Tag Archives: European Central Bank

Sturm und Draghi

23 Dec

The announcement that the ECB “unleashed a wall of money” to prop up ailing European banks has been greeted with general positive noises, and some confusion. The money is €489 billion in three-year loans, meant to inject liquidity into a tightened banking system, and to allow the banks to, among other things, buy up sovereign debt that the ECB won’t buy directly. The confusion arises from the relationship between the words and actions of Mario Draghi, the recently arrived president of the ECB. Draghi has been at pains to say that the ECB will not act as a lender of last resort, buying up sovereign debt that nobody else wants, without a major EU treaty-change that includes enforced austerity. As he said in an interview with the Financial Times “We have to act within the Treaty. In general, there must be a system where the citizens will go back to trusting each other and where governments are trusted on fiscal discipline and structural reforms.” Yet, as any number of commentators have noted, providing this wall of money seems to be a kind of end-run around the treaty problem. Though it might not work in the long-run, it is taken by the likes of Paul Krugman as the admirable ‘subtlety‘ of eurocrats, finding solutions within the legal arrangements.

There is of course something positive about the head of an unelected, somewhat secretive, yet enormously powerful institution formally stating that he must follow existing law – the EU treaty in this case. Indeed such affirmation of the treaty is especially important given that many have called on Draghi simply to ignore the treaty and backstop the sovereign debt of southern European countries, or argued that it wouldn’t really violate the treaty. But there are deeper, more widespread political problems here, not least with Draghi’s own political game. If, in fact, Draghi and the ECB were merely playing the responsible Big Bank, keeping its head down and following the rules, and leaving the politics to the politicians, then that would be…something. But it is quite evidently not what Draghi has been doing.

The two-timing – saying one thing, and coming up with new, inventive ways of doing the other – illuminate something of a power game that the ECB is playing. Publicly, Draghi is holding back the ECB backstop under conditions – namely, judicially or politically enforceable limits on fiscal policy of European states, inscribed in a new treaty. That is a straight-up political demand, backed by the power that only the ECB possesses: the economic power to bail-out the southern states and European banks. It is a political demand, moreover, made upon already hurting European publics to endure not just a period of contraction, but a major restructuring of the relationship between their states and their economies. The idea behind the rewritten treaty, in other words, is not just to impose the pain of austerity measures, nor even to dismantle the welfare states, but to inscribe the logic of constraint and lowered expectations into the new supranational and by extension national political institutions.

Draghi, of course, is not the only political agent here – Merkel has led the charge for treaty-change with austerity written in. But her actions are unabashedly and professedly political, and understood to be so.  Draghi’s statements and positions are taken to be somehow the words of an expert, nevermind the ‘subtle’ coercions of offering a continental bailout only on strict terms. Draghi’s views are supposed to be the limited advice of an economic expert, and one who in some sense a neutral actor, outside and above politics – like the institution he runs. What makes the political ploy here worse is the power that backs it. As noted, the ECB is the only one with the potential to offer a bailout, or at least commit to printing enough money to buy up debt, which might calm the bond markets and save the banking system. In certain ways, then, Draghi is not just more German than the Germans, but has a power they don’t have.

Of course, the two-timing – such as the wall of money – reflects the fact that the ECB is not all powerful. Or at least, that it is not so flush with power resources that it can wait out this game of financial chicken longer than those unwilling to make the sacrifices Draghi demands. After all, waiting too long makes backstopping a whole lot more expensive, risky and potentially less effective – no doubt one reason Draghi felt compelled to engage in this recent refinancing operation. But it has to be said that Draghi is playing a political game, one that favors certain interests over others, with potentially far-reaching consequences depending on the ultimate political and legal changes.

Of course, as mentioned, the point is not that Draghi is some all powerful financial witch-doctor, who can wave his magic wand – or not – and get the world to do his bidding. In fact, the other striking feature of the debate around ECB actions is the way in which it speaks to the restoration of a certain status quo ex ante. Although the financial crisis of 2008, and its potential sequel in Europe, produced numerous arguments that mainstream economics had been discredited, and that a “new economic paradigm” was needed, what is striking is just how little has changed. Before the crisis, the dominant view was that a period of Great Moderation had been achieved, largely thanks to the machinations of expert central bankers who fiddled with interest rates. One of the background assumptions of this view was that monetary, rather than fiscal, policy was a finer instrument of economic engineering, not least because ‘less political’ and thus less prone to the messy distortions of democratic politics. Central bankers were gods, or at least master governors, to be appreciated and listened to (despite their continued interest in things like wage suppression). Little moves with interest rates were guessed at and awaited; the public divined, parsed, and poured over statements by the likes of Greenspan a bit like Kremlinologists looking for the relevant post-Cold War obtuse institution of power. Everybody knew that their economic fate was largely out of their hands, but thankfully in trusted hands.

