Jean-Claude Trichet and the Coming Depression
Brad DeLong wrote an excellent article several months ago titled “The Republic of the Central Banker” about the vast and often underappreciated power wielded by central bankers. His focus, naturally, is on the U.S. Federal Reserve system and its chairman. But the central banker who holds sway over the largest economic unit is no longer the Fed Chair. Rather, it’s the head of the European Central Bank, Jean Claude Trichet. His decisions have vast influence over the fate of the entire global economy. And he seems to not be doing a very difficult job, arguing confidently that there’s no risk of deflation and maintaining the ECB’s lifelong obsession with inflation.
This is a problem for Europe. But it’s a problem for us, too. American households are increasing their savings rates which is macroeconomically counterproductive in a downturn. Counterproductive but probably unavoidable considering the past years of dissavings. But the world needs someone to be reducing savings and generating demand. And many of the people in a position to do that live in Germany. But absent a central bank that appreciates the gravity of the situation and is interested in stimulating demand, it won’t happen. And all of us around the world will suffer for it. I think confidence had developed over the past few decades that whatever might come to pass, policymakers wouldn’t just repeat the blunders of the Great Depression era. But that confidence seems to some extent misplaced.
26 Responses to “Jean-Claude Trichet and the Coming Depression”
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March 2nd, 2009 at 3:32 pm
But the world needs someone to be reducing savings and generating demand. And many of the people in a position to do that live in Germany.
Well, that was the basic setup in 1941. Hopefully this time we’ll generate the demand with a lower body count on both sides.
March 2nd, 2009 at 3:40 pm
I don’t think Matt is correct here. The biggest problem in Europe is the absence of a concerted fiscal stimulus, and Trichet has nothing to do with that.
March 2nd, 2009 at 3:50 pm
Hey matt cover powershift, we are!
http://www.ugaliberal.com
March 2nd, 2009 at 4:05 pm
Not only is ECB policy ridiculously tight but european banks are much more leveraged than U.S. banks and very heavily invested in Eastern Europe. Austrian banks have lent $230 billion euros to eastern europe (about 70% of austrian GDP)…even a small impairment (very likely) will bankrupt the entire austrian banking system.
March 2nd, 2009 at 4:16 pm
“But absent a central bank that appreciates the gravity of the situation and is interested in stimulating demand, it won’t happen.”
Well now, isn’t “simulating demand” with cheap credit exactly what central bankers have been doing for the last 25 years? Like the result?
March 2nd, 2009 at 4:22 pm
Shorter MattY – “The global economy doesn’t work the way I thought it would”.
Mike
March 2nd, 2009 at 4:30 pm
The European Monetary Union deal was German-orientated policy – an obsession with possible inflationary upsides – at the new European Central Bank. It can’t be changed.
March 2nd, 2009 at 4:37 pm
Why Oh Why:
Actually, Matt has a point. Central bank policy actually exacerbates fiscal policy’s difficulties, both by making it more difficult for governments to borrow themselves, but also by counter-acting government activity in the private sector – you want both public and private to spend more at the same time, not going against each other.
March 2nd, 2009 at 5:06 pm
When everyone, or nearly so, who remember how bad something was, dies, it’s time for that thing to happen all over again.
March 2nd, 2009 at 5:22 pm
The gravest threat to a stable monetary and fiscal policy in the last sixty years has been inflation.
The head of the European Central Bank is right in continuing to follow the Bundesbank’s principle in prioritising fighting inflationary tendencies. Inflation eats up the value of money and seriously damages any resemblance of monetary orderliness.
March 2nd, 2009 at 9:30 pm
re:There’s no evidence that the risks of a deflationary sprial [sic] are any greater than the risks of an inflationary spiral.
1873-1896?
March 2nd, 2009 at 9:50 pm
1923 seems to be deeply, deeply etched in the German psyche.
The thing about the German view is that the inflation of 1914-1923 was caused almost entirely by willful government policy.
