The ECB has expected AD growth right where it wants it

Vaidas Urba sent me the latest ECB report:

The March 2015 ECB staff macroeconomic projections for the euro area foresaw annual HICP inflation at 0.0% in 2015, 1.5% in 2016 and 1.8% in 2017. In comparison with the Eurosystem staff macroeconomic projections published in December 2014, the inflation projection for 2015 had been revised downwards, mainly reflecting the past fall in oil prices. In contrast, the inflation projection for 2016 had been revised slightly upwards, also reflecting the expected impact of recent monetary policy measures.

As regards measures of longer-term inflation expectations, the ECB Survey of Professional Forecasters for the first quarter of 2015 indicated that the expected five-year-ahead inflation rate was 1.77%. Medium and long- term market-based measures, such as forward inflation-linked swap rates, had broadly stabilised since the previous monetary policy meeting.

.  .  .

With regard to the monetary policy stance, the members generally shared the assessment that significant positive effects from the monetary policy decisions taken on 22 January 2015, in conjunction with the package of measures decided in June-September 2014, could already be seen, namely an easing in financial market conditions and in the cost of external finance for the private economy. Moreover, recent data on economic activity had been somewhat positive and there were signs of a turnaround in inflation dynamics, including a stabilisation in market-based measures of inflation expectations. This provided grounds for “prudent optimism” regarding the scenario of a gradual recovery and a return of inflation rates to levels closer to 2%. It was recalled that the March 2015 ECB staff macroeconomic projections were predicated on the full implementation of all monetary policy measures taken by the Governing Council, including the expanded APP comprising monthly purchases of €60 billion, which were intended to be carried out until the end of September 2016 and, in any case, until the Governing Council saw a sustained adjustment in the path of inflation consistent with the aim of achieving inflation rates below, but close to, 2%. The March 2015 projections should therefore not be interpreted as suggesting that the latest monetary policy measures were less necessary. On the contrary, they confirmed that full implementation of these measures was required to deliver on the Governing Council’s mandate. At the same time, the Governing Council would continuously assess the effectiveness of the measures and would regularly review progress towards the attainment of the objectives as evidence accumulated over time.

The ECB thinks the current stance of monetary policy is just right.  (I think that’s crazy, but it doesn’t matter what I think.) The ECB also called for structural reforms, but pointedly did not ask for fiscal stimulus, indeed cautioned against slacking off on the deficit reduction targets.  Given their insane monetary policy, their stance on fiscal policy makes sense.

For instance, suppose the Germans were suddenly to do lots of fiscal stimulus, what effect would that have?  Both theory and empirical evidence suggest it would be a beggar-thy-neighbor fiscal policy.  The ECB believes it would have to tighten monetary policy to avoid overshooting their 1.8% inflation target.  Yes, the German stimulus would boost NGDP in Germany. However since overall eurozone NGDP would be stabilized via monetary offset, non-German NGDP would have to decline. This might occur through a stronger euro, for instance.

Indeed this is exactly what happened in 1992, when German fiscal stimulus associated with reunification led to a stronger ECU, which drove countries like Britain and Sweden deeper into recession and eventually out of the EMS.

The ECB may be completely incompetent at monetary policy, but give them credit for opposing the type of fiscal policies that caused all sorts of problems in 1992.

PS.  Also give the ECB credit for understanding the circularity problem—note the last portion of the third paragraph quoted above.

PPS.  I don’t know if anyone’s trademarked “beggar-thy-neighbor fiscal stimulus” yet, but if not I get first dibs.


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40 Responses to “The ECB has expected AD growth right where it wants it”

  1. Gravatar of Blue Eyes Blue Eyes
    13. April 2015 at 09:14

    Indeed. And thank goodness we in Britain had that dry run, or otherwise we might have joined the Euro!