Now we are supposedly on the other end of that paradigm, yet caught in the Sturm und Draghi of another bewildering central bank’s enigmatic words and actions. It is hard to accept how it is that so little could change. Or worse yet, how much the old pattern in certain ways has become even more entrenched. The most significant economic decisions are placed in the hands of undemocratic figures, even when this means toppling national governments (Italy, Greece) to replace them with technocrats. And the dominant common sense is in favor of austerity, rather than rational, democratic control of the economy. The dead-weight of ideological conformity and (hopefully changing) public passivity is what stands out most strongly. At the end of the day, the power of a figure like Draghi is a back-handed reflection of the relative absence, or at least weakness, of alternatives. The truth in the conspiracies about bankers manipulating everything is so much that central bankers favor certain interests but dress up their policies as the public interest (which they certainly do). Conspiracies are a distorted registration of the weakness of the Left, a distortion dangerous because it replaces the political weakness of a potential movement with the comforting illusion that power is beyond anyone’s reach in the first place. Draghi and his ilk should be put in their place and own up to the political game that they play. But they won’t do it voluntarily, and it will take another kind of politics to expand rather than shrink the horizon of economic possibility.

Interview with Peter Hall

6 Dec

Continuing the series of The Current Moment interviews, today we are publishing an interview with Peter Hall, Krupp Foundation professor of European studies at Harvard University. Peter Hall has published widely in the field of European political economy and comparative politics. His published books can be viewed here. One of his recent papers explores the political origins of the current economic crisis.


What are the stories right now that you think people either aren’t paying enough attention to, or about which we have the wrong view?

On this side of the Atlantic, we are mesmerized by the fiscal dimensions of the global economic crisis and not nearly attentive enough to what will be required to ensure the U.S. remains competitive and capable of robust economic growth over the longer term.  Above all, that will require large investments in human capital and public infrastructure, since these are the resources on which all kinds of businesses depend for success.  Despite the efforts of some analysts, such as Michael Spence, and of President Obama himself to argue that, by focusing on these issues, we can address the immediate problem of unemployment and long-term growth together, these issues have not yet become central to public debate.  I wish Americans could see how rapidly China is moving on these fronts and how fruitful such strategies have been in parts of Europe, such as Finland.  We are so obsessed with the short-term, on both economic and electoral fronts, that we are moving far too slowly to lay the basis for renewed growth over the long term.

In Europe, discussion of the Euro crisis is dominated by many myths.  But the one yet to be questioned at all seriously is the myth that deregulating markets in labor and goods so as to intensify competition in them will regenerate growth in the southern European economies.  Such moves are typically described as ‘structural reform’ – a term that has become the mantra of the EU and IMF.  In the long run, structural reform may make some economies more competitive, but to pretend that it will revive economic growth in the short to medium term is an illusion.  Yet this illusion is at the center of most of the plans concocted to revive the southern European economies and resolve the Euro crisis.

For obvious reasons, this is a convenient myth, but it is an empty slogan, all the more pernicious because it diverts attention from the role that government has to play in the revival of economic growth.

Let’s turn to the Eurozone debt problem. The dominant view is that Greeks and Italians are corrupt, inefficient and lazy, and that is why they find themselves in this mess. What is your view of what is going on?

For the most part, this is a canard, encouraged far too quickly by many politicians in northern Europe who reacted to the sovereign debt crisis as if it were an issue of morality rather than a crisis with economic and political foundations that threaten the viability not only of the Euro but of the EU.  Those politicians now realize the full dimensions of the crisis, but their initial reactions has made the task of persuading their electorates to accept measures that might genuinely cope with it much more difficult.

The difficulties from which Greece and Italy are suffering have something to do with problems of political, as well as economic, development.  Both countries would be better off with public institutions less prone to corruption.  But to suggest that that their people are not working hard enough or retiring too early is to misrepresent the problem altogether.  Comparative data suggest that the de facto retirement age is not very different in most of southern Europe than in northern Europe and that the southern European countries have taken just as many steps as those in the north to make their markets more competitive over the past ten years.

