What is the European Central Bank Thinking?
Willem Buiter has an excellent post up at the FT asking, basically, why on earth the European Central Bank is sitting on its hands while the Euro area undergoes inflation. He points out that its attitude toward deflation is both dumb and in violation of its legal mandate under the treaty establishing it:
The asymmetry in the response of the ECB to inflation rates above the level deemed consistent with price stability in the medium term, as opposed to inflation rates below that level is staggering and poses a material risk to the independence of the institution. [...] The ECB is violating its price stability mandate by tolerating, aiding and abetting deflation in the Euro Area.
Buiter observes that recent changes in the relative position of the “core” vs “headline” inflation rate give us a case study in this asymmetry:
When the headline rate was high but the core rate was below the ECB’s long-term 2 percent target, the ECB emphasized the headline rate and tightened monetary policy. But now that the headline rate is negative, the ECB chooses to emphasize the core rate and decline to ease further. I would note, in addition, that even the core rate is substantially below the ECB’s self-proclaimed target.
When I was in Germany, my group had the opportunity to speak with Bundesbank President Alex Weber. Unfortunately, the discussion was off the record. But suffice it to say that in keeping with stereotype, rather than in keeping with the actual legal mandate of the ECB, Weber’s point of view is very much that this kind of asymmetry is appropriate and he was very committed to the idea that the purpose of central bank independence is to allow one to be indifferent to the human consequences of this kind of commitment to low inflation at all costs. That really doesn’t seem correct to me. Among other things, as Buiter says it seems to me that this behavior is actually threatening the ECB’s independence. It’s one thing to go against a plain reading of your legal mandate. And it’s one thing to allow employment and production to become depressed. But to do the two simultaneously is willfully playing with fire.
The rubber hasn’t really hit the road on this issue yet since the recession’s not that bad in France and Germans are maniacal about inflation. But things are really falling apart in Spain and Ireland and the Germans are probably looking at a big run-up in unemployment soon, too.
36 Responses to “What is the European Central Bank Thinking?”
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October 19th, 2009 at 1:05 pm
Do you mean “deflation”?
October 19th, 2009 at 1:07 pm
Yeah. This is the kind of error that actually does interfere with comprehension. Correct this quick, Matt.
October 19th, 2009 at 1:10 pm
I hope for Europe’s sake and for the world’s that the ECB isn’t like the Fed, but if it is, then it’s hardly surprising that it has held off lowering rates until after the center-right victory.
October 19th, 2009 at 1:20 pm
Once again, Think Progress – you have my e-mail. It’s hard to find work these days. For a small fee I will proofread Matt’s posts and we will all be better off.
October 19th, 2009 at 1:21 pm
Matt this post is basically incomprehensible unless you fix your mistake, bro.
October 19th, 2009 at 1:25 pm
The ECB is sitting put because that is what the Germans want. The Euro was a stupid idea and Europe will realize it sooner or later.
October 19th, 2009 at 1:28 pm
Hasn’t post-WW II history shown you that the Europeans are willing for the US to bear any burden and pay any price?
They are more than happy for us to do the heavy slogging of monetary and fiscal policy to get the world economy back on its feet, just like they were happy to let us spend all that defense money to topple the USSR.
And they will again be the first to critisize the driving once the bus gets back on the road.
October 19th, 2009 at 1:30 pm
The swings between core and headline inflation are striking, likely close to the root of the problem. It would be an impossible banking conspiracy that could cause such swings. Complaining about a tight-fisted ECB is kicking the wrong mule.
October 19th, 2009 at 1:30 pm
“But suffice it to say that in keeping with stereotype, rather than in keeping with the actual legal mandate of the ECB, Weber’s point of view is very much that this kind of asymmetry is appropriate and he was very committed to the idea that the purpose of central bank independence is to allow one to be indifferent to the human consequences of this kind of commitment to low inflation at all costs.”
It’s an understandable point of view for the head of the Bundesbank given Germany’s history. Given the ECB’s adherence to it, the QE that the ECB has done was pretty remarkable. But it’s not good for the Eurozone as a whole for the ECB to cling to it in the face of deflation.
October 19th, 2009 at 1:39 pm
Some more hyperkeynsian ideology plz )-:.
October 19th, 2009 at 1:42 pm
This is a third-order issue. What the ECB does with interest rates pales in importance to what happens with US stimulus and banking policy.
The effect of Fed easing should have made that clear.
