Assume a can opener

How many economists would agree with the following statement?

Over the past four years monetary policy at the Fed and ECB has been impacted by the zero bound on nominal interest rates.  Fed officials have indicated that they would be cutting interest rates if they could.  Central banks have also experimented with unconventional monetary stimulus, and there is some debate as to how effective these unconventional measures have been.

Pretty bland, eh?  I’d guess most economists would agree.  What do you think?

And yet the statement is clearly, obviously, unambiguously false.  Economists don’t know it’s false, but the lowly stock market traders on Wall Street certainly know it’s false.  A couple hours ago they marked down the value of US stock futures on news that the ECB had decided not to cut interest rates.  That’s right, rates in Europe are not at the zero bound, nor have they been there at any time during the crisis.  Indeed for 98% of the past 4 years the ECB’s target interest rate has been HIGHER than it is today.  That’s right, for 98% of the last 48 months it’s been at least 0.75%.  In 2012 it was 1.25%.  As recently as 2011 the ECB was raising rates.

It’s also the case that people like Paul Krugman have insisted that austerity is costing jobs in Europe even though the only model that predicts that effect relies on the assumption that rates are stuck at zero.  So what do Keynesians do with the inconvenient truth?  They simply assume it away.  They talk as if the ECB is at the zero bound.

Economists love their models, and their associated stylized facts.  And when the facts don’t match the model, they simply assume away the facts.  Assume the eurozone is at the zero bound.  Yes, and assume a can opener while you’re at it.

Here’s the explanation offered by Draghi:

FRANKFURT (Reuters) – The European Central Bank kept its main interest rate on hold at a record low 0.5 percent on Thursday as it waits to see whether early signs of stabilisation in the euro zone will blossom into an economic recovery.

Economic data improved in May and ECB President Mario Draghi said this week he still sees “a very gradual recovery” starting later this year, taking pressure off the ECB to act again, as it had promised to do if necessary after cutting rates in May.

“This can be seen as a reaction to the slight improvement in the purchasing managers indices (PMIs), which seem to signal that the worst is over in the euro zone,” said David Kohl, chief economist for Germany at Julius Baer.

So Draghi thinks the eurozone economy is doing so well (based on second derivatives) that no stimulus is needed.  How many American economists understand that this is what’s going on in Europe?  Based on those I read, and talk to, I’d estimate about 1% tops.  The eurozone is in a deep nominal recession because the ECB wants it to be in a deep nominal recession.  They’ve been steering the eurozone economy with interest rate adjustments over the past four years.

BTW, another myth is that the ECB can’t ease because it is a strict inflation targeter.  WRONG!!!  The ECB itself forecasts 1.4% inflation in 2013 and 1.3% inflation in 2014.  Try again.

I suppose 99% of the profession thinks I’m a nut for devoting my life to easier money in America and Europe.   With America I can sort of understand, we really are (sort of) at the zero bound.  But the ECB is not.  I can’t imagine why there aren’t mass protests of economists outside the gates of the ECB headquarters.  Monetary stimulus would help the crisis countries without making their debt situation worse.  Where’s the outrage at their policy?

PS. Do you recall this story:

Thoreau was jailed for refusing to pay taxes during the Mexican War. When Emerson saw Thoreau in jail, he asked him, “what are you doing in there?”

Thoreau’s reply to Emerson: “Waldo, the question is what are you doing out there?”



38 Responses to “Assume a can opener”

  1. Gravatar of Marcos Marcos
    6. June 2013 at 06:46

    “With America I can sort of understand, we really are (sort of) at the zero bound.”

    For the market monetarists even at the zero bound monetary policy is highly effective I know that this is another case but would be good to remember for avoid misunderstandings.

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    6. June 2013 at 06:57

    Well, it’s ‘assume away the can opener’, but it’s a common defense mechanism. I just came upon a rather amusing example in Ricardo Lagos ‘Southern Tiger’, in which he mocks Augusto Pinochet for worrying about what he termed, “socialists” (scare quotes by Lagos).

    Want to guess what political party Lagos himself belonged to?

  3. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    6. June 2013 at 07:06

    Also, an even more amusing attempt at self-justification by Lagos, in his memoir, was when those “socialists” ambush Pinochet’s motorcade with rocket launchers. Lagos gets arrested, but proclaims this an outrage, as Pinochet surely knew he had nothing to do with it.

    Forgetting, apparently, that earlier in his book he admits to being in constant (and clandestine) contact with the violence prone wing of the Chilean Socialist Party, trying to cobble together an anti-Pinochet coalition. Lagos claims to be an economist–I can’t find a single piece of evidence in his book that he is–so, he was just assuming away a rocket that penetrated El Presidente’s Mercedes.

