Thomas Raffinot on the eurozone disaster

Thomas Raffinot sent me an interesting report on the eurozone.  I had trouble copying from the pdf file, but you can read the full report here.  This graph shows his estimate of how far ECB policy has diverged from the optimal policy, given the ECB’s mandate:

Screen Shot 2014-03-06 at 10.01.47 PMFree Exchange has a new post that has me a bit perplexed. Indeed there is a non-zero probability that I’m about to make a complete fool of myself.  The post explains in detail why ECB policy is far too tight, using either the unemployment or the inflation metric, and then seems to end by endorsing what it calls the ECB’s “masterly inactivity.”

Moreover, inflation appears to have stabilised for the time being though at a pretty low rate given the ECB’s target of just below 2%. The headline rate has now stayed at 0.8% since December while the core rate (excluding volatile elements like food and energy) picked up to 1% in February, having fallen to a record low of 0.7% in December. Unemployment remains high, at 12% of the workforce in January, but it has also stabilised, having remained at this level since October.

.   .   .

The crucial element in the new forecasts is what they show for the longer-term inflation outlook. The December projections had shown inflation falling from 1.4% in 2013 to 1.1% this year and then edging up to 1.3% in 2015. The new forecasts show it a little lower this year, at 1.0%, picking up to 1.3% in 2015 and reaching 1.5% in 2016. In his opening statement to today’s press conference Mr Draghi drew attention to the fact that inflation would be rising by 1.7% in the year to the final quarter of 2016, in other words more or less at the ECB’s target rate.

.  .  .

In its new capacity as single supervisor (a job it takes over formally in November) it is pulling out all the stops to diagnose the health of euro-zone banks and to ensure that the necessary treatment is administered. But in the more familiar realm of monetary policy, the ECB is pursuing a strategy of masterly inactivity.

Now perhaps this is just sarcasm.  Those who read my comment section will occasionally see me strongly objecting to comments that were intended as sarcasm, and indeed came from commenters who agree with me.  I’m a bit slow.

If it was signed “R.A.” I would immediately know that the “masterly inactivity” comment was meant derisively.  But I’m not familiar with “P.W.”

In any case, ECB policy is just completely dysfunctional.  There is a case to be made for current Fed, BOJ or BoE policy, but there is no case to be made for ECB policy. It’s completely inexcusable under any reasonable interpretation of the ECB’s mandate, even the “German” interpretation.

Meanwhile here’s what’s happening in a country that until recently was mocked by American and European economists:

Kazufumi Yamamoto is having such a hard time finding waiters and sushi chefs to fill jobs at Ganko Food Service Co. that he’s going to boost wages for the first time in more than a decade.

“Positions remain open for several months, leaving some restaurants heavily understaffed,” said Yamamoto, personnel head at the sushi-chain operator in Osaka. “The labor shortage has worsened to the point we have no choice but to increase pay.”

The troubles facing Yamamoto, 43, reflect the pressures of a labor force that’s shrinking, with just nine high school graduates on the hunt for a private-sector job now for every 10 just five years ago. Smaller companies reliant on part-time workers are bearing the brunt, pressuring them into wage gains that have yet to be reflected in the broader job market.

While nationwide pay fell in the year through January, and will probably rise less than 1 percent this year, according to economists surveyed by Bloomberg News, smaller and mid-sized employers such as hand-cleaner maker Saraya Co. are considering salary gains of 2 percent or more. The nation is within a few years of an overheated job market that makes inflation, not deflation, Japan’s challenge, economist Masaaki Kanno says.


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30 Responses to “Thomas Raffinot on the eurozone disaster”

  1. Gravatar of dannyb2b dannyb2b
    7. March 2014 at 17:17

    Why not let inflation run a bit higher if targeting inflation? Extra supply should come online as a result of higher NGDP which includes higher I.

  2. Gravatar of Lorenzo from Oz Lorenzo from Oz
    7. March 2014 at 17:53

    If I was a conspiratorial Eurosceptic, I would suggest that policy is deliberately too tight to create an ongoing mega-crisis which will force the EU further along the path to political superstate.

