“The credibility of the ECB is one of the few things left.”
No, this is not an old news article from the 1930s, it’s from today’s Financial Times:
A political backlash against fiscal austerity left mainstream French and Dutch politicians struggling on Monday to shore up support as a key economic indicator highlighted the eurozone’s slide into deeper recession.
François Hollande’s first round victory in the French presidential elections – which raised fears of renewed wrangling over the eurozone’s economic strategy – and the collapse of the Dutch government, after a clash over fiscal policy, hit financial markets.
The heightened political uncertainty sent European stock markets tumbling and put pressure on French and Dutch sovereign debt, while Germany’s government bonds benefited from inflows from spooked investors.
Economic fundamentals also appeared to deteriorate as purchasing managers’ indices for the 17-country eurozone showed private sector economic activity had contracted unexpectedly sharply this month, dashing official hopes of an early return to growth.
The composite index covering manufacturing and services fell for a third consecutive month to 47.4 points in April, the lowest reading for five months. A figure below 50 indicates a contraction in activity. That pointed to an intensification of a recession which started in the final three months of last year, when the eurozone debt crisis was at its most intense. Economists had expected a modest improvement.
In the Netherlands, one of the eurozone’s most fiscally disciplinarian governments collapsed as Mark Rutte, prime minister, tendered his government’s resignation at a meeting with Queen Beatrix, clearing the way for elections. That sent the euro down to $1.3105 against the dollar, a session low. In France, the Socialist Mr Hollande’s first-round victory was accompanied by a surge in support for the far-right National Front.
And here’s how the ECB responds to the collapsing Eurozone economy:
Mario Draghi, European Central Bank president, has struck a distinctly gloomy note on eurozone growth prospects, dropping previous references to a gradual recovery this year.
. . .
He played down the prospects of the ECB reactivating its government bond-purchasing programme. The central bank had to stick to its “primary mandate” of combating inflation and not breach the European Union ban on “monetary financing” – central bank funding of governments. “The credibility of the ECB is one of the few things left,” he said.
Let’s do a survey. What’s more scary:
1. That the head of the ECB said this.
2. That the head of the ECB doesn’t seem aware of the irony in what he is saying.
While campaigning for re-election in 1932, Herbert Hoover bragged that although the economy was looking a bit weak, voters could take comfort in the knowledge that his adroit leadership had preserved the dollar/gold peg. Soon after, that old regime was swept away by a political and economic tsunami.
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25. April 2012 at 06:33
Scott, as you say, most economists don’t really get nominal economics – they can’t even see what New Keynesianism implies, let alone market monetarism. The only solution is for you and Nick to write a textbook.
25. April 2012 at 06:39
certainly the ECB has a lot more credibility than the EuroZone politicos…
25. April 2012 at 06:51
Soros has made a living betting against governments, whats that saying about protesting too much?
weidmann responding to Soros:
http://www.bloomberg.com/news/2012-04-24/weidmann-says-bundesbank-is-preserving-euro-stability.html
the irony is that if Germany was taking its own medicine, the German economy would be cooled off, which would give the ECB more space.
25. April 2012 at 07:06
The utter stupidity of ECB representatives is breathtaking. Have a look at this interview of Mario Draghi for Bild Zeitung: http://www.ecb.europa.eu/press/key/date/2012/html/sp120323.en.html
Highlight:
“The key data for the euro area, such as inflation, the balances of payments and in particular budget deficits, are better than in the United States, for example”
Does anybody noticed what is missing there? Like mentioning such an unimportant data like unemployment/employment or growth? This is looking very bad.
25. April 2012 at 07:37
Er, what credibility? Sorry Scott, but everyone believes they will keep funding member states’ debts by devaluing their currency. Its why the Swiss had to peg to the Euro, because the Euro (and USD) kept dropping.
25. April 2012 at 07:42
The failure of the European project could be the greatest tragedy of our century.
25. April 2012 at 08:00
“Herbert Hoover bragged that although the economy was looking a bit weak, voters could take comfort in the knowledge that his adroit leadership had preserved the dollar/gold peg.”
A perfect example of the excesses of ideology. The ideology of the gold standard was more important to Hoover than mass unemployment and starvation. Some of us think the purpose of the economy is to produce goods and services for human beings.