The roots of the Euro crisis lie, at a much more basic level, in asymmetries in the organization of the political economies in the north and south of Europe.  In general, as David Soskice and I observed in Varieties of Capitalism (2001), the organization of the political economies of northern Europe gives their firms capacities for wage coordination, skill formation and continuous innovation that suit them well to operate strategies of export-led growth, and EMU provided them with guaranteed markets in the rest of Europe.  By contrast, history has left the southern political economies with fissiparous trade unions and limited capacities for concerted skill formation or continuous innovation.  In the past, they coped with that by operating growth strategies led by domestic demand and then devaluing their currencies to offset the inflationary effects of such strategies on their external competitiveness.  In EMU, they were unable to do that.  Instead, not unreasonably, they took advantage of the cheap credit flowing from northern Europe to promote economic growth.  But, unable to offset the inflationary effects through devaluation, they lost competitive advantage to the north.  The result can be seen in the gross imbalance of payments between the two parts of the Eurozone.

The standard recipe for the recovery from the Eurozone crisis is austerity and structural reforms in the peripheries, plus some recapitalization of banks. Do you think this is the right way to go?

To appreciate the Euro crisis, we have to realize that there are two sides to it.  On the one side, there is the longer term problem of how to devise a structural adjustment path that will restore prosperity to both the south and the north.  On the other side, this is a crisis of confidence, notably in the markets for sovereign debt but spreading over time to the European financial system as a whole.  The European Union has remarkable capacities for muddling through, and, given enough time, I believe it can resolve this long-term problem adequately if not perfectly.  But it is never going to get to the long term if it does not effectively address the immediate crisis of confidence and, as everyone now acknowledges, its efforts to do that over the past year have consistently offered too little, too late.

The immediate crisis is what worries me.  With respect it, there are two issues.  Is there a way for the members of the Eurozone to restore confidence in the markets?  And, if that can be identified, will the member states and the ECB be willing to take the requisite measures.  At this point, I think, as do many others, that the only way to restore confidence in the bond markets is for the ECB to guarantee the sovereign debt of its member states against default, except perhaps for Greece where the markets have already priced in a default.  Various schemes have been mooted whereby the ECB might do this, indirectly if not directly.

The problem is that it will not be easy for the ECB or the member governments to do this.  Mario Draghi and the German government currently oppose such a step.  It is forbidden by Article 123 of the Treaty establishing EMU, and the German Constitutional Court likes to take that Treaty seriously.  The only ray of light here is that the relevant resolution passed by the German CDU at its recent conference does not entirely rule out such a step, describing it as ‘a last resort’.  I think the time for last resorts has come, and I could imagine a deal in which the member governments agree to much stricter enforcement of fiscal targets and long-term support for the ECB in return for a measure of this sort.  However, it is an entirely open question whether the Eurozone governments have the political wherewithal to make this move.  If they do not, I think the crisis of confidence is likely to persist and strengthen until an Italian, Spanish or even Belgian default looms, and then it may be too late to save the Euro.  It takes a confidence trick to resolve a crisis of confidence and the sooner one acts, the less costly the resolution.

What do you think would address the trade and debt imbalances between Northern and Southern Europe? Do you think it can be done within the European monetary order?

This is a question about whether balanced structural adjustment is feasible over the long term within the confines of EMU.  Certainly, the current approach of imposing all the costs of adjustment on southern Europe (of which Ireland can be considered an honorary member) is likely to fail.  Except possibly in Ireland where growth is gradually picking up, there is no reason to expect that rapid enough growth can emerge from such austerity to render the debt load of these countries sustainable.  At a minimum, long-term stability depends on a more coordinated set of fiscal policies in which some reflation in northern Europe is married to a softer adjustment path in southern Europe.  However, this will not be easy to secure.  In particular, as Wendy Carlin and David Soskice have observed, reflation poses risks to the wage coordination on which the northern European economies depend for their competitiveness.

Even then, for reasons I have noted, there is some question about whether the southern European economies can prosper within EMU.  Portugal and Greece, in particular, do not have especially strong export sectors and are not likely to grow them overnight.  These countries have long depended on growth strategies that are accompanied by moderate levels of inflation and, because the ECB has to pursue a monetary policy of one-size for all of Europe, it cannot always dampen down that inflation effectively.  In the wake of the sovereign debt crisis, borrowing costs are likely to remain higher in the south, which will help.  But the danger is that, if the southern European governments cannot pursue growth led by domestic demand for fear of its inflationary consequences, they may experience only low levels of growth for the foreseeable future.  Structural reform will help in the long run but likely only a little.