    Alternatively, ECB policy represents the consensus of mainstream European macroeconomics, magnified by Bundesbank dominance. The point of the Euro, after all, was a deutschmark for everyone. Deference to the Bundesbank is built into the implicit (if not explicit) architecture.

  3. Gravatar of lxdr1f7 lxdr1f7
    7. March 2014 at 18:26

    Is monetary policy irrelevant? If sticky prices are only a short term phenomenon then why not just never interfere at all with the money supply? Real GDP will be the same in the long run right?

  4. Gravatar of Frances Coppola Frances Coppola
    7. March 2014 at 19:19

    The ECB has no mandate whatsoever to target unemployment, so the fact that Eurozone unemployment is over 12% is not its concern – it is a matter for the fiscal authorities. And the ECB is looking at inflation in the medium term. According to Free Exchange, it seems the ECB believes that the medium-term outlook for inflation is close to target at 1.7%. Therefore there is no need for the ECB to do anything.

    However, this might backfire. NY Fed researchers point out that higher inflation expectations might be due to anticipated monetary easing: http://libertystreeteconomics.newyorkfed.org/2014/02/just-released-the-inflation-outlook-in-the-euro-zone-survey-says.html

  5. Gravatar of Benjamin Cole Benjamin Cole
    7. March 2014 at 19:24

    Stop the Insanity!

    The ECB is pompously pettifogging, or cowering in the face of microscopic rates of inflation when it has 12 percent unemployment?

    FOMC members mention inflation 500 times in a single meeting (not even a full day meeting)…and that in 2008?

    When did the economist-central banker nexus become monomaniacally obsessed with inflation? This is what is known as an “unhealthy perversion.”

    Can we have prosperity again, maybe a for a few years, Fat City all around and then start to worry about inflation?

  6. Gravatar of Lorenzo from Oz Lorenzo from Oz
    7. March 2014 at 19:46

    Frances Coppola: The ECB has no mandate whatsoever to target unemployment.
    Not quite true. Price stability is the ECB’s primary objective, but the Treaty on the Functioning of the the European Union also requires it to:
    http://en.wikisource.org/wiki/Consolidated_version_of_the_Treaty_on_the_Functioning_of_the_European_Union/Title_VIII:_Economic_and_Monetary_Policy#CHAPTER_2:_MONETARY_POLICY
    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.
    Such high unemployment does not look like an efficient allocation of resources, even on the most rigid view of the “natural” rate of unemployment.

    It is also required, by Article 3A of the European Union treaty, to support the general economic policies of the European Union.
    http://eur-lex.europa.eu/en/treaties/dat/11992M/htm/11992M.html

    They can concern themselves with unemployment (and income expectations) if they choose to.

  7. Gravatar of ssumner ssumner
    7. March 2014 at 20:50

    lxdr, What did Keynes say about the long run? Or maybe you are just being sarcastic. Remember that I have trouble telling who is serious–you need to attach a smiley face.

    Frances. The ECB has a mandate to make the eurozone a well functioning currency area. Unemployment is very relevant to that mandate. Their current policy may destroy the eurozone. The fact that the ECB believes inflation will eventually get back on target is completely irrelevant. In 1932 most sensible people believed the deflation would end within a few years. And it did. Does that mean monetary policy was not too tight in 1932? Of course not. Money is far too tight right now, regardless of what they think will happen in 2016. No disaster lasts forever, but when it’s been going on for 6 years and there is still no light at the end of the tunnel other than wishful thinking from the ECB, then policy has failed.

    I would also point out that medium term inflation was not the criterion used by the ECB when they raised rates in 2011. They panicked because current inflation was above target. I don’t think anyone seriously believed it was going to stay above target.

    The ECB is also very foolish to target the CPI, rather than the GDP deflator. And they are very foolish to target price indices that are inclusive of indirect taxes.

