottom has fallen out and no way you can put that back with monetary policies even very aggressive ones (if that already would be possible, quod non) and certainly not by cutting rates 1/2%. Both real investors and consumers are simply not buying it.

    Unemployment is simply not in the mandate. It only colours things that are in the mandate at best. According to the treaty that is therefor the national governments' cup of tea (not doing a really great job I agree, but you simply have to blame them not the ECB (not that they probably will really care)).

    Another issue. Anyway the German public will pull the plug (at least very likely) if the inflation (or more likley the perception of inflation) in their own country looks considerably higher than 2% (it is not the case now btw, but was a few months ago). They donot give a d&#@ about the fact that the text of the treaty looks to implicate that around or close to 2% inflation for the whole zone might be acceptable. They will simply kick Merkel in her admittingly not unimpressive backside out of office and into retirement and the person after her will be forced to pull the plug, probably the whole project.

    Which to answer one of your next posts is the reason that dumping the Euro considerably, will not happen. As that means Germany's importprices eg energy and food will rise substantially and subsequently inflation in Germany. Food and energy prices usually give the perception of an even higher inflation. So it will look even worse than it already would be.
    Certainly not before the election and also after that. Merkel would be in her last term if reelected, but 3/4 of her party's MPs are not (but would be if they agreed with that).

    2. Yes, there is something seriously wrong. But it is not the ECB's policy it is simply the legal construct of the EZ and the way it was originally sold to the homecrowds.
    The former considerably limits the policies the ECB can adopt, both legally and politically.
    The latter makes a change basically impossible. There is no platform in a lot of countries, including Germany, for treatychange. Anyway a treatychange to that effect would require amending the German Constitution via referendum (which would be a partyspoiler as you might understand).

    Simply largely overstepping the mandate is effectively only possible if all major players agree. Which is nearly certain not the case seen the huge conflicts of interest. Or at least would have some serious deniability, which is very unlikely to happen as the homecrowd will blame their local governments anyway whoever makes the decision and this is not an issue that will be forgotten the next election.

    Again you should not apply the rules for handball in a football match simply because you are trained as a handball referee. Things donot work that way.
    This is mainly politics with huge conflicts of interest with as a consequence that the legal stuff is much more important than what economics tells you. To give percentages 70-80% politics 20-30% Economics and I am probably flattering the economics side with this. With percentages differing of course depending on the issue.

    And as said earlier all the anti-austerity rhetoric is simply mainly the Southern countries unable or unwilling to push through the measures and the North not willing to pull the plug for that (at least yet). Very little to do with being convinced by any macroista in that respect.

  6. you are appreciated downunder.

    please keep it up

  7. Well, unemployment is not part of the ECB mandate, unlike the FED. One may ask whose responsibility EU unemployment is then, and the answer is: no one. It's very convenient for policy makers if they are not responsible, and extremely convenient when nobody is responsible. As for inflation, the question apparently is: which inflation? Or perhaps better: inflation where? The answer is: in Germany.

  8. There is not a mistake ? Should it not have been written "In macroeconomics speak, to move down the LM curve until demand is restored"?

  9. One has to ask when economists in the reality based community will stop asking why the wider Eurozone economy is being beaten and accept that the consensus represented by the ECB/Germany and parts of the European Commission is that beating the economy serves their longer term class and national interests.

    In fact given the ECB’s behaviour up to now anyone who stills sees their policy decisions as technocratic incompetence rather than neoliberal malice needs an intervention from a friend with bucket of icy cold water. I think some of this confusion arises from Draghi’s occasional interventions to stop the situation spiraling totally out of control being mistaken for the ECB not being perfectly satisfied with things being as bad as they are now.

    The permanently angry J W Mason’s "Pain Is the Agenda: The Method in the ECB’s Madness" remains the best expression of this position.