  4. Gravatar of Rademaker Rademaker
    6. June 2013 at 07:06

    I’ve been curious about something; if the Eurozone has higher real interest rates than, for example, the USA, does that open it up to a carry trade where it is the beneficiary of foreign funding? Could the ECB’s stance be defensible from that point of view?

  5. Gravatar of W. Peden W. Peden
    6. June 2013 at 07:11

    Patrick Sullivan,

    Just to say that I’ve had a very pleasant and informative afternoon going through your recent (and some past) posts on your blog.

  6. Gravatar of ssumner ssumner
    6. June 2013 at 07:25

    Marcos, Yes, that’s why I said “sort of”—even that would be wrong, but perhaps understandable.

    Patrick, Sounds like a good example.

    Rademaker, The tighter monetary policy would be contractionary even if it attracted funds from elsewhere. That strengthens the euro and depresses exports. I seem to recall that the euro rose this morning on the ECB news. Can someone confirm?

  7. Gravatar of jknarr jknarr
    6. June 2013 at 07:37

    Low rates are a symptom of the disease — not the cure. Higher rates would be a symptom of a cure. Low rates only are traditionally a cure insofar as the central bank provides more base money to banks to suppress the target rate — this is not applicable at the zero bound.

    Of course, Bernanke knows all of this —
    “But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. ”

    Tight money, low inflation, and zero rates are official policy — no mistake.

    We should not frankly care about what assets the Fed buys, or their nominal size — that’s their problem. On the other side, the nature of Fed liabilities means everything to NGDP, and to you and I.

    Reserves are only meant to underwrite loans, to clear among banks, and to provide a nexus for currency formation.

    Currency and demand deposits, by contrast, clear the entire NGDP — if you want to double NGDP, have to focus on currency/DD. For instance, the Fed could buy assets for cash from the public to create both.

    They could do it tomorrow, and they know this — low rates, bubbly financial markets, and low household income is official policy, and this fact goes without scrutiny or oversight.

    I might say that this also implies that the economics profession only plays the tunes that they are paid to play –which leads to hand waving on the left about fiscal policy , and whining about pushing on a string / ultimate hyperinflation on the right. The studied omission of effective monetary policy (direct Fed purchases from the public — a pedigree back to Keynes) suggests willful ignorance at best, corruption at worst.

    Only Scott appears to “get it”. Which is why he’s worthwhile, and the rest of the profession is mostly silly.

  8. Gravatar of W. Peden W. Peden
    6. June 2013 at 07:41


    The funny thing about the left/right debate is that you get some poor confused people who end up saying that monetary policy is ineffective with regard to RGDP because we’re in a liquidity trap, but could potentially cause hyperinflation. (It’s not just the shadowstats bunch who say such things.) Such confusion can only be the result of a move away from systematic causal thinking to highly partisan doom-soaked debates. Once again, there is a definite place for professional economists to try to drag the debate back to models and well-tested theories.

  9. Gravatar of jknarr jknarr
    6. June 2013 at 07:43

    ps — Scott, tight money is official policy in Europe as well.

    How else can you get nations to give up their political sovereignity? Debt is a much more civilized means of control than war. If the silly Greeks want to preserve their little democracy, they must be reeducated.

    European austerity, high unemployment, misery and despair — these are features, not bugs!

  10. Gravatar of Max Max
    6. June 2013 at 07:43

    If you want to be picky, even Japan is not at or below 0.0%. They were at one time, but now they are at 0.1%.

    But so what? Whether the the central bank’s lower limit is 0.5% (ECB/Bank of England), 0.25% (Fed/Riksbank), 0.1% (BOJ), or 0.0% (nobody), makes little difference. It’s the fact that there is a lower limit that creates a problem, not the exact level.

  11. Gravatar of W. Peden W. Peden
    6. June 2013 at 07:52


    The issue here isn’t the ZLB or its importance, but whether the ECB is at the ZLB.

  12. Gravatar of Rademaker Rademaker
    6. June 2013 at 07:54

    @ scott sumner; a strengthening currency does at bottom improve the real terms of trade of a nation (i.e. more cheap imported goods), it is just nominal frictions that turn it into a problem. And for a currency to be strengthened foreign inflows is better than for it to happen as a result of policy actions that are not in the same way a free lunch.

    I guess for my reasoning to make sense though, it would have to be impossible for the ECB to push real rates above the (corresponding*) Fed’s rate, since every time it tried the carry trading would push it down again. In that case it would benefit from retracting policy to maximally “leech” off the inflows from the states…

    I don’t know if this can realistically be going on; * an explanation for the +/- 1% difference would be needed (risk premium? a premium for expected exchange rate changes?).