I think there is problem with how historians rate our Presidents. They tend to downplay economics and concentrate on foreign policy and minor ethics scandals, assuming depressions and inflation just happen – like a plague of locusts or something. That’s why most surveys I’ve seen put Hoover in the middle of the pack. Hoover should be at the very bottom, with Jackson, Van Buren, Grant and Cleveland following closely in the economic policy category. Washington, Lincoln, FDR and Reagan should be at the top.
I know you’re busy, but if you need an idea for a book you could do a ranking of the economic policies of the Presidents.
25. April 2012 at 08:09
I applaud the attempts by Draghi and Weidmann to hold the line that was instrumental in building the prosperity of Germany and the Netherlands etc (and was once coveted by most other European countries), but the pressure on them must be enormous. What particularly annoys me about Soros is that he is one of the few individuals who actually has the money to put where his mouth is (eg by conducting his own peripheral government bond purchase programme), but, as far as we know, he does not.
25. April 2012 at 08:21
Scott, it is not fair to compare a price level target peg to a gold price peg.
25. April 2012 at 08:23
Scott, this is unrelated, but I’ve been reading Robert Lucas’ slides on the Great Depression. I understand the mistakes he makes on slides 32 and 35, but am unsure what the best response is to his argument on slides 29-31. It seems like a version of the dearth of safe assets story. Can you explain it to me? Surely he is at least partly right. Here are the slides:
http://www.econ.washington.edu/news/millimansl.pdf
I’m assuming you haven’t commented on this already, or I’d be happy for that link.
25. April 2012 at 08:24
Great Recession, sorry – though he correctly makes a comparison with the GD, though doesn’t see the full similarity.
25. April 2012 at 09:11
I’ll say it again: Let’s peg central banker and staff salaries to real increases in GDP.
If you are on safe government salary, then a deflationary recession (and cheaper housing) is not such a bad outcome.
25. April 2012 at 09:35
[…] 1975 looks far more like 1929 than either does like 2009. What is the explanation? That Milton Friedman’s lesson was taught in the interim? That the Gold Standard messed everything up? Not sure… Here’s Scott Sumner: […]
25. April 2012 at 09:37
Benjamin, wouldn’t that lead to irresponsible expansions beyond potential output (artificial booms)?
25. April 2012 at 10:41
Saturos,
I don’t think so since its pegged to RGDP, not NGDP.
25. April 2012 at 11:03
I keep thinking about the Darwin Awards.
25. April 2012 at 11:25
Saturos-
1. Well, currently we are encouraging deflationary perma-recessions, ala Japan. The pecuniary incentive for central bankers and staffs is to bring about deflation, while they are in fixed salaries, and possibly earning step increases by seniority. And remember–these guys generally do not open up a restaurant on the side. This is how staffers make their money.
2. The job of the Fed should be real growth. How can we pay anybody who does not bring about real growth?
3. If a banker is leaving in one year, yes he/she might have a financial incentive to blow the doors open and print money. This could be handled by staggering board seats (chronologically) and delaying final bonuses to some period after time of service.
But definitely there should be big bonuses for real growth, and perhaps secondary bonuses for keeping inflation in check.
However, if my suspicions are correct we are entering an era of sustained low inflation and interest rates, a sort of Japan-lite. The Fed has to concentrate on growth–stacking the deck in favor of growth policies might be warranted.
25. April 2012 at 12:15
I keep thinking about the Darwin Awards.
survival and procreation is its own reward.
25. April 2012 at 12:22
Trichet was a disaster with two major blunders on his watch: July 2008 and April/July 2011. Euro-area NGDP went negative in both cases, with predictable and devastating consequences. Draghi has been better but his efforts are being sabotaged by hawkish German sabre rattling, which is likely depressing base velocity and short circuiting the path to stronger NGDP. Berlin could screw up a wet dream.
25. April 2012 at 12:27
So, the eurozone money supply keeps following output down, so incomes keep falling, so debt burdens keep getting worse and this is policy “credibility”.
You know, I thought money was for facilitating transactions. Silly me.
25. April 2012 at 12:33
It is more scary that he said it.