  2. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    13. April 2015 at 09:50

    Remember when it was speculated that Paul Krugman had been kidnapped, tied up in his basement and an imposter was writing his NY Times Op-eds? I think it’s happened again;

    http://www.brookings.edu/blogs/ben-bernanke/posts/2015/04/13-german-wages

    ‘Germany’s trade surplus redirects spending away from other countries, reducing output and incomes abroad. Higher wages in Germany should promote spending by German households on both domestic goods and imports, reducing the imbalance.’

  3. Gravatar of Matt McOsker Matt McOsker
    13. April 2015 at 12:36

    How would Germany have done reunification without some level of fiscal policy? You had to merge two different economic entities that were subject to very different sets of circumstances. West Germany essentially absorbed a weaker economy with less social benefits, and weaker infrastructure.

  4. Gravatar of Scott Sumner Scott Sumner
    13. April 2015 at 12:53

    Blue, Good point.

    Patrick, Someone bring back the Krugman of the 1990s.

    Matt, I should have been clearer about 1992. My point was not that Germany had no good reason for fiscal stimulus—as you point out the stimulus may have been justified. My point is that the effect was to reduce AD in other ECU countries. Thus it’s not something you’d want to do solely to help other countries. But Germany’s critics are claiming that today a German stimulus package would help the PIIGS, and advocate it exactly for that reason.

  5. Gravatar of BP BP
    13. April 2015 at 15:09

    Amazing.

    Did the ECB Board members all go to a particular university?

  6. Gravatar of benjamin cole benjamin cole
    13. April 2015 at 15:50

    Central bankers cannot be trusted with central banking.

  7. Gravatar of TravisV TravisV
    13. April 2015 at 16:20

    (Sigh) Roger Farmer:

    “The problem of excess financial volatility is one that cannot be solved by any individual; but it can be solved by government. The Treasury has the power to make commitments on behalf of future generations. The FPC, by exercising that power on behalf of the Treasury, can make trades in the financial markets that capitalise on the inefficient boom-bust financial cycles that are the source of so much human misery. In this way, the FPC will at the same time stabilise volatility in the market and promote financial stability.”

    http://rogerfarmerblog.blogspot.com/2015/04/new-solutions-to-old-problems.html

  8. Gravatar of CMA CMA
    13. April 2015 at 16:42

    “Monetary policy that stabilizes NGDP does not cause financial instability.”

    Purchasing assets increases asset prices now in hope of increasing intrinsic value later, hence instability.

    Purchasing assets to achieve a certain level of NGDP is stimulating the financial sector too much, undermining RGDP. The financial sector underpins asset trading and creation therefore it grows unnecesarily compared to tools that create growth without AP’s.

    More speculation makes business cycles more volatile and more assets purchases/sales to stabilize cycles increases the volatility to a point where its unmanageable.

  9. Gravatar of TravisV TravisV
    13. April 2015 at 17:58

    San Francisco Fed: Do not take market-based views at face value

    http://www.reuters.com/article/2015/04/13/usa-fed-expectations-idUSL2N0XA1BH20150413

  10. Gravatar of ThomasH ThomasH
    13. April 2015 at 18:51

    Unless borrowing rates have increased, why would you expect or want governments to borrow less?

    And the price level trend also seems still to be below target. It till take inflation above 2% to meet the target anytime soon.

  11. Gravatar of ThomasH ThomasH
    13. April 2015 at 19:03

    “But Germany’s critics are claiming that today a German stimulus package would help the PIGS, and advocate it exactly for that reason.” The problem is inter-regional price and wage stickiness. The PIGS cannot devalue relative to Germany, so Germany needs to inflate, which would happen if ECB would get Euro-Zone inflation substantially above 2%. If it did, the optimal thing for German government to do would be to invest in project with present costs and future benefits. [If it were impossible to find enough good project inside Germany, they could invest in other Eurozon countries or even non-Euro Zone countries, which would help devalue the Euro. I guess you could call that combination of ECB monetary policy and German government investment a “stimulus package” and if so I’d agree with the critics.