    I’m not sure what the fiscal authorities can do about unemployment. If you mean German style labor reforms then I’m all for that. But otherwise fiscal stimulus will do nothing for employment due to monetary offset.

  8. Gravatar of dannyb2b dannyb2b
    7. March 2014 at 23:45

    Is the long run a specific period of time under MM? 10 years or more?

  9. Gravatar of TravisV TravisV
    8. March 2014 at 07:53

    I’m sorry to see this:

    “‘The Kudlow Report’ Cancelled, Larry Kudlow Becomes CNBC Senior Contributor”

    http://www.mediabistro.com/tvnewser/the-kudlow-report-cancelled-larry-kudlow-becomes-cnbc-senior-contributor_b216443

  10. Gravatar of Michael Byrnes Michael Byrnes
    8. March 2014 at 08:01

    lxdrf17 wrote:

    “Is monetary policy irrelevant? If sticky prices are only a short term phenomenon then why not just never interfere at all with the money supply? Real GDP will be the same in the long run right?”

    No, because short-run non-neutralities will affect aggregate supply.

    The current crisis caused a loss of lots of labor hours that can never be recovered. Some but not all of those were probably wasted hours, but to the extent that productive labor was lost, it is lost permanently from aggregate supply.

    We also now have a new class – “the long term unemployed” – that includes many who may be permanently lost to the labor force. Again, perhaps some of these were non-productive, but it stretches credibility to think that all of them fit that category. To the extent that productive workers have been lost from the labor force, that is another permanent hit to supply.

    Short-run non-neutralities can cause a permanent loss of real wealth.

    70s-type inflation is another example of this.

  11. Gravatar of Morgan Warstler Morgan Warstler
    8. March 2014 at 10:07

    Folks, let’s not forget:

    “Greece posts first current account surplus since 1948”

    http://www.bbc.com/news/business-26257413

    This was ALWAYS the plan:

    “Greece’s current account surplus was helped by record tourist spending”

    They have to become Florida / South Carolina, deregulate, and unstick sticky wages as much as humanly possible.

    “Falling wages have helped Greek firms’ competitiveness, leading to a rise in exports of non-fuel goods by 2.1% to 14.2bn euros in 2013.”

    Now look, you can say it is inhumane…

    But I have done business with Greek startups, and they were not being worshipped like the gods they deserve to be by their leaders.

    AND THAT WAS AN IMMENSE HUMAN TRAGEDY. The WRONG people in Greece had been important and had to high status for hundreds of years!!!!

    So yes sure, we can fiddle a a bit with MP, but anytime Greece, we’re talking GREECE has to grow up and act right, well things aren’t all that bad.

    Selah.

  12. Gravatar of Daniel Daniel
    8. March 2014 at 10:23

    unstick sticky wages as much as humanly possible.

    Because why put an extra blanket on when you can try to move the Earth closer to the Sun.

  13. Gravatar of Morgan Warstler Morgan Warstler
    8. March 2014 at 10:51

    Dan, I’m a big fan of geo-engineering, even if there is no global-warming. And anyone who believes in global warming, well we should measure their belief by whether they are desperate enough to try geo-engineering.

    It’s all about who is high status. About what talents and skills set are rewarded, about WHO GETS THE GRAVY.

    And middle men, politicians, organizers, academics, bureaucrats, rent seekers, journalists, military men, financiers, must all get in the back of the bus and let the inventors and entrepreneurs drive.

    We can agree on that right?

  14. Gravatar of ssumner ssumner
    8. March 2014 at 11:08

    danny, The long run can be a week or 20 years, it depends how long it takes the system being considered to adjust to the shock.

  15. Gravatar of Brian Donohue Brian Donohue
    8. March 2014 at 11:23

    For years and years, The Economist used to snicker at muddled, old-fashioned “dual mandate” Fed vs the sleek new central banks with their laserlike focus on inflation.

    Ironically, the dual mandate is closer to a NGDPLT mentality.