What is even more scary is that the monetary system was delegated to the median voter (it was first moved to Gov. to fund wars) and that the median voter does not know that need not be so.
25. April 2012 at 13:25
Arguing with some friends the other day about monetary policy I think I was defending market monetarism against a Keynesian who started talking of the need for more credit creation to kickstart the economies of Europe. That someone had to gear up, to take on more debt, in order to see economies on the move. But then it clicked with me that something your wrote in a comment the other day, that something that I worry aobut, more credit, was not in fact necessary to get economies moving. Merely more money, and that is not the same thing. Can you point to a particular post where you discussed money vs credit more explicitly? Or write a new one?
25. April 2012 at 13:57
Metaphor for the European economy:
Two Spanish teams in the Champions’ League semi-finals, comprising the best and most expensive teams in the world, and one German team. The Germans make the final (to face a British team), neither Spanish team does.
25. April 2012 at 13:58
There is the “IT” fetish and the “Credibility” fetish. Both, the latter for sure, a legacy of RBCT>
25. April 2012 at 15:15
DeLong:
“Target the path of nominal GDP, people!”
http://delong.typepad.com/sdj/2012/04/did-ben-bernanke-just-say-that-the-depression-era-fed-made-a-mistake-by-allowing-inflation-to-get-above-2-during-the-great-d.html#comment-6a00e551f0800388340168eab90581970c
25. April 2012 at 16:21
… and one more on Bernanke credibility
http://ftalphaville.ft.com/blog/2012/04/25/974591/bernanke-and-the-wrong-credibility-issue/
25. April 2012 at 17:55
Disappointing Bernanke interview:
* Reaffirmed an “oil standard.” Bernanke pointed out the PCE inflation would drop barring another “oil price shock.” Does this mean an oil price shock would be met with a sharp drop in NGDP in order to preserve creditor’s oil purchasing power?
* FOMC policy forecast maintain a disconnect: there’s a pledge to maintain rates near zero through 2014. However, 5 members forecast 1% or higher by YE13 and 7 members forecast 2% or higher by YE14. Furthermore, the average forecast for long-run Fed Funds rate is 4.2%, which is incompatible with a 2% inflation target and the low Wicksellian interest rate of the future. The Fed will provoke another crisis as soon as it declares “Mission Accomplished.”
* Talked about measuring “too-big-to-fail” by utilizing bond spreads of big vs small banking institutions. This makes no sense. A bank diversified across geography and product has self insurance that Abilene Community Bank Strip Mall Development Lender doesn’t have. The former relies on other divisions for insurance while the latter has the morally hazardous reliance on the FDIC and government for bailouts if strip malls perform poorly.
There’s probably more, but I haven’t found a transcript yet.
25. April 2012 at 18:13
small banks may not even have liquid bonds, so the bond spreads might not be meaningful. or if they primarily have deposits, and use swaps for maturity transformation.
the headline of this press conference should have been: FOMC adopts strict inflation target, abandons employment mandate.
he sounded defensive, more than in Jan. good. feel that heat. turn it up.
25. April 2012 at 18:24
dwb
Great link on De Long. He “lies” with a straight face! Did a post:
http://thefaintofheart.wordpress.com/2012/04/25/from-the-people-that-brought-you-the-idea-of-a-self-financing-deficit/
25. April 2012 at 18:34
Negation of Ideology writes: “A perfect example of the excesses of ideology. The ideology of the gold standard was more important to Hoover than mass unemployment and starvation. Some of us think the purpose of the economy is to produce goods and services for human beings.”
In fact in 1932 the Fed was sitting on a huge stock of excess gold reserves–early that year it still had twice what it needed to meet the 40% gold cover requirement on outstanding FR notes. Even as late as the bank holiday, it had $1 billion in excess gold. What’s more, the 40% requirement was itself quite artificial, and could according to the rules have been suspended “indefinitely” if necessary. It follows that the gold standard didn’t stand in the way of monetary stimulus during the Great Contraction episode. That it did not stand in the way of fiscal stimulus ought to go without saying.
So I ask: who is it that’s letting “ideology” influence their understanding of the steps necessary in 1932 to combat the depression?