October 19th, 2009 at 1:47 pm
I think one thing this post misses is how big a mistake it would be for any central banker to ever admit that deflation may be a problem. Doing everything in their power to prevent a deflationary spiral would include never acknowledging the deflation. If they way they are worried about deflation, that is what they will get. Nobody will lend and nobody will borrow.
October 19th, 2009 at 1:50 pm
You cant just try fire the economy up to non crisis level unemployment and beyond with zero interest rate/ huge stimulus/intendend currency devaluation without any thinking of the consequences. That last atempt by Greenspan/Bush should have been enough of an ilustration.
October 19th, 2009 at 1:53 pm
But to do the two simultaneously is willfully playing with fire.
But central bankers have played with fire over and over again. They are tuned to the interests of ‘investors’ (the rich), see their primary job as taking of same and are perfectly happy to inflict pain on non-bankers. Inflicting pain on non-bankers is perceived as sensible and brave, whereas inciting pain on bankers and investors is dangerous and horrible.
It’s an unarticulated, unconscious version of Randroidism. And it has a long track record of not working. Which is why, in the middle of the century, central bankers were stripped of their power. Having reacquired it, it turns out that they’re returned to their same old tricks, as always.
Assuming they actually think differently is like assuming a $cieno really doesn’t believe in body thetans. In the end, central bank independence gains society little worth having and comes with a great deal of ill effects.
max
['Surely the last coupla of decades have demonstrated clearly why you don't put economists in charge of the overall economy, generals in overall charge of wars, or lawyers in overall charge of the law. They're specialists, not generalists.']
October 19th, 2009 at 2:10 pm
Yah, too bad the ECB isn’t run by enlightened easy money guys like Greenspan & Bernanke. I mean, if they took one look at America right now they’d realize how well those policies worked out.
October 19th, 2009 at 2:11 pm
Little Matty and his economic illiteracy are jaw dropping (I’m assuming M.Y. meant “deflation” and not “inflation” here and that this was a mere typo).
Monetary dilution does not cure recessions, it causes them. Further, there is nothing to fear from deflation which is merely a natural readjustment to real prices after the horrible dislocations and malinvestments caused by Krugmanite monetary dilution.
The inflationary dislocations caused by the Fed and World War I resulted in the depression of 1920, the one you never hear about (because it totally disproved the Keynesians – in advance). No Keynesian type solutions were tried and the crisis was over quickly.
Between the second quarter of 1920 to the third quarter of 1921, wholesale prices fell 44%. Factory employment and industrial production fell 30%. The Fed raised the discount rate from 4% to 7% and then back to 4%. The Harding government did basically nothing in the way of so called Keynesian stimulus. Harding specifically and intentionally did nothing to interfere with falling wages and prices. Further, Federal spending declined from $6.3 billion in 1920 to $5 billion in 1921 and $3.3 billion in 1922. Tax rates, meanwhile, were slashed—for every income group. And over the course of the 1920s, the national debt was reduced by one third. The crisis was over quickly. Thomas Woods has an interesting article and excellent video on this topic.
The 1920 depression demonstrates that even after a horrible inflationary dislocation caused by the Fed, war and horrible “progressive” wartime economic controls, prices and wages can and do readjust fairly quickly without the need of government interference. And that the natural drop in all prices as the result of the readjustment (”deflation”) is to be applauded, not feared.
October 19th, 2009 at 2:24 pm
Bob Roddis, let me reiterate the suggestion that you take an economics course not in pamphlet form.
October 19th, 2009 at 2:42 pm
Remind me again of how the ECB’s governance structure works? I know that the Traditional Big Economies got way more seats than the Countries Who Needed the Euro to Really Take Off, but I thought the latter group still at least had a voice in ECB decisions. Is this likely to lead to schism within the bank board and/or tension on the Euro as a common currency?
October 19th, 2009 at 2:50 pm
Mr. Carbone:
Since you have no substantive response (like everyone else on this blog for months on end), I assume that you have no familiarity whatsoever with my position and cannot present even an outline of a critique.
Why not read one of my “pamphlets” and write a critique? De Soto’s book is over 900 pages.
Or try Rothbard, over 1500 pages
Or a short one, Human Action at only 930 pages.
Keysianism had been completely eviscerated before Keynes perpetrated his great hoax in 1936.
It really does not hurt my feelings that you all know nothing about a theory which you are apparently afraid to learn, if only to critique it.