It may well be that Europe can live with persistent imbalances of payments at some level, but the question is whether more effective coordination of fiscal policies will be enough to allow the southern European economies to grow at rates that are politically acceptable to their electorates.

The hegemony of the demand for austerity is striking. It is offered as the solution to the Eurozone crisis, as well as to the American situation – the US Congress even created a supercommittee to find savings. Yet it seems odd to have such agreement around austerity in the midst of a potential double dip recession. What is wrong with the demand for austerity? How do you account for the strength of this common sense?

The demand for austerity can be explained to some extent by the fact that we have just lived through a period in which financial innovation married to inadequate financial regulation made possible much higher levels of leveraging of assets, leading to higher levels of debt, whether in the public or private sectors of the U.S. and Europe.  To some extent, we are paying today for what we ate yesterday.

The best way to pay back these debts, of course, is from the fruits of more rapid economic growth and that is most likely to be secured, as John Maynard Keynes argued, by reflationary policy. Thus, in the context of global recession immediate austerity does not make good economic sense.

To explain why so many are advocating it, then, we have to recognize that economic policy, whether at the national or international level, is rarely driven entirely by concerns about how to improve overall economic well-being.  It is made by actors, who may be political parties or governments, who are also seeking distributive benefits for their constituents, and, in many cases, these distributive demands are cloaked beneath calls for austerity.  Thus, the demand of several northern European governments, including the Finns and the Dutch as well as the Germans, for austerity in southern Europe is motivated, to a significant extent, by a concern to ensure that they do not pay the costs of adjustment in the wake of the Euro crisis.   I see the demands for austerity of many Republicans in the U.S. as an effort to cut public spending programs that they think serve Democratic rather than Republican constituencies.  If distributive concerns were not at the heart of those demands, those Republicans would be much less reluctant to raise taxes in order to balance the budget.

In the US, there is an influential view that we need to have continued expansionary monetary policy but contractionary fiscal policy. That seems to be the recipe of the moment, with the Fed even contemplating another round of quantitative easing. What do you think of this approach to inadequate demand and balance sheet problems?

As the French would say, I am willing to accept this for lack of something better.  Something better would be a coordinated reflation in which more expansionary fiscal policy was now playing a larger role.  We have arrived at this situation, I think, because central banks, including the Federal Reserve and the ECB, have been willing over the past three years to do what governments have been unwilling or unable to do.  For that, they deserve considerable credit.  One can reasonably ask whether the best way to respond to an era marked by a large expansion in lending is to pump even more money into the system, but, since inflation remains low in most of Europe and North America, partly because the trade unions have been so weakened and unemployment is high, this seems to be an appropriate strategy.  In the absence of a substantial fiscal stimulus to aggregate demand, however, it is unlikely to lower unemployment much.

Debt, especially mortgages and student loans, have become a major issue over the past few years. What if anything do you think should be done about it? How should we understand the growing debt of American households in the past decades?

As Ragurham Rajan and others have pointed out, in the United States, during the 1980s and 1990s, easy consumer credit and home equity loans became a substitute for social policy.  They have been the means ordinary people with little in the way of savings used to survive adverse life events and fluctuations in the economy.  Student loans can be seen, in similar terms, as a substitute for publicly-funded education.

They can also be seen as a key component of the growth model operated in the United States over that period.  Growth in this country was led by domestic demand and the only way to sustain demand in an era when disposable income for households at or below median incomes stagnated was to promote the kind of asset boom in housing that gave many the illusion that their wealth was increasing even if their income was stagnant.

In the past two years, as home prices declined and some forms of credit became harder to secure, American households increased their savings and that, in itself, is gradually reducing the debt burden of the private sector. I do not see any need to take steps to further reduce that debt.  Indeed, it is difficult to see how the American economy can continue to grow without the availability of such credit.

However, there are serious longer-term problems on the horizon.  More than half the American populace has no savings for retirement at a time when larger cohorts can be expected to retire and health-care costs continue to rise exponentially, eating into the disposable income of many families.  Part of the problem is that most of the fruits of economic growth over the past three decades have gone to people in the top 1 percent of the income distribution.  In the long run, the solution will have to entail engineering a more equitable distribution of wealth so that ordinary working families have the means to increase both their savings and their spending.