25. April 2012 at 18:48
Thanks Saturos, I’d like to write a book on market monetarism someday.
jck, Yup, they have lots of credibility. They promise to hold down aggregate demand in the eurozone to levels that will produce a catastrophic recession, and the markets believe they will do so.
dwb, Soros is certainly right about the euro.
JV, But unemployment is not “key data.” Seriously, thanks for that quotation, it’s worth another post.
Doc, Credibility that inflation and NGDP growth will stay very low.
Arthur, It’s unfortunate, but Europe was a much bigger problem in the 20th century. The biggest problems of this century will occur elsewhere.
Negation, If historians put Hoover in the middle of the pack they are even more clueless than I thought. There is a new study that shows a president’s rating with historians is very strongly (and positively!) correlated with the percentage of Americans who were killed in wars during his administration. If you want historians to like you–start a very bloody war.
Rebeleconomist, I don’t see where the ECB contributed at all to the prosperity of any European country.
123, Why not?
Saturos, Yes, he’s partly right. But the early stages of the Great Depression were actually caused by a fall in the monetary base, not a banking crisis.
I think he overstates the effectiveness of the Fed in this crisis.
Ben, Or we could let the market set the money supply at the level expected to produce healthy NGDP growth.
Nick, Yes, what ever happened to the Darwin Awards.
Tommy, Lorenzo, Floccina, I agree.
James, I don’t know if I have such a post–maybe I’ll do one someday.
Marcus, That’s right. They are trusted to do the wrong thing, just as they promise to.
dwb, Very depressing.
25. April 2012 at 19:45
[…] don’t even have to hide the fact that you don’t care about the unemployed. Commenter J.V. DuBois sent me the following: The utter stupidity of ECB representatives is breathtaking. Have a look at […]
25. April 2012 at 19:54
Thanks Scott. I think the stories between GD and GR are very similar – an unnecessary tightening to head off an irrelevant asset/commodity spike, followed by passive tightening in the teeth of rapidly declining AD, with falling nominal income precipitating a debt crisis which then shuts down much of the financial system, which can’t be fixed (despite futile attempts) until AD starts expanding again. And then opportunistic presidents seizing the moment to expand government radically, passing “recession-fighting measures” which in fact have nothing to do with it.
But I see the UK has just gone back into recession. Will you do a post on that, or do you think this post applies just as well to Britain? Perhaps you might say a little more about Britain’s supply-side woes which render its economy exceptionally weak.
25. April 2012 at 20:31
Benjamin, I think the reason we are in the hole we’re in is because the only good monetary textbook out there, Mishkin, devotes most of his AS/AD analysis of the inflation target to warning against responding to a decline in output below potential (in a very misleading series of diagrams) with monetary ease, as it would just be irresponsible accomodation. Of course, he fails to distinguish between supply-side and demand-side drops in output.
So the whole ideology of IT is not just biased, but absolutely paranoid against what it calls accomodation – probably because of what everyone learned in the last two chapters of Mishkin in college. No chance that economists-in-general (who determine Fed policy, as Scott says) would sign on to a program that pays central bankers to “accomodate”, as they see it.
James, read Friedman’s 1968 speech on interest rates. (I keep recommending it to everyone). As Nick Rowe would say, you can receive credit by borrowing homes or real assets, even in a moneyless economy. Expanding borrowing has no fundamental relationship between increasing the supply of the unit of account and the medium of exchange. It just happens to be the case that we live in a fractional-reserve system where the money-multiplier contributes to the supply. But there is no fundamental ontological identity.
26. April 2012 at 00:08
Scott: “I don’t see where the ECB contributed at all to the prosperity of any European country.”
This shows the mistake that you and other proponents of NGDP targeting are making, and perhaps also why you are puzzled by the “Bernanke conundrum”. Monetary policy is a perpetual struggle against the temptation – sometimes from rogues within the central bank itself – to gain short-term popularity by going easy, at the expense of the long-term sustainability of the framework. Many monetary policy frameworks may make theoretical sense, but what really matters is how well they allow this temptation to be resisted. I suspect that now that Bernanke is actually responsible for monetary policy, he understands that he has to consider potential actions not just in terms of how they mitigate the present crisis, but also how easily they can be withdrawn when no longer needed, and how they might change behaviour in the long-term.