  12. Gravatar of Nick Nick
    14. April 2015 at 02:23

    Debt financed VAT cut? Problem solved?

  13. Gravatar of benjamin cole benjamin cole
    14. April 2015 at 04:48

    Nick–QE financed debt financed VAT tax cut.

  14. Gravatar of Bonnie Bonnie
    14. April 2015 at 08:41

    @TravisV:

    I think I’ve fixed the first paragraph of that Reuters article:

    Federal Reserve policymakers should not read too much into interest rates or rates of inflation because prices are hard to decipher, according to research released Monday by the San Francisco Fed.

  15. Gravatar of TallDave TallDave
    14. April 2015 at 10:00

    HICP inflation at 0.0% in 2015, 1.5% in 2016 and 1.8% in 2017.

    Winning! Just don’t look at NGDP.

    Unless borrowing rates have increased, why would you expect or want governments to borrow less?

    Well, some government are going bankrupt.

  16. Gravatar of ssumner ssumner
    14. April 2015 at 11:32

    CMA, You said:

    “Purchasing assets increases asset prices now”

    That’s not at all clear. In the 1960s the Fed bought lots of bonds, and that action caused bond prices to fall.

    You said:

    “Purchasing assets to achieve a certain level of NGDP is stimulating the financial sector too much, undermining RGDP.”

    That doesn’t even make any sense. Define “assets” Define “certain” Define “stimulating” Define “too much” Define “undermining”.

    I don’t even know what that means, so how can I respond?

    Thomas, You’ve convinced me that they’ll fall short on inflation, but it won’t work unless you can convince the ECB.

  17. Gravatar of Anthony McNease Anthony McNease
    14. April 2015 at 13:58

    Ok so both the EBC and the Fed appear to be fine with NGDP in the ~3% range which is not good. Given this reality (at least for the next couple of years) how do things improve?

    Scott, if you’re right that this is an AS problem then what non-monetary policies can be enacted to help AS shift right? Technology, taxes, trade and probably the best would be lifting regulations that cause distortions in cash flows (territorial taxes, double taxation), subsidize transactions, and limit trade. Also, if AS shifts to the right wouldn’t this then lower the price level or at least reduce the rate of price level increases? Would this potentially prompt the central banks to ease money in response if they are targeting inflation?

  18. Gravatar of CMA CMA
    14. April 2015 at 17:58

    “CMA: Purchasing assets to achieve a certain level of NGDP is stimulating the financial sector too much, undermining RGDP.

    SSumner: That doesn’t even make any sense. Define “assets” Define “certain” Define “stimulating” Define “too much” Define “undermining”.

    I don’t even know what that means, so how can I respond?”

    By “assets” I mean any asset such as a bond or stock.

    A “certain” level of NGDP meant a specific level of ngdp growth, say 5%. I was trying to compare the effect of 5% ngdp growth on the financial sector using emoney helicopter drops and asset purchases.

    “Stimulating” the financial sector means increasing activity of the financial sector.

    “Too much” is a subjective term I know. The best definition of too much financial sector growth is if it undermines real gdp. Too much finance undermines real gdp if it grows at the expense of other sectors.

    “Undermining” real gdp due to the fact that the financial sector is too large and draws resources away from other more productive sectors.

    Do you agree that asset purchases overly stimulate the financial sector compared to e-money heli’s(hel-e)? You can achieve the same ngdp growth using hel-e’s but with higher real gdp and stability.

  19. Gravatar of Major.Freedom Major.Freedom
    14. April 2015 at 19:52

    Sumner wrote:

    “That’s not at all clear. In the 1960s the Fed bought lots of bonds, and that action caused bond prices to fall.”