One thing that seems to tie the American and European situation together is the considerable growth of financial activity. Is there anything to the view that the last decades can be understood as a period of financialization? If so, what does it mean to say the economy has become financialized?

Seen from a long-term perspective, this does indeed look like an era of financialization.  The share of profits in the economy going to the financial sector expanded dramatically.  With the invention of new financial derivatives and the development of financial markets, many firms ostensibly devoted to manufacturing, such as General Motors, have made an increasing share of their profits from financial activities that leverage their capital.  That has contributed, in turn, to rising income inequality at the high end of the distribution, as those skilled at financial engineering generated profits large enough to allow them to demand astronomical levels of compensation.

In my view, it would be an exaggeration to say that the economy has become ‘financialized’.  There are still many productive components of the American economy that do not turn on finance.  However, it is apparent that we are all vulnerable to the systemic risks that a large financial sector, increasingly devoted to speculation, entails, and that is a serious cause for concern.  Although some of the financial innovation of recent decades has made some markets more liquid and borrowing easier for some productive firms, I doubt that this type of ‘casino capitalism’, to borrow a phrase from Susan Strange, ultimately contributes enough to economic prosperity to justify those risks.  We are currently paying serious costs for this and, unless financial regulation becomes more stringent than is currently anticipated, I think there will be more to pay.

Related to that question, what do you think accounts for the ‘bubbliness’ of the US and European economies, and especially the scale of these bubbles? We have seen a number of different bubbles and credit crises – housing bubbles in the US, UK, Ireland, and Spain; sovereign debt events in Greece, Portugal, and Italy, perhaps even France. While there was the dot come bubble in the late 90s, and the East Asian financial crisis, those don’t seem to have had the magnitude and systemic character as the latest period. What is, or isn’t, different about what we’re experiencing now?

I do not believe that any single set of factors can explain these diverse developments.  The housing bubbles can be explained, at least in basic terms, by a long period of easy credit, made possible, as I have noted by the expansion of the financial markets in various kinds of derivatives.  That was made possible, in turn, by what I consider lax financial regulation.  It is ironic that economists liked to describe this period as an era of ‘great moderation’.  In each case, however, some ancillary factors were at work.  In Spain, the cost of borrowing was greatly reduced by the confidence effect associated with entry into EMU.  In Ireland, it was encouraged by rapid rates of economic growth.

The sovereign debt crisis has more complex roots.  In Greece, which enjoyed the same easy access to credit as Spain, the fiscal fecklessness of the government is notable.  In Ireland, some of the problems can be attributed to the government’s mistaken decision to guarantee the bonds of its banks.  In different ways, Portugal, Spain and Italy remained creditworthy on the fundamentals but fell afoul of the spreading crisis of confidence in the markets, which has yet to take its last victims.  There are some parallels with the East Asian financial crisis.  The current crisis is worse partly because it has struck the major financial sectors of the western world and we now face the question of who will rescue those who normally do the rescuing.

How optimistic/pessimistic are you about the ability of national democratic procedures to provide solutions to the current economic crises in Europe and in the US? What do you think of the recent proliferation of technocratic governments in Greece and Italy? Does the current crisis expose some basic tensions between capitalism and democracy? If so, how exactly?

In this as in every other case, as Winston Churchill once said ‘democracy is the worst form of government except for all those other forms that have been tried from time to time’.  The notion that governments led by geriatric Eurocrats will resolve their countries economic problems more readily than elected governments is another of those illusions that bedevil the Eurozone.  They have legitimacy in Brussels but imposing austerity is ultimately a task that demands domestic political legitimacy.  I see this as a stop-gap solution that might, at best, persuade officials in Brussels and Berlin that everything has been tried and they must pay more heed to the pain and demands of national electorates.

It is obvious that the cumbersome decision-making procedures of the European Union are not up to the task of heading off a crisis in the financial markets.  But that is not a problem with democracy.  It is a problem of international negotiation.  Democracy enters the picture to the extent that the views of national electorates limit the willingness of their governments to share the costs of adjustment, and that is admittedly a problem for Europe.  A continent so proud of the ways in which its social policies reflect ‘social solidarity’ has been unable to summon up the sense of continental solidarity that would justify a more equitable and efficient solution to the crisis.  But social solidarity does not simply bubble up from below.  It is created by inventive political leadership and we are still waiting to see if the political leaders of Europe are capable of that.

