Message to the ECB: We told you so

Quasi-monetarists and Keynesians both warned the ECB that it was making a mistake by raising interest rates in response to commodity inflation, even as NGDP expectations were falling.  Indeed, we claimed they were making precisely the same mistake as they made in July 2008, when the ECB raised rates in response to high oil prices, even while NGDP growth remained weak.

It now looks like we were right; the ECB goofed and will soon have to reverse its policy.  Yields on German debt are plunging to ultra-low levels, particularly at the short end of the yield curve.  Three month bills yield 1.07%, while three year yields are only 0.71%.  Unless I have misread the data (I’m not used to following the German bond market), the markets are predicting a reversal of ECB policy in the near future.  (They recently raised their target rate to 1.5%.)

BTW, Kantoos is the best source for information on the ECB and Germany.

Here’s today’s market data:



17 Responses to “Message to the ECB: We told you so”

  1. Gravatar of W. Peden W. Peden
    10. August 2011 at 07:23

    It’s amazing to watch mistakes being made in real time.

  2. Gravatar of A. Carraro A. Carraro
    10. August 2011 at 07:26

    Another interesting observation is that the ECB doesn’t really follow their own target. 1m EONIA is already 88bp and they have done this over the years (rates never went below 1% but EONIA was at 45bp for months). It’s also very volatile compared to FED FUNDS, showing how badly they are managing…

    I still have to get a good explanation why you’d want to ignore your own target. Surely that’s against any proper comunication policy (and an unfair subsidy to the banks that can pocket the difference most likely).

  3. Gravatar of Rob Rob
    10. August 2011 at 07:41

    The Fed was arguably over a week late to guarantee overnight inter-bank lending in 08. It’s scary to think what might happen in europe on the watch of the ECB….

  4. Gravatar of John John
    10. August 2011 at 07:58

    It’s funny for someone to be criticizing a central bank for making the wrong decision when due to the nature of central banking itself, it would be impossible for them to make the right decision. The correct interest rate for the bank to set would be whatever rate would prevail on a free market, but the existence of the bank itself changes the data. Central banks will always be wrong and their mission to foster credit expansion is particularly dangerous to the market economy.

  5. Gravatar of Martin Martin
    10. August 2011 at 11:40

    Scott, isn’t this the entire problem with inflation targeting? Inflation-targeting, apart from the problems with constructing a basket of goods, will lead to variable NGDP-growth.

    When there is a (small) real shock to the economy instead of keeping NGDP on trend and letting inflation rise, they will contract to keep inflation on trend.

  6. Gravatar of Martin Martin
    10. August 2011 at 11:42

    BTW if you want to play ECB banker 😛

  7. Gravatar of Gregor Bush Gregor Bush
    10. August 2011 at 12:58

    They’ve already lowered rates. The market is saying that the ECBs purchases of Italian and Spanish debt are not expected to be fully sterilized and thus have pushed rates lower than the stated refi rate. The 3-month overnight index swap is down to 0.91%, down 40 bps since July 22nd. The EONIA rate plunged on the annoucement of the bond purchases on August 5th. So it was a really a stealth quasi-easing; the type of thing you do when you don’t want to admit you made a mistake.

  8. Gravatar of W. Peden W. Peden
    10. August 2011 at 12:58

    Martin- I notice that the fourth best person to play that game has a really cool Scottish name…

  9. Gravatar of Martin Martin
    10. August 2011 at 13:27

    Haha nice Peden, hadn’t looked too much at the hall of fame. How did you do it? Highest I got was in the high 80’s.

  10. Gravatar of W. Peden W. Peden
    10. August 2011 at 13:39


    K% rule, of course: try to keep “money growth” between 3.5% and 4% by roughly targeting their inflation forecasts and the supply shocks will figure themselves out. Any other approach breaks down under supply-shocks. Forget everything you were told about the importance of stable interest rates. And, obviously, don’t overdo things when there’s an oil crisis or a stock market boom, because it’s very easy to get into a deflationary spell and very hard to get out because you only have access to interest rate policy.

    Actually, given the way they’ve made the game, if you have access to uncoventional monetary policy you could get 99,000+ every time by just fixing money growth between 3.5% and 4%. I had no idea that the Belgian central bank had such a monetarist bent. I’d expect such hardcore monetarism from the Bundesbank, but not really any other central bank (except maybe the Swiss).

    (In my defence, I’m barely out of my teens and it’s still socially acceptable for me to get obsessed by computer games.)

  11. Gravatar of W. Peden W. Peden
    10. August 2011 at 13:45

    Rick McAffee also made a monetary policy game ages ago, which focused more on the tools. It was well-made for a 1997 free game and allowed the use of reserve requirements and open-market operations as well as the discount rate.

    Like many a non-economist, what really interests me about monetary economics is the practical applications.

  12. Gravatar of Martin Martin
    10. August 2011 at 14:28

    You mean this game?

    Thanks for the tips: I hear reality has a strong monetarist bias. ;).

    (Same here, early tweens)

  13. Gravatar of W. Peden W. Peden
    10. August 2011 at 14:34

    That’s the one. It made me realise just how much importance is placed on OMOs in US monetary policy.

  14. Gravatar of Scott Sumner Scott Sumner
    10. August 2011 at 17:45

    W. Peden, A. Carraro, and Rob. I don’t know much about the ECB, but the more I learn the crazier it seems.

    John, You said;

    “The correct interest rate for the bank to set would be whatever rate would prevail on a free market,”

    I agree.

    Martin, Yes, that’s right. I’ll check out the game later . . . too many comments in too many posts.

    Gregor, Thanks for that info.

  15. Gravatar of Rien Huizer Rien Huizer
    11. August 2011 at 05:48


    Kantoos is OK but he is a soulmate of yours. He is definitely not an exponent of mainstream German views. The media in Germany are not as feral at the UK ones but, for some reason they also attribute more importance to the views of a kid expressing the views of a prominent prime broker than that of a respectable academic mind. Just like the once good FT. Readers and viewers seem to think that people standing in front of a forest of screens know best. Just like the white coated dentist in the old toothpaste advertisements. Snake oil sells better than common sense. Very American, these Germans.

  16. Gravatar of Rien Huizer Rien Huizer
    11. August 2011 at 05:53

    @ Martin,

    Why do UK kids not play this game instead of looting Mr Khan’s shop? Because they are outside the EUR. See what you get into when you do not follow your mates’ advice?

  17. Gravatar of Scott Sumner Scott Sumner
    11. August 2011 at 18:58

    Rien, Thanks for the perspective on Germany.

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