  16. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. March 2014 at 12:41

    Lorenzo from Oz,
    To clarify, the relevant part of the Treaty on the Functioning of the EU is Article 127(1):

    http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2008:115:0047:0199:en:PDF

    THE TREATY ON THE FUNCTIONING OF THE
    EUROPEAN UNION

    CHAPTER 2 MONETARY POLICY

    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…”

    And the relevant part of Article 3 of the Treaty on the EU is Section 3:

    http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2008:115:0013:0045:EN:PDF

    THE TREATY ON EUROPEAN UNION

    TITLE I COMMON PROVISIONS

    Article 3 (ex Article 2 TEU)

    “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…”

    So not only *can* the ECB concern itself with unemployment, provided price stability is assured, the ECB is *obliged* to contribute to *full employment*.

  17. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. March 2014 at 13:10

    Moreover, nowhere in the EU Treaties is the meaning of “price stability” ever defined. So what constitutes price stability is entirely up to the discretion of the ECB.

    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”.

    http://www.ecb.int/mopo/strategy/pricestab/html/index.en.html

    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).

    Michael Woodford’s ideal monetary policy target is what he calls an “output gap adjusted price level target” (OGAPLT):

    http://www.washingtonpost.com/blogs/wonkblog/wp/2012/09/15/michael-woodford-i-personally-would-have-gone-further-but-what-the-fed-did-is-definitely-a-step-in-the-right-direction/

    But he agrees that OGAPLT and NGDPLT are similar enough that they can be considered alternatives.

    So what I imagine is that OGAPLT might be considered a compromise, between the price stability mandate of the EU Treaties, and NGDPLT.

  18. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. March 2014 at 13:38

    Scott,
    “I would also point out that medium term inflation was not the criterion used by the ECB when they raised rates in 2011. They panicked because current inflation was above target. I don’t think anyone seriously believed it was going to stay above target.”

    Just to enlarge upon this point, although headline inflation was elevated, core inflation was not.

    Here’s what the European Commission’s Spring 2011 Quarterly Report on the Euro Area had to say about the output gap and inflation on the eve of the interest rate increases in April and July 2011 (Page 16):

    http://ec.europa.eu/economy_finance/publications/qr_euro_area/2011/pdf/qrea1_en.pdf

    “The economic and financial crisis of 2007-2009 has resulted in a large output gap that is only gradually closing. According to the Commission’s autumn 2010 forecasts, the output gap of the euro area reached a trough of -3.8 % in 2009 and is projected to remain sizeably negative for some time, reaching -1.6 % in 2012. For comparison, the OECD Economic Outlook of November 2010 sees the euro-area output gap at -4.9 % in 2009 and -2.7 % in 2012. (13) Yet, euro-area core inflation area has been remarkably stable. From a peak at 2.7 % in March 2008 it has fallen to a trough of 0.8 % in April 2010 and since then gradually climbed back to 1.1 % in February 2011.”

    So the ECB chose to raise rates in 2011 despite the fact that the European Commission’s estimates showed the output gap would “remain sizably negative for some time” and despite the fact core inflation was only 1.1% in February 2011.

  19. Gravatar of Vaidas Vaidas
    8. March 2014 at 14:22

    Mark,
    at that time the ECB was convinced that the core inflation is not a useful indicator. I remember ECB presentations which compared the volatility of US and Eurozone inflation and output with a conclusion that the European policy wins on both counts and the reason is the laser-like focus on minimizing the volatility of headline CPI.

    The most striking feature of the rate hike episode was the fact that the decision was unanimous.

  20. Gravatar of Lorenzo from Oz Lorenzo from Oz
    8. March 2014 at 15:09

    Mark; thanks, that is clarifying.

  21. Gravatar of Mark A. Sadowski Mark A. Sadowski
    8. March 2014 at 15:42

    Scott,
    Off Topic.