You can only really tell how a monetary policy framework works after it has been strongly tested. The ECB did well by making token hikes is response to rising inflation in 2008 and 2011, but clearly the present test is by far the greatest it has faced. If the ECB can get through this test without compromising its inflation objective, and of course without losing any core member of eurozone, then you will see the benefit. Like the understanding that the Bundesbank was able to create, European businesses and politicians will appreciate that they must find real solutions to economic problems, investors will trust the euro, and sustainable prosperity will follow.
26. April 2012 at 00:09
Scott, it is terribly depressing…only good news – I got Bob’s book in the mail…
26. April 2012 at 01:45
Scott, it is not fair to compare a price level target peg to a gold price peg, because these days we do not observe the equivalent of gold hoarding or the equivalent of higher gold reserve ratio. Indeed, there is no equivalent at all. How can you hoard CPI, or how can central banks change the CPI/reserve ratio in the wrong direction?
26. April 2012 at 08:37
George Selgin,
I don’t dispute that the Fed acted incompetently during the Great Depression. They certainly had the power to at least alleviate the contraction even with the gold peg. I don’t see how that exonerates Hoover – or the gold standard. When FDR ended the gold standard, we had some of the best economic growth in our history. Other nations recovered when they went off gold. FDR also passed legislation making the Fed more of a public institution and less private. Hoover was not powerless to make appointments or propose legislation with regard to the Fed.
I read some of Hoover’s memoirs(you can find them free online). He sharply criticized efforts in Congress during his tenure to issue a few billion dollars of legal tender US Notes to offset the 33% cumulative money supply drop. This was at a time of 10% annual deflation. Even after his much deserved defeat, he tried to get FDR to commit to keeping the gold peg.
So even after his Presidency, Hoover was taking credit for blocking the only serious efforts to stop the deflationary debt spiral.
26. April 2012 at 12:03
Here’s a quote from non other than Brad DeLong:
“The ECB cannot induce banks to make more loans and fund more investment and consumption spending by swapping bonds for reserves as long as the value of pure liquidity is zero and reserves are as good as – nay, better than – short-term bonds.”
even though he made the quote with reference to justifying a fiscal stimulus, he does make a good point.
Neither monetary or fiscal stimulus are helpful as they will only help the economy reach the pre-crisis status quo. A much better approach is an institutional reform which will finally remove the distorted signals in the market…
26. April 2012 at 12:51
I vote for #2 being scarier than #1. But I also don’t think that #2 is true. Members of the ECB, particularly Draghi, make comments that they may not necessarily believe but that are required to avoid political pressure in the future. Watch what they do, and not what they say, and you’ll realize that they actually just lie a lot.
27. April 2012 at 10:45
Saturos, I agree with those comparisons. I’ve done quite a few posts on Britain (where I do see both AS and AD problems), perhaps I’ll do another post. The AS problems are greatly expanded government (under Gordon Brown’s leadership) and higher MTRs.
Rebeleconomist, I think those views are just crazy. The Titanic is going down and you are worried about whether the proper dining arrangements are being maintained. But I will say this, Herbert Hoover would have agreed with you.
Lars, Yes, I got mine too.
123, The equivalent is supply shocks.
Vuk, Monetary policy does not “help” by generating loans.
Federico, I agree.
27. April 2012 at 11:50
“The equivalent is supply shocks”
Well, Hoover has engineered deflation, and he has caused the collapse of inflation expectations. It was these two mistakes that have caused the most damage, not the overreaction to supply shocks.
27. April 2012 at 19:57
Propagation of Ideology:
When FDR ended the gold standard, we had some of the best economic growth in our history.
You have a rather funny way of saying that when the nation was on a gold standard we had some of the best economic growth in history.
28. April 2012 at 17:22
123. I meant that supply shocks can cause unemployment to soar under CPI targeting, just as gold hoarding can cause unemployment under a gold standard.
28. April 2012 at 18:45
“When FDR ended the gold standard, we had some of the best economic growth in our history.”
“You have a rather funny way of saying that when the nation was on a gold standard we had some of the best economic growth in history.”