On the larger question, my view is that the global financial crisis has thrown into stark relief the importance of the state in any democratic system.  The crisis itself is rooted in failures of financial regulation that can be linked to the unwillingness of governments to assert the authority of the state on behalf of the people against powerful financial interests.  And the inadequacy of the response to the crisis, especially in the U.S., can be attributed, in some measure, to the widespread reluctance on the part of many people to trust the state with their resources.  In many respects, that is the legacy of the neo-liberal era that followed the economic crisis of the 1970s, when many policy-makers and citizens became disillusioned with the capacity of governments to direct the economy.  Hence, the American government faces the current crisis hobbled by rising levels of distrust in government.  It is not acting more forcefully on the fiscal front partly because large segments of the American population are willing to vote for politicians who claim that government is the problem rather than the solution.

What are your views of the nascent protests (Occupy Wall Street, Indignados) developing in response to the introduction of austerity packages in Europe and the US? Are these movements a continuation of or a break with the anti-globalization movements of the past? Are they likely to fundamentally change public perceptions and government policy or will they have only a very small lasting impact?

There have been two notable political responses to the current economic crisis.  One is marked by a backlash against immigration, in both the U.S. and Europe, reflected in the growing popularity of radical right parties in Europe and the salience of immigration to national political debates in the United States.  This is a familiar feature of economic crises.  The U.S. has a long history of nativist movements.  The other is reflected in the Occupy Wall Street movement and its European analogues.  I can only hope that the former is contained and the latter encouraged.

It is difficult to see how these sporadic protests can be translated into any immediate changes in policy, not least because they have yet to articulate clear political demands.  However, I think they are having an impact.  They have struck a chord in popular opinion.  They bring issues of unemployment and inequality to the fore.  In the short term, I think that may influence voters in American elections next year, and, over the medium term, I believe that even these limited protests will help to shift political discourse in directions that favor those seeking to address issues of inequality and unemployment.

Democracy versus debt sustainability

23 Nov

Debt sustainability has emerged as one of the key issues of the day and one that brings the different poles of the rich world together: the United States, European economies and Japan are all struggling with the problem of how to cut public debt. There are few better accounts of current thinking on this matter than the recent report published by the International Centre for Money and Banking Studies (ICMB), run by Charles Wyplosz.

Written by some of the world’s leading economists (Wyplosz, Eichengreen etc.), the report gives a simple explanation for today’s problems: individuals prefer to free ride on goods rather than to pay the full cost for them. Given half a chance, even when from a collective perspective this is not rational, individuals will shirk from paying for something themselves. The result is that in the provision of public goods, governments have been forced to borrow in order to meet public expectations. The authors of the report call this the common pool problem.

In a telling graph (p49), the authors show that the problem has tended to be manageable in when GDP growth is strong. As both the US and Europe exited from the post-war Golden Age of national Keynesianism in the 1970s, governments turned to borrowing in order to make up the gap between transfer payments and tax revenues. The authors cite the cases of Germany and the Netherlands: in Germany, the ratio of spending on transfers and subsidies rose by 9.5% of GDP between 1970 and 1995 whilst total revenues rose by 6.1%; in the Netherlands, transfers and subsidies rose by 7.1% of GDP, total revenues only by 5.6%.

The report identifies four ways of reducing public debts: default, inflation, cutting spending/raising taxes and growth. It does not consider defaulting as a serious policy option and dismisses the chance of advanced economies experiencing a sudden spurt in GDP growth. This latter point is striking: only those economies catching up are likely to experience high growth levels, they claim. After that, when you are close to the technology frontier, it’s all low growth (pp56-59). That leaves only inflation and restrictive fiscal policy as serious policy options. Inflating away the debt they argue is unlikely in Europe’s case given the ECB’s stringent price stability mandate. The only option left is the one that hurts people most: cutting government spending or raising taxes.

The authors argue that the better option is to cut spending since raising taxes only lays the basis for more spending later on. The report then outlines the institutional fixes that are needed in order to undertake spending cuts. There are many different solutions proposed here, each tailored to fit with the national political system in question (presidential, parliamentary etc.). However, what the institutional reforms all have in common is that they seek to distance decision-making and implementation over government spending from political discretion. Politicians must either have their hands tied or be disinvested of responsibility for spending decisions. In the case of the Eurozone, the authors suggest that the European Commission should be given the powers to judge whether a country’s institutional framework is appropriate for the goal of reducing public debt. Countries that fail to win the Commission’s support would find that its debt is no longer accepted as collateral by the European Central Bank in money market operations.