    I’m way out on a limb on all of this; apologies if I’m not making much sense.

  13. Gravatar of jknarr jknarr
    6. June 2013 at 07:55

    WPeden — yes there is a place for professional economists, but let’s examine this.

    A professional has specialized knowledge, works wholly in the client’s interest, and is paid a premium for the services.

    Economists have specialized knowledge, but who is the client?!

    Every academic economist has visions of being swept up by Wall Street or DC, getting paid the big bucks, and getting the acclaim and attention they crave.

    Bottom line, Wall Street and DC are the clients — and what do they demand? Tight money.

    Tight money boosts the value of every yield-bearing financial product. Higher debt price = more debt supply. More debt supply = more fees.

    Tight money impoverishes every other balance sheet — the states, the municipalities, the households — and centralizes power into a money-printing Federal government. This is also happening in Europe. It’s a feature, not a bug.

    It would be nice if the profession was scientific, but it is fundamentally corrupted by the money. Don’t toe the line, lose the prospect for (relative) riches and fame.

  14. Gravatar of Petar Petar
    6. June 2013 at 08:07

    About that inflation…. “The bank sees no deflation, nor risk of deflation in any eurozone country. And lower inflation was not of itself a big problem. “With low inflation, you buy more stuff,” Mr Draghi explained.”

  15. Gravatar of TallDave TallDave
    6. June 2013 at 08:31

    And Mark Sadowski’s post about the enormous Fed QE operations in the past is a very powerful argument that the Fed isn’t doing enough today, despite all the “unconventional” talk.

  16. Gravatar of Ashok Rao Ashok Rao
    6. June 2013 at 08:55

    I don’t talk to economists frequently (I only read their blogs) but I don’t get the sense that anyone thinks the ECB is at the ZLB. I remember quite clearly Krugman aghast at ECB policy in 2011 (especially) but definitely throughout.

    I find the Keynesian argument about fiscal austerity in EZ two-fold: one the expectation that ECB will tighten too quickly (which is not unfounded at all) will counteract offset, and b there’s not enough room before hitting the ZLB to offset the degree of spending cuts.

    Also, I think there’s an important difference between arguing for stimulus and against deep, deep austerity in Southern Europe.

    A .75% cut in rates will not employ the 50% of unemployed youth. Tyler Cowen today gives a great example of non-Keynsian government spending employment in southern economies with weak private sectors.

  17. Gravatar of Edward Lambert Edward Lambert
    6. June 2013 at 09:04

    Scott, you are in a delusion too, thinking that the economy can return to its potential RGDP of the bubble years. There is a reality happening here. The advanced countries are going down and it is delusional to think that loose monetary policy will change the dynamics of that.
    The only true solution is to raise labor share of income, that means Japan, US and parts of Europe.

    Abenomics is empty without a policy to raise labor share. Disinflation will have the last laugh.

  18. Gravatar of jknarr jknarr
    6. June 2013 at 09:09

    Edward, look at the long term nominal and real GDP per capita for the US. The US is multiples below potential — this is what is driving low interest rates.

    Not sure what you mean by bubble years, but financial bubbles are symptoms of tight monetary policies. If you think through the effect of policy on NGDP, and NGDP on yield, and yield on the price of financial assets, you may see.

    Scott is 100% right that the economy can return to the extraordinarily long and durable NGDP and RGDP trend.

    Willfully tight monetary policy prevents this from happening.

  19. Gravatar of Geoff Geoff
    6. June 2013 at 09:13

    “I can’t imagine why there aren’t mass protests of economists outside the gates of the ECB headquarters.”

    That’s likely because you purposefully remain ignorant of the distortionary effects of inflation on economic calculation, and of the heterogeneous nature of the inflation process which sees, among other things, some people harmed and others benefitted in the short run while everyone is harmed in the longer run (the longer run of which includes today, and the last few years, as the consequence of the effects of inflation prior to that).

  20. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. June 2013 at 09:19

    The primary objective of the European Central Bank, as laid down in Article 127(1) of the Treaty on the Functioning of the European Union, is to maintain price stability within the Eurozone. However, nowhere in the Treaties is the meaning of “price stability” defined. (Go read them if you don’t believe me.)

    The Governing Council of the ECB in October 1998 defined price stability as inflation of around 2%, “a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%” and added that price stability “was to be maintained over the medium term”. The Governing Council confirmed this definition in May 2003 following a thorough evaluation of the ECB’s monetary policy strategy. On that occasion, the Governing Council clarified that “in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term”.