    No it didn’t, it caused the bond prices to be higher. You can’t infer from an observation of a temporal fall in bond prices that the Fed buying bonds “caused” that temporal fall, unless you are including an a priori theory, which is apart from the historical trend of bond prices, that the Fed buying bonds causes bond prices to fall. It is only then do you take the observations of bind prices and claim the Fed caused bond prices to fall.

    You cannot claim by way of the data of history alone that the bond buying did not make bond prices higher than they otherwise would have been without the bond buying, or with otherwise less bind buying. You cannot observe that counterfactual world. That is why you are taking your a priori theory and pretending the data of history is somehow speaking to that theory being true, when in reality, that theory is only as good as the logical structure of the theory and the fundamental non-empirical axioms you accept are true.

    Nothing in MM or in any positivist branch of history masquerading as economics can pretend to know that the data shows or suggests or proves that the Fed’s bond buying caused bond priced to fall.

    And nice try with the sloppy “lots of” bond buying. That is bit even wrong. It doesn’t mean anything other than a self-serving psychological fix.

  20. Gravatar of Jose Romeu Robazzi Jose Romeu Robazzi
    15. April 2015 at 10:29

    Off-topic, Prof. Sumner
    If I understood correctly one state has forbidden cash transactions on second hand goods. This sound harsh even for a Brazilian like me, used to have the government intervene in almost everything …

    http://mises.org/blog/forcing-cajuns-go-cashless

    Opinions?

  21. Gravatar of Britonomist Britonomist
    15. April 2015 at 10:37

    Bernanke on switching targets or raising the inflation target when at ZLB:

    “Finally, a principal motivation that proponents offer for changing the monetary policy target is to deal more effectively with the zero lower bound on interest rates. But economically, it would be preferable to have more proactive fiscal policies and a more balanced monetary-fiscal mix when interest rates are close to zero. Greater reliance on fiscal policy would probably give better results, and would certainly be easier to explain, than changing the target for monetary policy. I think though that the probability of getting Congress to accept larger automatic stabilizers and the probability of their endorsing an alternative intermediate target for monetary policy are equally low.”

    http://www.imf.org/external/np/seminars/eng/2015/macro3/index.htm

  22. Gravatar of bill woolsey bill woolsey
    15. April 2015 at 13:58

    Ceteris paribus, if the Fed buys bonds, their prices rise. However, it is possible that other investors might sell more bonds than the Fed buys leading to bond prices falling.

    Now, if these other bond sellers were going to sell the bonds anyway, then the Fed purchases caused higher bond prices, ceteris paribus. More exactly, bond prices fell less than they would have otherwise.

    But if the reason the bonds were sold was that the Fed bought the bonds, then the sale of bonds was an indirect effect of Fed bond purchases. The Fed buying bonds caused bond prices to fall.

    Why? If the bond purchases were part of an policy of raising the money supply, then resulting inflation in prices reduces the real purchasing power of money and so the desirability of holding bonds.

    The Fed bonds bonds with newly created money. Some of those holding bonds or else potential bond buyers instead purchase stocks or metals or something.

    The effect of the policy is lower bond prices.

    We can get a parallel argument when prices and sticky and a shortage of money results in expectations of depressed real output and employment. The Fed buys bonds with newly created money. Some of those currently holding bonds sell them and instead purchase houses and cars or stocks or machines. The higher expected real income results in more consumption now and the higher expected real output leads to more investment now.

  23. Gravatar of Major.Freedom Major.Freedom
    15. April 2015 at 14:42

    Bill Woolsey:

    “Ceteris paribus, if the Fed buys bonds, their prices rise. However, it is possible that other investors might sell more bonds than the Fed buys leading to bond prices falling.”

    Precisely, and that is a good example of why we can’t infer from any correlation between Fed buying bonds and bond prices falling that either “caused” the other.

    Even if the fall took place minutes after the bond buying announcement, and did so 100 times in a row, the principles of empiricism strictly prohibit any claim otherwise.