It is difficult to know what is most chilling about the report: its skepticism regarding the growth prospects for advanced industrial economies or its willingness to curtail democratic procedures in the name of eliminating “deficit bias”. Either way, its recommendations fit well with the prevailing wisdom in national capitals. In Italy and Greece, national democracy has given way to technocratic administrations charged with implementing government spending cuts in the face of massive public opposition. In the Eurozone, the focus is on monitoring government spending and beefing up sanctions to be imposed on those members unwilling to curtail their debt. Outside of the Eurozone, in the UK and in the US, more inflationary policies are considered. There, however, the focus is still primarily on reducing spending.

What is most striking about the report is its starting point. In explaining the crisis, there is no reference to the international economy or to domestic politics as such. Today’s problems are not put in any historical context or tied to any particular decisions or set of interests. No mention of global imbalances. No mention of financialization. Instead, their explanation is one that holds across all time and all societies: the selfish irrationality of individuals and how that translates into dysfunctional representative institutions. Under those assumptions, capitalism can only be saved from itself if the running of it is given up to technocrats.

This gets the problem the wrong way round: since the 1970s, we have seen a steady accretion of political power away from majoritarian institutions. We have seen the birth of what some call “the regulatory state”. Political discretion has shrunk and yet advanced industrial economies today face severe public debt crises. To blame individual selfishness and the difficulty of properly pricing collective goods in a democracy is too easy. It shifts the blame away from capitalism and puts it squarely on the shoulders of ordinary people. Compelling reading for the ICMB’s audience perhaps; less so for the rest of us.

Where next after sterilized intervention?

9 Nov

As all eyes turn to Italy and whether or not Silvio Berlusconi will step down in order that a technocratic government (headed by economics professor and former European Commissioner Mario Monti?) take over to quell market concerns, there is an interesting technical discussion underway about how far the ECB can go in its controversial buying up of the government bonds of troubled Eurozone member states. A matter not unrelated to events in Italy.

The FT’s Alphaville notes that the real practical limitation on the ECB’s intervention lies in its policy of sterilization. So far, the ECB’s interventions have been sterilized, meaning that its buying up of bonds issued by embattled Eurozone members has not led to an expansion in the money supply. When that happens, given the ECB’s fervent attachment to its price stability mandate, interventions will stop.

Alphaville cites a report by Rabobank which has tried to put some figures on where this limit to the ECB’s actions may lie. In order to understand the figures, we need to understand how the ECB sterilizes its interventions. Very simply, the ECB arrangement is that in exchange for its purchase of government bonds, European banks are meant to place an equivalent amount of cash at the ECB. The ECB every week, in line with its bond purchases, issues banks with seven day deposits. The money banks leave with the ECB in the form of these deposits is equal to what is introduced into the Eurozone money supply by the ECB’s bond purchases, leaving the net effect equal to zero.

With this arrangement, the ECB’s room for manouevre depends on the willingness of European banks to place their cash in these ECB deposits. According to the Rabobank report, this is not a problem at the moment given how much banks have borrowed from the ECB. The attractive rates offered by the ECB mean that banks have been happy to place what they have borrowed back at the ECB. But the actual situation, with European banks having so far (at the end of October) borrowed a total of 587 billion Euros from the ECB, is far from normal. For Rabobank, pre-crisis levels of borrowing by banks are around 450-500 billion Euros. With 200 billion Euros in capital requirements, that leaves the ECB with a maximum of 300 billion Euros for sterilization. So far, the cost to the ECB of its bond market interventions is 184 billion Euros. This leaves 116 billion Euros left for future sterilization purposes. Assuming the ECB will buy up bonds at a rate of 11 billion Euros a week, this means sterilization will have to stop by early 2012.

It may seem like a purely technical matter but the end of sterilized interventions would signal – for the ECB – a fundamental shift in its mandate. Some think it would rather let bond markets collapse than be pushed into making unsterilized intervention. Others assume that a behind-the-scenes evolution in the ECB’s role will be sanctioned by national leaders, themselves meeting to discuss the issue in their shadowy Eurogroup and Francfort group formations. If the ECB is indeed to be transformed into a lender of last resort – a move The Current Moment has said is a bad one given the absence of public support for more federalism in Europe – it should occur as part of a conscious and intended political choice and not as a technical detail of interest only to the financial pages of the broadsheet press.