    In short, the Governing Council is at liberty to change the price stability mandate anytime it wishes to. It could for example make the inflation rate target symmetric, it could raise the inflation rate target or it could do away with the inflation rate target altogether and institute a Price Level Target (PLT).

    Furthermore, despite persistent Bundesbank propaganda to the contrary, the ECB does not, nor did it ever, have a “single mandate”. Article 127(1) of the Treaty on the Functioning of the EU is very explicit that provided price stability is assured the central bank is obliged to contribute to the general economic policies of the European Union in order to serve the general objectives of the EU as set out in Article 3 of the the Treaty on European Union. These include “balanced economic growth”, “full employment” and “economic, social and territorial cohesion, and solidarity among Member States”.

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. June 2013 at 09:22



    Article 127 (ex Article 105 TEC)

    “1. The primary objective of the European System of Central Banks (hereinafter referred to as ‘the ESCB’) shall be to maintain price stability. *Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union*. The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 119…”

  22. Gravatar of Mark A. Sadowski Mark A. Sadowski
    6. June 2013 at 09:23



    Article 3 (ex Article 2 TEU)

    “1. The Union’s aim is to promote peace, its values and the well-being of its peoples.

    2. The Union shall offer its citizens an area of freedom, security and justice without internal frontiers, in which the free movement of persons is ensured in conjunction with appropriate measures with respect to external border controls, asylum, immigration and the prevention and combating of crime.

    3. The Union shall establish an internal market. *It shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment*. It shall promote scientific and technological advance.

    It shall combat social exclusion and discrimination, and shall promote social justice and protection, equality between women and men, solidarity between generations and protection of the rights of the child.

    *It shall promote economic, social and territorial cohesion, and solidarity among Member States*.

    It shall respect its rich cultural and linguistic diversity, and shall ensure that Europe’s cultural heritage is safeguarded and enhanced…”

  23. Gravatar of Jason Jason
    6. June 2013 at 09:26

    I am actually confused here: the effective Fed Funds rate is at 0.25%, and not actually at “zero”. Does the ZLB effect suddenly turn on at 0.25%, but not at 0.5%?

    I imagined that there would be a transition from effective interest rate policy to ineffective — not a sudden break.

    i.e. Take the compounded interest rate formula exp(r*t) = 1 + r*t + 0.5(r*t)^2 + … and ZLB regime is where r*t is small such that exp(r*t) ~ 1

    You have to go from 0.25% to 2.5% for exp(r*t)-1 to go up by an order of magnitude. I imagine differences in the amounts of money you’d make lending the government money at the various small rates are essentially in the noise of other economic factors (especially inflation rate, if we are talking about nominal interest rates).

  24. Gravatar of jknarr jknarr
    6. June 2013 at 09:34

    Jason — they keep it at 25 and 50bp because they are afraid of effective monetary policy — they want policy tight.

    Properly zero rates would mean that all sorts of financial assets — money market funds in particular — would be liquidated for cash. They prefer some monetary tightness to a nonlinear and possibly uncontrollable easing that could occur at the proper ZLB.

  25. Gravatar of ssumner ssumner
    6. June 2013 at 10:01

    Max, Did you read my post? The ECB has not been at the 0.5% level that you (wrongly) call the lower limit for 98% of the past 4 years. So what do you say about that?

    And they might well cut rates in the future (accordoing to the article.)

    Petar. Priceless!! That’s worth a post.

    Talldave, Good point.

    Ashok, Then why does Krugman keep claiming the ECB is at the zero bound?

    Edward, Of all the major developed countries, doesn’t Germany have the most aggressive low wage policy right now?

    Mark, Yes, and most people don’t know that either.

    Jason. The US target is 0% to 0.25%. But the key difference is that the Fed no longer uses rates as an instrument, as it doesn’t want to lower then any further (say to 0% to 0.15%) In contras,t the ECB has been continually lowering, raising, and lowering rates over the past 4 years. They just lowered rates last month. They might lower them next month.

  26. Gravatar of W. Peden W. Peden
    6. June 2013 at 11:07

    I’m pretty sure the Economist is reporting deflation in Greece…

  27. Gravatar of Andre Andre
    6. June 2013 at 11:40

    What difference does it make if you are at the literal 0% lower bound or if you are at a 0.5% political lower bound?

  28. Gravatar of 123 123
    6. June 2013 at 11:49

    No. ECB rates are lower than the US rates. Draghi is paying 0bps IOR, Bernanke is paying 25bps IOR. Some members of the ECB’s governing council are discussing negative IOR, and Draghi says he is technically ready to pay negative IOR. There is no such discussion at the Fed.