Basically, the German government decided to pay for World War I by printing more money. After the war was over, in order to avoid the political costs of ending the inflationary cycle, the government continued it. Then, when they made absolutely no effort to figure out a way to pay the reparations they had agreed to in the Treaty of Versailles, the French occupied the Ruhr, and the Cuno government responded by just running the printing presses at full speed for a year.
Basically – the hyperinflation was caused by a whole series of irresponsible policy decisions, none of which had anything to do with efforts to get the economy out of a recession.
March 2nd, 2009 at 10:42 pm
“But the world needs someone to be reducing savings and generating demand. ”
For 35 years we have been obsessed with demand at the expense of savings. We have filled the air with CO2 and rental storage units with stuff. Stuff stuff and more stuff. The bigger stuff has been purchased with credit. We have borrowed from future demand for stuff for a long time.
The model of ever increasing demand, for stuff, if that stuff makes us happier or healthier or better individually or collectively is besides the point, is flawed in its own right. The idea that everything depends upon economic growth is flawed. Especially since the mid eighties when any recession risked a serious financial crisis. Since financial means became the only means to achieve the growth everyone desired and thought was ‘natural’ or our right as time went on the system became more fragile. More dependent upon an ever icreasing amount of debt.
We have a dillema here. There are no savings, to speak of. China’s so called savings were really a money printing exercise as they did not sterilize their dollar to RNB conversions. Households relentless lowered savings in part because of very low interest rates which punished savings. Corporations treated cash on the balance sheet like a leper.
Demand will come from more borrowing, ie the Treasury, the borrower and lender of last resort, or by direct central bank printing. Ultimately both are nuts. The dream of endless growth is crashing into reality. Most cannot conceive that there is not a rational way to turn things back to the way they were. Just try to believe it.
March 2nd, 2009 at 10:57 pm
Generally, if there’s not enough demand, it means that we are making the wrong things.
If someone is making black and white televisions, and no one wants to buy them, the solution is to get them to stop wasting resources making B&W TVs, not to try to increase the demand for them.
The problem with Keynesianism is that it assumes that somehow people we can’t get people to consume what we are creating rather than assuming that perhaps our production is not coordinated correctly.
I somewhat agree with rapier, although I think that China is better off, savings-wise than he thinks it is, and I do think that continued economic growth is possible, although ideally it would take the form of improved technology and higher quality of consumption rather than higher quantity of consumption.
March 3rd, 2009 at 3:17 am
“The European Monetary Union deal was German-orientated policy – an obsession with possible inflationary upsides – at the new European Central Bank. It can’t be changed.
”
I agree, and as a European I’am totally against a stimulus.
I think it won’t work. We don’t need to waste money.
March 3rd, 2009 at 5:48 am
MY’s obsession with blaming Germany for the financial crisis is risible, as is his belief that if every German would only emulate the irresponsible spending behavior of their US/UK counterparts, the financial crisis would just go away.
March 3rd, 2009 at 6:03 am
At what point do we stop talking about the coming depression and start admitting it’s already here?
March 3rd, 2009 at 12:23 pm
One thing that seems to be missing from this discussion is the point that a central banker’s words have to be viewed not only in terms of their truth value. A central banker must also always be thinking of the dimension of their words as actions themselves that can change the field of reference. In this case we should bear in mind that a necessary component of a deflationary spiral is for deflationary expectations to have set in. If a consumers or investors believe that prices may go down, they will delay spending or investing, taking demand off of the table. This dynamic produces deflation as a foregone conclusion. In other words, if Trichet really does believe that deflation is a hazard, maybe the very last thing he should do is admit it. It seems to me a more likely course that he would quietly carry out anti-deflationary policy measures as cannily as possible. A central banker who proclaims that deflation may be on the horizon just might be a menace to the economy, although alternatively if they lose all credibility the crisis can come from another direction.
rapier, just a quick question regarding your statement on the fallacy of endless growth. Isn’t long-term GDP expansion an absolute necessity for an economy with a fractional reserve banking system and a fiat currency? What is mean is that if the money supply is loaned into existence, doesn’t the interest have to come from somewhere?