    “Inflation Targeting! The Terror from Beyond Space” is on Turner Classic Movies (TCM) right now:

    https://www.youtube.com/watch?v=OZHrCkEmgFo

  22. Gravatar of TravisV TravisV
    8. March 2014 at 21:47

    In an old post, Prof. Sumner wrote the following:

    https://www.themoneyillusion.com/?p=4114

    “If the Fed wants 2.5% inflation expectations, it can keep pumping money into the economy until the 12 month TIPS spread is somewhere between 2% and 3%. The circularity problem will keep this from working perfectly, but it will allow you to avoid large errors.”

    Could someone explain what the “circularity problem” is to me?

  23. Gravatar of Willy2 Willy2
    9. March 2014 at 02:27

    – Yes, japanese companies are raising their wages. But what happens with all those japanese pensioners ? Do they get a pay raise as well ? If they don’t get a raise as well, then they will be squeezed financially more.
    – When companies are raising wages across the board then that’s a force pushing interest rates higher. And that’s the last thing the Japanese government wants with its (government) Debt/GDP ratio at over 200%.
    – Seems Draghi is very well aware that all this monetary policy is futile.

  24. Gravatar of TravisV TravisV
    9. March 2014 at 05:39

    China analysis: “Low inflation could be good news for markets as monetary tightening is definitely not justified,” said Ting Lu, an economist at Bank of America-Merrill Lynch.

    “Low inflation gives the People’s Bank of China more room to ease the liquidity situation and tame rising rates.”

    http://www.reuters.com/article/2014/03/09/us-china-economy-cpi-idUSBREA2803920140309

    http://seekingalpha.com/news/1615793-chinese-exports-unexpectedly-plunge-inflation-eases

  25. Gravatar of TravisV TravisV
    9. March 2014 at 05:55

    These sentences might be worth a post / criticism:

    http://www.reuters.com/article/2014/03/09/us-china-economy-cpi-idUSBREA2803920140309

    “No analysts believes China will launch another big-bang government spending package to stimulate the economy, given the country is still suffering from the repercussions of its last pump-priming package in 2008/09 worth 4 trillion yuan.

    Instead, analysts think the government may keep interbank rates low to support lending, and increase spending in areas that support a new Chinese economy, such as the environment.”

  26. Gravatar of TravisV TravisV
    9. March 2014 at 13:39

    How can a Chicago finance guy be making such a horrible argument……

    http://economistsview.typepad.com/economistsview/2014/03/the-federal-reserve-and-wealth-inequality.html

  27. Gravatar of Matt C Matt C
    9. March 2014 at 22:27

    I’m with you Professor. I can’t pick up if it is sarcasm or not (to be fair it is really hard to pick it up when people are merely writing it rather than saying it) but I agree with what you are saying. The policies have been a disaster and have really added to the pain, particularly for southern Europe.

    People like to act that some of these high debt countries were irresponsible and that Germany should not have to clean up after them but that is absurd. I am not saying these countries are perfect, but many of their debt levels were reasonable until about 2007-2008. And since then their deficits have skyrocketed and even now have merely leveled off.

    Professor, do you think the Eurozone will collapse? Or do you think the other member countries will start putting more pressure on Germany? I can’t see things remaining at the status quo for much longer.

  28. Gravatar of ssumner ssumner
    10. March 2014 at 10:58

    Mark, Thanks for that info on the ECB’s actual mandate, as opposed to what many people think their mandate is.

    Travis, Thanks, I did a post on that UC paper over at Econlog.

    Willy, You said:

    “If they don’t get a raise as well, then they will be squeezed financially more.”

    More?

    More???

    More?????

    More???????????

    Not sure if you are being sarcastic, but they’ve just had 20 years of deflation.

  29. Gravatar of ssumner ssumner
    10. March 2014 at 10:59

    Matt, I doubt it will collapse, they’re very stubborn.

  30. Gravatar of Sumner Trolls Krugman Sumner Trolls Krugman
    18. March 2016 at 13:23

    […] readers, let me clarify that I am kidding. Ireland is still on the euro, and subject to the “eurozone disaster” as diagnosed by Sumner. So my point is, whatever rhetorical device Scott uses to explain why […]

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