October 19th, 2009 at 2:55 pm
I see that Matt doesn’t subscribe to the Hunter S. Thompson school of nothings-off-the-record. Matt *could*, since his writing – or at least this blog – doesn’t depend on access to officials. Since Matt gave us the gist of Mr. Weber’s thinking, I’ll presume there wasn’t any value to breaking an assumption of confidence.
October 19th, 2009 at 4:28 pm
Bob Roddis:
I have usually found that Austrians are unable to be educated. You, however, may be different, so I will give you a link that you might find interesting:
http://bilbo.economicoutlook.net/blog/?p=5419#more-5419
October 19th, 2009 at 5:07 pm
jimbo:
I submit that you statists have the burden of proof (beyond a reasonable doubt) on all of your propositions since you propose calling in the SWAT team to enforce your theories. I almost always propose sitting back and doing nothing to my fellow humans. I don’t see why I have to justify not whacking my neighbors by calling in the SWAT team.
Your Billy Blog states:
I submit that there is no such “thing” as “aggregate demand” and that as a category, it is essentially worthless. Why don’t you offer a proof that there is such a thing as “aggregate demand” in the first instance? And why anyone should care. What business is it of the government if everyone decides to become a hippie and lay around staring at their toes? I suppose the government’s interest would be that no one would be producing anything that could be seized for perpetual war on third world people, but other than that…..
Second, I submit that Billy Blog’s proposition “budget deficits build productive infrastructure which exerts a positive influence on economic growth” is preposterous. Budget deficits and monetary dilution allow governments to engage in constant warfare. The slaughter of WWI would have been impossible to wage without a central bank and deficits. There probably wouldn’t have been a USSR or WWII or Maoist China (and attendant slaughters of innocents) without WWI. Do your mechanical models of people as molecules take that into account?
Third, I’ve never found anything written by Mr. Mankiw that had any substance. Am I suppose to defend him?
Fourth, of course there will unemployment for awhile after a Krugmanite monetary-dilution inspired boom and bust. Of course, during this period people should save and not spend. Free market interest rates would probable rise (and properly so) during this period. The 1920 experience showed that this shouldn’t be a long term problem. Of course, if there hadn’t been a Fed induced WWI slaughter and dislocation, there wouldn’t have been a problem that needed solving in 1920, would there have been?
Fifth, the idea that government borrowing does not “crowd out” private investment is preposterous. Without a government bond to purchase, where would investers go for a return on their investment? They would be forced to invest in a private investment, by definition. Or has Keynes solved that problem of a single dollar being in two places at the same time?
October 19th, 2009 at 5:52 pm
stevie, what are talking about? You’re off the rails. We don’t produce anything of value (excepting advanced weapons, fighter jets and the other goodies of the military-industrial complex). Europeans still at least produce goods (especially Germany), they create ACTUAL wealth, rather than empty financial hucksterism and ‘re-packagings’. As a commenter above noted, just look at contemporary America and you can witness the wonderful fruits of American casino neoliberalism.
If you’re talking about the U.S. carrying the national security burden of the West, I think a lot of Europeans rather hope we’ll step down from this unasked for role (at least since the Cold War and the Balkans). A lot of rest of the West is rather scared of us, and our unhinged militarism.
Frankly, Matt, I think I’ll go with German social democracy and the fusty ECB. While the Central Bank’s current policies are open for critique (a la Krugman), you neglect to note the hefty German social safety net that helps to mitigate the horrible economic suffering we’re witnessing amongst the bottom third in this country. The ’social contract’ (in the historic Enlightenment sense) exists in Germany and the rest of Northern-Western Europe, unlike here. In our country the ’social contract’, notwithstanding Obama, appears to be a distant echo in some faded FDR speech/policy.
October 19th, 2009 at 5:54 pm
From the linked Mankiw piece: government budget deficits finance non-government saving
Translation: economics is nothing but monetary accounting.
And I can’t help but notice that none of the Keynesians here have ever answered the questio nof how the early 20s recession/depression was cured without an increase in government largesse.
October 19th, 2009 at 6:14 pm
So if Europe INFLATING, or DEFLATING? I honestly couldn’t tell from the blog post. Was there an error?
October 19th, 2009 at 6:43 pm
MNPundit:
Don’t we all agree that when M.Y. said:
he meant:
This seems clear from the context after reading the Willem Buiter article to which he links. It seems to be cleary a typo and I am not attacking M.Y for a typo.