  24. Gravatar of CMA CMA
    15. April 2015 at 18:55

    bill woolsey

    “It is possible that other investors might sell more bonds than the Fed buys leading to bond prices falling.”

    Sure but they would fall even more if the fed didn’t buy bonds and add to the demand for bonds.

    The reason people may sell bonds is because of the income effect and this effect can be generated by the central bank without purchasing bonds. Emoney heli’s therefore generate AD while generating lower levels of financial sector growth and speculation due to stimulating at higher rates.

  25. Gravatar of dtoh dtoh
    16. April 2015 at 03:33

    @scott @bill woolsey

    A good way to think about the impact on bond prices is as follows.

    1. Think of an upward sloping curve with the the amount of financial assets (e.g. bonds) that the non-financial sector exchanges for goods and services on the x axis; and the price of those financial assets on the y axis. The higher the price of assets, the more that gets exchanged.

    2. The curve also shifts left or right depending on NGDP expectations. With higher expectations – the curve shifts to the right, i.e. more financial assets get exchanged for goods and services at any given level of asset prices.

    3. Fed OMP moves the equilibrium point in two ways: a) along the curve (asset purchases push prices up), and b) by shifting the curve left or right through changed NGDP expectations. These movements will usually be in opposite directions so the impact of the new equilibrium on asset (e.g. bond) prices is going to be indeterminate.

    Bottom line though, you can have very significant asset purchases by the Fed which cause prices to fall (rates to go up).

  26. Gravatar of ssumner ssumner
    16. April 2015 at 05:34

    Anthony:

    1. More immigration, please!
    2. Allow denser housing development
    3. Eliminate occupational licensing laws
    4. Tax reform
    5. Cut military spending
    6. Health savings accounts
    7. Education vouchers
    8. Reduce intellectual property protections
    9. End the war on drugs
    10. Replace welfare with wage subsidies

    And of course that’s just the tip of the iceberg.

    CMA, I don’t agree with anything in your comment, especially the claim that NGDPLT somehow “stimulates” the financial sector. Only in the most indirect way imaginable, as when someone claims NGDPLT causes global warming because in a healthy economy more people can afford cars. There is no direct effect on the financial sector, and the helicopter approach would not have a different effect on the financial sector, it would simply waste massive amounts of money.

    BTW, minus 10% is a “certain” NGDP target, does that boost the financial sector? Your comment implies it does.

    Britonomist, I will do a post, obviously I don’t agree.

    Bill, You said:

    “Ceteris paribus, if the Fed buys bonds, their prices rise. However, it is possible that other investors might sell more bonds than the Fed buys leading to bond prices falling.”

    In a rational expectations world it’s easy for Fed bond purchases to lower prices. But I agree with your overall comment, I suppose it depends how one defines “ceteris paribus.”

    dtoh, But people usually buy goods with money, not financial assets.

  27. Gravatar of ssumner ssumner
    16. April 2015 at 05:44

    Jose, It’s not quite that strict, but still a ridiculous law.

  28. Gravatar of dtoh dtoh
    16. April 2015 at 06:11

    @scott

    ” But people usually buy goods with money, not financial assets.”

    Absolutely. People and firms (usually) have to first exchange assets for money in order to effect the exchange of assets for goods and services. If they exchanging more assets for goods, they need more money.

    That’s why you see the corresponding increase in money when NGDP goes up.

  29. Gravatar of Don Geddis Don Geddis
    16. April 2015 at 09:18

    @MF: “we can’t infer from any correlation … that either “caused” the other

    How do you ever infer any causal relation at all? Can you give a concrete answer for any specific example of a causal relation that you do think is valid to infer?

    Even if the fall took place … and did so 100 times in a row, the principles of empiricism strictly prohibit any claim otherwise.

    What a charmingly naive epistemology you have. Perhaps you’re not familiar with Bayesian probability theory. In short: you’re completely incorrect, about your idea that it is impossible to draw any conclusions from empirical data.