    1. The post you reference is well worth reading. There is indeed a big gap between what the ECB is actually mandated to do and what it actually does: see me at

      or more recently Andrew Watt at

      But where I feel the critique goes to far is in seeing any delegation as playing to a neoliberal agenda, and the idea of the US as a promised land in this respect. While it remains far too inflation averse, the US Fed has been the most progressive among the major central banks in recent years. Do we really think that if US monetary policy had been in the hands of US politicians, it would have been better?

      I see the problem with the ECB as twofold. First, it shares a ordoliberal view of the world along with most European policymakers - including too many on the left. The absence of any critique of this perspective in certain Eurozone countries is frightening. Second, it is not accountable in any serious way, unlike its counterparts in the US and UK. Establishing accountability when you have 17 governments is a real problem.

    2. Read this for the Bundesbank view, which I think is shared by (most of) the ECB council.

      What is precisely your critique on the ''ordoliberal'' view as expressed in this interview?

  10. Simon, colleagues, there are a number of inaccurate stamenets in these comments. The ECB does in fact have a (weak) dual mandate, albeit one which it has been allowed to interpret far too freely. The subsidary mandate (to support the economic policies of the EU) has been conflated with the primary one (price stability), permitting, for example, Trichet to repeat the phrase "we have only one needle in our compass". For a little more detail see:

  11. is a good start to understand how the ECB thinks and acts (though it is a bit old now). Section 7 of the paper is probably the most interesting to answer your questions.

    1. I had a quick look at section 7. The quote from Duisenberg on p35 is particularly interesting, because even if you take the actual/forecast point as a slip, it does describe what is now happening. But that is inconsistent with having an inflation target close to 2%, unless 1.5% is 'close to' 2%.

      What I struggle with here is choosing between three interpretations:

      1) That the ECB has a coherent view which is consistent with their mandate.

      2) That the ECB has a coherent view, which is inconsistent with their mandate but which is consistent with an alternative mandate which they wish to keep hidden

      3) That the ECB wants to achieve its mandate, but has an incoherent/incorrect view of how this should be done.

      Taking no action when expected inflation is 1.3% and falling appears to rule out (1). The paper you reference might point to (2) - where the hidden mandate is average inflation well below 2%, but it is also consistent with (3).

      For example, I can make no sense of the statements that the ECB is not in the business of fine tuning, and instead is focused on price stability. As the paper says, to achieve price stability you need to fine tune. If, instead, you have an asymmetric response, you will not achieve price stability - instead inflation will tend to vary, as you allow allow movements below 2% to persist.

      So I remain mystified, but thanks a lot for the reference.

    2. The ECB is drawn into a lot of this stuff because the EZ politicians didnot act and things were running out of control. It simply lost this game of chicken.
      It stretched its mandate therewith to the max and probably went over it.
      It will however never admit so, it will for obvious reasons not state that it probably overstepped its mandate.
      As a consequence thereof its overall policies are simply incoherent. It will not coherently step over its mandate it is not suicidal and looking for trouble. It is better to be a bit incoherent than in a civil war.

      Re the percentages. A year ago that sort of of differences were allowed to happen as well on the upside (inflation close to 3%). Whether it is a rough approach to the percentage or a compensation for last year or whatever else we still will have to see.
      My guess with the German Constitutional Court still having to rule on a related issue that they are very careful. You can see that in their statement since a few months these are as if a lawyer has been looking at all the things. Before that they were from a legal pov simply a mess.
      From that angle if you take a rough approach upside one year consistent is to take a similar rough approach when it is on the downside.

      Everybody is assuming the inflationdefinition you have. This one however from a legal pov still not fully clear. It most likely is as you state but there is still no absolute certainty in that respect(only that the ECB interpretid it that way).

  12. What more can the ECB do?

    The ECB can only create central bank money but this isn't in circulation. An abundance of central bank money and low interest rates can encourage the commercial banks to create money for borrowers but any euros created this way will be created with a corresponding debt. This presents an obvious problem in a world already awash with debt.