M.Y is criticizing the Euros for the decision to “decline to ease further”. This will probably cause European unemployment to rise and M.Y. is upset about that.
October 19th, 2009 at 7:27 pm
Correction:
I wrote in #24: From the linked Mankiw piece:
I should have said from the linked billyblog piece (i.e. linked in comment #21).
October 19th, 2009 at 7:41 pm
I’ll admit that the “let them eat cake” attitude of First World liquidationists never ceases to amaze.
It would be easier to take them seriously if they seemed to mind the hardship that their policies would result in – over any timeframe. But when you read lines like “deflation is nothing to worry about” it is hard to take the rest of the argument seriously.
October 19th, 2009 at 9:33 pm
There wouldn’t be deflation to worry about if there hadn’t been Krugmanite Keynesian monetary dilution in the first place. The monetary dilution causes the dislocation and malinvestments in the first instance which are not sustainable and which make everyone poorer. It is essential that these malinvestments be liquidated ASAP to have a return to true prosperity. The alternative is to steal money from the efficient to give to the dingbats that malinvested. Which prolongs the despair. How just. How compassionate.
Apparently, Keynesians and Krugmaniacs aren’t just confused, they must actually desire the poverty, dislocation and unemployment that their monetary dilution policies invariably cause (as long as we are freely ascribing malevolent motives to our opponents). And, of course, there has been no explanation as to how the 1920 depression was cured by doing nothing while massive and unprecedented intervention prolonged the Great Depression for 16 miserable years.
So who is callous and cruel?
October 19th, 2009 at 10:21 pm
Re: Monetary dilution does not cure recessions, it causes them.
Yes, and vaccines do not prevent disease, they cause it; and water does put put fires, it causes them….
The day cannot come soon enough when Austrology takes its rightful place alongside alchemy and Young Earth Creationism.
Re: We don’t produce anything of value
This is simply untrue.
Back before this mess started, the US was producing 23% of the world’s industrial output– more than any other nation. Yes, more than China (which clocked in at 13%).
October 19th, 2009 at 10:22 pm
jimbo:
Here’s what I posted on the Bill “billyblog” Mitchell piece you linked (it hasn’t been through moderation yet, let’s see if he lets it through):
Your theory about “aggregate saving increases with income and the latter responds positively to spending” is based on the assumption that the economy is all about moving money around, and issues of actual produced goods, etc. are tangential.
That, I think, is the flaw in Keynesianism. It neglects the fact that money actually is just a tool that stands for the value of real assets. It is not what the economy is actualy based on.
October 20th, 2009 at 12:50 am
The nuts really come out and frolic with these macro posts, don’t they?
October 20th, 2009 at 3:46 am
It seems to be cleary a typo and I am not attacking M.Y for a typo.
It’s not a typo we’re talking about here. Matt pretends to be a professional writer, yet everyday he makes careless, easily-correctable errors like this.
October 20th, 2009 at 5:03 am
‘…just like they were happy to let us spend all that defense money to topple the USSR.’
And the Berliners shot in 1953, the Hungarians shot in 1956, the Czechs shot in 1968, the Poles imprisoned in the early 1980s obviously just needed to do nothing while America spent all that money toppling the USSR. Stupid Europeans – only good for demonstrating in the streets against oppression, and not actually willing to spend one red cent on the American military-industrial complex.
Even worse, a lot of those ungrateful Europeans, with all kinds of experience of occupying or being occupied, attempted to warn the U.S. that invading a place like Iraq would be costly, and without benefit.
And roughly 20 years after the cold war ended, those Europeans are still trying to point out that the cold war is history, something that a number of Americans just don’t seem to want to hear. And we Americans are still ‘protecting’ Europe with our bases and only recently cancelled anti-missile facilities, regardless of the wishes of the Europeans.
From a certain European viewpoint, American style ‘protection’ these days looks like that certain style of profitable business done by well organized organizations that are famed for their general unwillingness to take no for an answer.
October 21st, 2009 at 8:32 am
[...] design, but there’s still a long ways to go, and the European Central Bank’s deflationary bias is disastrous. This makes it hard for the world to get out of the economic [...]
October 23rd, 2009 at 4:02 pm
[...] Optimistically, it’s been my experience that members of other countries tend to have a better appreciation than America does that making loud public demands is often a counterproductive diplomatic approach. But one has to fear that the real culprit here may be the European Central Bank’s weird deflationary bias. [...]