  30. Gravatar of ssumner ssumner
    17. April 2015 at 06:45

    dtoh, You said;

    “That’s why you see the corresponding increase in money when NGDP goes up.”

    No, that’s why you see the corresponding increase in NGDP when money goes up.

  31. Gravatar of dtoh dtoh
    17. April 2015 at 10:07

    Scott,
    So I’ll ask the same question I left on the other thread, “Why does the counter-party to OMP enter into the trade?”

  32. Gravatar of ssumner ssumner
    18. April 2015 at 10:19

    dtoh, Because they are offered a good price?

  33. Gravatar of dtoh dtoh
    18. April 2015 at 14:07

    Scott,

    See my response in the other thread, but…. Assuming the ultimate counter-party to the trade is not merely a financial institution and OMP does not merely result in an increase in ER, then as I have said, in a positive nominal rate environment, the counter-party will not enter into the trade simply to hold more money, they only enter into the trade with the specific intention to use the money to buy more goods and services. They have been induced buy goods and services through a combination of higher asset prices and/or changed expectations of future NGDP.

    The counter-party acquires the money specifically to buy more goods and services. They are not (as the HPE would suggest) induced to buy goods and services because they suddenly hold more money.

  34. Gravatar of ssumner ssumner
    19. April 2015 at 06:57

    dtoh, I often sell financial assets to buy other assets.

  35. Gravatar of dtoh dtoh
    19. April 2015 at 08:41

    Scott,

    I often sell financial assets to buy other assets.

    Yes, but if you and I are exchanging financial assets with one another it’s a wash and has no impact on NGDP. If on the other hand you exchange assets with the Fed, then it results in an decrease in the net aggregate holdings of financial assets (or an increase in indebtedness if you want to think about it that way) by the non-financial sector. Unless you are doing the trade with the Fed to hold money (unlikely in a positive nominal rate environment), it will result in increased AD. If you trade assets with me, it will not.

  36. Gravatar of ssumner ssumner
    20. April 2015 at 05:52

    dtoh, No, you might take the money you get from the Fed and buy other financial assets.

  37. Gravatar of dtoh dtoh
    20. April 2015 at 07:53

    Scott,
    Sure, but unless there is an ultimate counter-party in the non-financial sector who doesn’t just swap assets, the money will simply end up as ER. (E.g. I sell Treasuries and buy CP, the CP issuer reduces it’s drawdown on a line of credit with it’s bank – the bank deposits the money back at the Fed.) Of course there may be a long chain of asset exchanges in the process, but the reason OMP is effective is because it does induce an end counter-party to exchange financial assets for goods and services. If not, OMP would be no more effective than if the Fed did OMP with itself, e.g. the NY Fed exchanged Treasuries for deposits with the St. Louis Fed.

  38. Gravatar of ssumner ssumner
    23. April 2015 at 17:39

    dtoh, It doesn’t much matter whether the hot potato effect runs from new money to goods, or new money to financial assets to goods.

  39. Gravatar of dtoh dtoh
    24. April 2015 at 01:34

    Scott,

    But it doesn’t start from new money. It starts because firms and people decide to exchange financial assets for goods and services (as result of higher asset prices or changed expectations of NGDP). In order to effect the exchange of assets for goods they enter into an intermediate trade with the Fed to acquire the money needed for the exchange. New money does not cause people to buy goods. It is an effect not a cause. If people had not already decided to buy more goods and services, there would be no ultimate counter-party to the OMP trade and there would be no money creation (other than ER).

  40. Gravatar of dtoh dtoh
    24. April 2015 at 01:45

    @Scott,

    To use another umbrella analogy, consider the following situation:

    1.A supermarket decides to discount all goods by 50% on rainy days.

    2. The supply of umbrellas increases.

    3. Sales increase at the supermarket.

    What is the cause of the sales increase… 1) or 2)?

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