    If no-one is willing or able to take on more debt then the ECB does indeed have a problem because the money supply is constantly being canceled out of existence through loan repayments.

    As Draghi noted on 27th Feb 2013;

    "It is a fallacy to make a mechanical connection between the creation of central bank liquidity and a rise in the money supply. The liquidity we provide to banks is used in the markets where banks lend to each other. It does not automatically increase credit or money in the economy - and so does not automatically lead to price pressure in the economy."

    The ECB could create some money without a corresponding debt directly for each Government distributing it using the same criteria that it does for redistributing the the seigniorage which each central bank records from the printing of new cash.

    If we wanted to get right to the root of the debt crisis problem we could declare all bank deposits as legal tender. It would then be illegal for banks to destroy money through loan repayments and they would be forced to intermediate existing money only. Hence money would not be created with a corresponding debt at source.

  13. The credit boom, also known as “the Goldilocks period” created massive amounts of debt. Derivatives massively exceed that. The idea of netting off is only valid if all parties survive with assets….. Unlikely! Claims amount to 200 Trillion? Unit of currency immaterial, as there is no way World GDP can repay…..

    All this debt and betting, created capital inflated asset values and returns to investors and governments. As the debt must be repaid or destroyed, by bankruptcy etc, then it is surely obvious that we have only just started this process, even to economists? Not only does this paralyse future growth, it means loss of businesses, the entire FIRE sector for a start. Keeping 10% may be possible…… Capital losses means loss of returns and then we have the discovery of how inflated those returns during the Goldilocks period actually were…..

    ECB response is in the category of a surgeon who does not care about theory: he must keep the patient alive. He confuses the economy with the population and banks with the economy. He will keep destroying capital and returns until the natural level of the economy is reached and then he will continue cutting. Over shoot will be a real bitch, ladies and gentlemen!

    The debt is represented in the only way possible: digital and written information. Fault will be found with this to stave off chaos. The blind butcher, the vaunted ECB, will eventually be itself gutted as policy realities, assassinated officials, suicidal attacks and utter misery become evident.

    Nonetheless, these debts will replace assets. Liabilities replace assets? Do I not know double entry? Well we have a machine that does that: banking and investment! The multiplier is negative now and has been for some time. It will remain that way until all real assets in the system, Insurance companies included, are destroyed in the same way as the depositors of lesser banks are. Capital flight will accelerate this. People will realize that an economist has less validity than an astrologer!

    I said on that this would cost Ireland 200,000,000,000 to the nearest 100,000,000,000. Those posts were wiped out. This is coming true, slowly. Hopefully, the Japanese may have taken irrevocable steps to destroy the entire fake edifice that passes as a civilizational achievement?

    Cash, (including gold etc) ammunition and determination will all vie for supremacy. Did I forget the Solar Minimum Period? Years without a summer? Food will be scarce too! Pumping money into commodities is impoverishing everyone, but will continue as banks can make profit and streeeetch out this process of destruction!

    Exquisite, this economics you preach!

  14. Simon,

    Let me try it in another way.
    Your methodology is simply wrong for answering this practical problem.
    You try to answer the question how the ECB should decide (in this practical world) with a theoretical model that totally neglects most of the issues that influence that decision.

    Things like not P%^#*ng of Merkel and Schauble; id the Buba and the DNB internally; not wanting to end up with more political problems yourself, keep the German public as calm as possible 1/2 year before an election, not do wild things as the German constitutional court still has to decide on important issue, legal text and legal situation in general, etc, etc.

    In other words reality is much more complex and your model is simply not appropriate to deal herewith. It can be used for decisions where background noise is very marginal, but not here where the main things are the earlier background noise. It simply misses 3/4 or so of the relevant issues. In other words horrible modelmaking at least for this decision.

    You can use the model question for alot of related questions: like: how should the ECB decide if only Macro should be considered. Perfectly suited for that.