  29. Gravatar of 123 123
    6. June 2013 at 11:50

    And markets have crashed because there was a 1/3 probability of new unconventional measures, not because of the interest rates.

  30. Gravatar of Iván Carrino Iván Carrino
    6. June 2013 at 12:45

    Scot, what if ECB fears that by easing monetary policy (even more) countries will not have the incentive to do the necesary structural reforms?

  31. Gravatar of jknarr jknarr
    6. June 2013 at 13:02

    Ivan, does the ECB have any mandate to direct a country’s fiscal stance? How about the “necessary structural reforms” in Germany?

  32. Gravatar of ThomasH ThomasH
    6. June 2013 at 14:27

    In standard IS-LM analysis doesn’t a decrease in (G-T) lead to lower income is the central bank keeps the interest rate the same, not necessarily at zero? Maybe that is the model Krugman has in mind.

  33. Gravatar of ThomasH ThomasH
    6. June 2013 at 14:29

    … IF the Central Bank …

  34. Gravatar of ssumner ssumner
    6. June 2013 at 14:59

    Andre, None, but that has no bearing on my post. Read it again.

    In any case there is no political objection in Europe to them doing another rate cut. Do you recall an outcry in May when they cut rates?

    123, I presume you agree that the ECB has had interest rates higher than current levels for 98% of the past 4 years, don’t you? So what would you say about that period?

    And I disagree about the market reaction. Some traders did expect a rate cut, so the disappointment on that issue played into the market reaction.

    Ivan, Then they should be tortured for months and then executed. It’s not the ECB’s job to drive Europe into a deep depression so that national governments will do the sort of microeconomic reforms that the ECB prefers. It’s up to the elected governments of the eurozone countries to do the reforms they choose to do.

    Jknarr, You make a good point in terms of Ivan’s question. Why not run a high inflation rate until the Germans agree to open their stores on Sunday?

    Thomas, Yes, that’s the model he has in mind, but it obviously doesn’t apply, as the ECB has been lowering, raising, and lowering interest rates over the past 4 years.

  35. Gravatar of 123 123
    6. June 2013 at 15:47

    Scott, most of the time, the ECB has paid 25bps on reserves just like Bernanke, except for the certain period in 2011 when Trichet caused the current recession. But since late 2011 when IOR has dropped to American levels again, QE-type measures are the most important ones, and the exact level of IOR is a secondary issue. The fact that Draghi is much more flexible on zero or negative IOR than Bernanke hasn’t helped much, did it?
    Before todays meeting, the consensus was no cut and no new non-standard measures.
    However there was a small probability of negative IOR, we could argue if it was 0.5% or 5%, and there was a possibili of new non-standard measures, we could argue if it was 10% or 33% (my own estimate was 33%). Since both the power and probability of QE-type measures is much larger, most of the market reaction should be attributed to disappointed hopes of QE or similar measures. BTW markets were calm when the interest rate decision was published 45min before the conference.

  36. Gravatar of Iván Carrino Iván Carrino
    6. June 2013 at 16:18

    Scott and jknar thanx for answering, I see your point but:

    What about ECB’s independece? There are a lot of governments (I can think of France, Spain) begging for a more expansionary policy so that they don’t face the political cost of adjusting the budget…

    So isn’t monetary expansion like a “shortcut” that should be avoided in order to have, in the long run, sustainable growth?

  37. Gravatar of ssumner ssumner
    7. June 2013 at 06:21

    123, ECB policy has been much tighter than the Fed’s policy, and the results are clear. As I’ve indicated many times, I am not at all certain that IOR has been a major factor. But I am pretty confident that the ECB’s tight money policy hurt, especially in 2011-12.

    Ivan, I’m saying the ECB should avoid a highly contractionary monetary policy. Why is that even controversial?

  38. Gravatar of 123 123
    7. June 2013 at 07:01

    Scott, yes, it is much tighter, and it remains tighter. It used to be tighter because of the IOR in Q1-Q3 ’11. It is tighter now too. Implicit quasi PLT that they sometimes hint at is a tighter policy than Evans rule + QE infinity. Still, I give them lots of credit for managing the aftermath of Greece’s debt writedown in a way that is much better than what Bernanke did after Lehman.

    My point is that you have to criticize them in the right way. They actually did much more than anyone could guess in terms of IOR. They are the world champions in LOLR. They just have to do something extra with unconventional monetary measures. And they are still debating it. And you have to criticize their framework which is not optimal and not transparent.

    By the way, there was a discussion here in the US about the idea that higher interest rates might increase the financial stability. But I haven’t seen anyone looking at the Eurozone experience in ’11.

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