Perhaps my wording was bad. It should read “Immediately after FDR ended the gold standard, followed a period of some of the best economic growth in our history.”
Obviously, at the exact instant when the gold standard ended, we hadn’t acheived that growth yet. I mistakenly assumed everyone would be intelligent to understand that.
30. April 2012 at 17:24
Negation: “When FDR ended the gold standard, we had some of the best economic growth in our history. Other nations recovered when they went off gold.”
The growth that took place between 1933 and 1937, far from having been possible only because the dollar had been unhitched from gold (which in fact it wasn’t), was entirely based on gold inflows from Europe: as Christina Romer has shown, there was scarcely any expansion of Federal Reserve credit outstanding during that period. In other words, had the gold standard remained in effect in the U.S., then according to the so-called “rules of the [gold standard] game, we’d have seen at least as much, probably more, M-expansion than actually occurred. So here again you are wrong in suggestion that expansion would have been prevented by “the gold standard.”
As for Hoover, I implied no general defense of his policies: my remarks concerned the role of the gold standard alone. But the view that his (often bad) policies were on the whole worse than FDR’s won’t stand much scrutiny. The NRA alone was worse than anything Hoover did; and FDR, it bears observing, both ran against Hoover on a “I’ll balance the budget” campaign, and refused to cooperate with him in his efforts to address the Feb. 1933 banking crisis. There is NO evidence that FDR had even given a thought to the monetary problem prior to his inauguration; and the steps he took afterwards were based on suggestions from Hoover’s Treasury officials. Finally, if FDR would (unlike Hoover) have favored issuing more greenbacks, he certainly never said so. (Hoover, for his part, did approve the rider to the FHLB that allowed for an emergency expansion of National Currency notes.)
30. April 2012 at 18:11
Propagation of Ideology:
Perhaps my wording was bad. It should read “Immediately after FDR ended the gold standard, followed a period of some of the best economic growth in our history.”
Your wording was fine. All I am saying is that your statement is equivalent to saying that on the gold standard we had some of the best growth in history. That’s what is implied by saying under fiat money we had some of the best growth in history.
If you had instead said that under fiat we had the best growth in history, then that would have been different, and wrong.
30. April 2012 at 18:13
George Selgin:
For all we disagree with, I fully agree with you on that post.
30. April 2012 at 18:13
For what little that’s worth, that is.
30. April 2012 at 19:11
The League of Nations pyramidal gold and foreign exchange standard was flawed in conception from the beginning and, given the international tensions between the European countries at the time, the sheer mistrust and lack of cooperation between the central banks and governments, augmented by the the rise of tremendous – internal as well as external – trade barriers, the whole system was a ticking bomb.
See, for instance, this paper for an overview of how badly this worked out in Romania back then, where the monetary problems were signficantly magnified by the great exposure to foreign trade (the country had one of the longest continuous Great Depression and also went into partial default):
http://www.nbs.rs/export/sites/default/internet/latinica/90/SEEMHNkonferencija/SEEMHN_14_Rumunija.pdf
As in Britain, the government tried to reestablish pre-WWI parity during the 1920s, despite the war inflation, and then it adopted the pyramidal monetary system sponsored by the League of Nations that emerged after WWI, a monetary system of gold plus foreign exchange reserves (dollar, franc and sterling). The fragility of this international monetary system was soon put to the test there and in many other countries linked to it.
When the NY Stock Exchange collapsed in 1929, a capital outflow hit the country, which was magnified and provoked a Romanian banking crisis following the collapsed of the famous Austrian bank Credit-Anstalt in 1931, a banking crisis further magnified by the fall in agricultural export and the farmers revenue because of the rising tide of protectionism.
But the nail in the coffin came when the British abandoned the gold cover of the sterling, also in 1931, and, later on, in 1933, the US abandoned the gold cover for the dollar as well, following the failure of the monetary powers to reach an agreement on “stabilisation” during the London conference. This actions generated a huge deflationary effect on the Romanian National Banks’ reserves, which stayed with the gold standard, like the French National Bank and others.. Eventually the government had to partially default on its foreign debt, which was due to mainly to French creditors.
The pyramidal gold and foreign exchange standard was a fragile, flawed system from the start and on top of that it was disastrously managed.