    Which brings me on some of my other hobbies. Any semi-idiot politician will find good reasons why he can brush away your points with reasons outside your model. Some examples which also makes clear that the other points can be essential for the issue at stake.
    -Say a decision will not be supported by the German government, that could mean that Germany simply pulls the plug out and any subsequent discussion on things as stimulus has become completely useless as the Euro ended up in the dustbin.
    -The German government will not be simply against it for being against it, it is for a reason. Usually a political one that it cannot be sold at home. Which is also an indication that your model has substantial wholes in it btw.
    -Say cuts at home but giving extra funds to say Spain for Stimulus. On a political level this discussion is closed by the argument that you are not going to cut your own taxpayers to transfer funds to non taxpayers.
    And subsequently with an argument outside your model all your good work ends in the dustbin.

    What you could do to get the methodology straight. After using your model try to make a decisionmodel for the exact question at stake (adding the other issues). And not simply assume that the issue is similar which is probably part of the reason you move into the wrong direction.

    As said from a pure Macro perspective the 2 questions mentioned above are very similar. But for decisionmaking they are nearly worlds apart.
    Plus they give the other side an easy reason to see you as some sort of weirdo with funny ideas to which no sensibel person pays attention. And present you that way to the homecrowd.

  15. 2

    The 10-15 points I mentioned earlier will have been pretty irritating, but onfortunately overall they are not less true. And there are a lot of other points that could have been mentioned as well.

    Your ideas can be very useful for decisionmaking in these kind of situations only you (and your colleagues) are terrible salesman. Part of it is not knowing your limitations (or adjusting and dealing properly with those, not simply 'assume' them away) part is simply as well presentation. It simply sucks for this purpose. Great for students at Oxford, horrible for this stuff as the audience is completely different. It is the general public now, a bit p#*%ed off general public as well and via the general political world (not the specialist political world only as before).
    A guy like Krugman already does a better job in that respect, however look at my earlier presentationpoints it is still crap. But at least he is open for it and gives it a try.

    Caused by the fact that before you are specialists reporting to specialist politicians. Those things have changed. The public (big part of it) sees it that guys like yourself made the mess to start with. And now the issues have moved from a Economic Affairs Ministry to the heart of mainstream politics. There are simply other laws applicable over there, whether you like it or not.

    So you can go on as usual as long as stuff is decided upon in the old fashioned way. For things like the Euro crisis or the economy now (such as this issue) you have to adapt or be brushed aside. Take your pick.

    1. I'll brush Rik aside any given day and keep Simon. Wanna bet that the majority of the public would to the same if that choice would have presented to them?
      Now, let me talk in the name of the general public. A major social unrest will happen and there nothing a bunch of intelectual legalists politicians could prevent that from happening. Keep on doing the austerror, there won't be much to control after the apovercalipse moment.


  16. I expect that at the root of the problem is that the ECB simply does not use the output gap in its projections for inflation. A frightening thought. Would be curious to know if there are any public examples that show this hypothesis is wrong.

  17. The ECB is operating an implicit price level target, and in his last press conference Trichet said: "We have delivered price stability over the first 12-13 years of the euro! Impeccably!" The ECB always ignores the short term inflation volatility, and they are happy with their current stance because the price level is very close to the 2% target path (still a little bit above it I believe), and market expectations 5 and 10 years ahead are well anchored to the 2% target path.

    The ECB is always concerned with the deflationary tail risk scenarios, but they prefer to use their main policy tools for the central scenario, and they address the tail risks with tools that are either temporary or verbal - 3 year LTRO's and OMT's are good examples. This week Draghi confirmed he is still happy that tail risks are effectively suppressed by OMT's.

    Why no QE? The ECB has got a monetary pillar - a 4,5% reference growth rate of M3, which is implicitly a level target of M3. Unfortunately, right now Bundesbankers are unhappy that the level of M3 is still above the reference path, and it is unlikely that we will get an unsterilized QE unless M3 will be expected to cross the M3 reference path quite soon, or if Bundesbankers will be persuaded that the level of M3 is above the target now not because the policy was too lax before the crisis, but because one-off structural changes happened before the crisis.

    The ECB is monitoring the situation very closely, this means that it is likely that in the coming months it will decide that the balance of risks has shifted to the deflationary side, and that the danger is too high that the prices will slip below the long term path. So it is very likely that the ECB will announce an additional stimulus quite soon.

    The bottomline - the ECB is a very competent institution and it will crucify the Eurozone on the cross of the 2% price level target with a great skill and very low CPI volatility. Other main central banks lack such fine technical know-how, but fortunately, their targets are better designed, so in the end macro outcomes will be better in other main currency areas despite higher volatility of central bank target indicators in those other main currency areas.

  18. Behind a lot of European thinking is an unstated assumption that exporting is good and importing is bad. In a literal sense, that is an error. Exporting is good in the sense that it allows an economy to exploit its infrastructure more extensively and efficiently, but importing is also good in the sense that it allows an economy to consume goods without having to invest in the infrastructure to produce them.

    Nevertheless, many people continue to think of trade as a zero-sum game with winners and losers, and that thinking leads them to the conclusion that Germany is particularly successful, and a model for everyone to follow. If you don't like German policy, there is something wrong with you.

    The problem with that is that Germany has created an economy for itself that cannot consume all it produces. Since its wages are low compared to its output, it must export. It has no choice. And that makes German prosperity hostage to the rest of the World. In particular, about 40% of German exports go to the euro-zone, which makes it important to Germany that Europe should not go back to the days of competitive devaluations which would, of course, allow the periphery to recover lost competitiveness rather quickly.

    The current apporach to keeping the euro-zone intact is bailouts on German terms. Germany provides the funds, and the recipients impose deep austerity with rising unemployment. However, the euro-zone has a very poor record in predicting the effects of its policies, and the social consequences of today's still-rising levels of unemployment are incalculable.

    An alternative policy would be to allow German wages and dometic consumption to rise, which would improve Germans' standards of living, but this runs headlong into the notion that a current account surplus is a sign of national virtue, and also the idea that hyperinflation would be just around the corner.

    The problem is that as long as Germany refuses to reflate, Germans cannot consume all they produce, and German employment depends on foreigners buying German goods, and 40% of exports go to euro-zone countries with rising unemployment and falling demand, so German exports to the euro-zone are bound to stagnate or even decline in any case.

    The short-term trend is then Germany having to export more and more outside the euro-zone to keep German unemployment low, and being enabled to do so by declines in the exchange rate of the euro. caused by the crisis in the periphery.

    Eventually people are bound to wake up to a picture of a euro-zone that only has two choices. One is a permanent state of low wages and living standards, continuing as Germany's main export market, and the other is taking back control of their own economies and exchange rates.

  19. They may be concerned about asset price bubbles. That if they were to lower interest rate too low a new one might start to develop.

    This is not official ECB agenda to be concerned over such things, but these decisions are not made by robots.

  20. Why isn’t the ECB doing something? Perhaps they’ve realised that monetary policy is a farce. As to QE, that boosts demand by boosting the value of the assets of the rich: just brilliant.

    As to interest rate cuts, they give us interest rates that are not determined by market forces, so that’s presumably a misallocation of resources: i.e. why skew the economy towards lending based activity – investment in particular? Makes no more sense than skewing it towards baked beans production.

  21. There is a 'Cold War Economics' ahead: Abenomics means the end of Central Banking independence and the largest experiment of market interventionism-keynesianism-whatever-you-may-call-it in decades. That is why it is deffinitely shocking to see Spanish liberal Prime Minister Mariano Rajoy claiming to be on the interventionist side. I bet this is a unpleasant demand in Ms. Thatcher's memory to ask for...

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