Explaining the strong Euro

31 Oct

As Europe’s sovereign debt crisis rages on, it is easy to forget about the Euro. In the midst of the crisis, the currency itself is holding up remarkably well. Andrew Watt,  over at Social Europe, has asked how it is possible that the currency – which many are predicting will soon disappear under the pressure of its own internal contradictions – is actually comparatively strong. He noted that the currencies weakened most by the crisis are the US dollar and the UK pound. The Eurozone’s sovereign debt problems have affected the value of the Euro but mainly in a way that has seen it depreciate against “safe haven” currencies such as the Swiss Franc. It has not so far depreciated significantly against the pound or the dollar. This may change, given the impact of the ECB’s decision over a year ago to start buying up the government bonds of countries like Greece. Deutsche Bank predicts that against the dollar the Euro will over the next 12 months depreciate from 1.38 $ per Euro to 1.25 $/Euro. Significant as that may be, it is also noteworthy for the EU’s current starting point, which is relatively strong against the dollar.

Watt correctly pointed to the European Central Bank as key to the Euro’s movements. One big difference between the Bank of England and the Federal Reserve in the US and the ECB in Frankfurt has been the practice of quantitative easing by the British and US central banks. One intention behind printing money is to depreciate the currency (by putting more dollars and pounds in circulation) and thus stimulate exports. The UK pound lost 1% of its value against the Euro after Mervyn King, director of the Bank of England, announced another 75 billion pounds of quantitative easing.

There is another way of looking at this same issue. A feature of the ECB is its peculiar exposure to political pressures. In some respects, it seems entirely immune from any such pressure. The ECB has maintained its hawkish policy on inflation, raising rates when all other comparable economies are cutting theirs. In 2011, the ECB has raised interest rates twice. With rates relatively higher in Europe, the pressure upwards on the Euro is maintained. It may seem absurd that as the Eurozone as whole struggles to avoid recession the outgoing ECB director congratulates himself on keeping inflation low. Trichet, in an article in Die Spiegel, earlier this year, was dubbed “the German Frenchman”. Over on the FT’s Alphaville blog, much is made of the ECB’s insulation from political pressures. As Joseph Cotterill quite rightly notes, the ECB is not here to save the world. Those expecting the ECB to transform itself into the Eurozone’s political saviour will be disappointed.

But to say that the ECB is entirely insulated from political pressure is wrong. Rather, its exposure to such pressures is selective. The decision by Trichet in May 2010 to start buying up the sovereign bonds of embattled European economies prompted the departure of then German board member and head of the German Bundesbank, Axel Weber. This decision, which saw the ECB go beyond the terms of its mandate, was widely seen as evidence of French pressure. The ECB’s role is thus far from politically neutral. Its actions reflect the specific configuration of the European Union’s supposedly supranational institutions. Formally independent from member states, these institutions are heavily shaped by the outlooks and preferences of national executives and national officials. At the same time, they are very far removed from events on the ground and from the concrete interests of majorities within EU member states. The ECB’s actions reflect the varied interests of Europe’s governments but not those of its people.

Relying on the ECB

26 Oct

Yannis Varoufakis, radical Greek economist and author of a leading blog on the ongoing Eurozone crisis, has given a compelling account of the present dilemma faced by Europe’s leaders.

He notes that with respect to today’s meeting of the Eurogroup, three issues are on the table. Firstly, what should be the percentage of the Greek write–down? Private bondholders agreed back in July to a 21% reduction in net present value. Today, the figure most often cited is 60%. Back in July, discussions raised about what exactly constituted a default and how much arm-twisting could private creditors take before their bruised limbs became evidence of a default. These discussions return today, with European governments and the ECB wanting to avoid a so-called “credit event”.  The Financial Times reports that bondholders, represented by the Institute of International Finance, are fighting the 60% figure, proposing their own plan which would see them recoup more of their money after a Greek default.

The second issue is about how much help should be provided to other peripheral Eurozone economies, such as Spain. This issue is also, though no one is talking about it openly yet, about what can be done to help Italy. The focus of this discussion is the European Financial Stability Facility. To what extent can it be used as a vehicle for providing guarantees to troubled Eurozone members? One idea is to create a purpose-built fund that can provide guarantees to those willing to buy the bonds of embattled sovereigns (Italy and Spain). Another idea is that a special fund be created that can buy these bonds directly. With regards to the former, Varoufakis notes the circularity of the idea: since Italy and Spain are involved in providing the EFSF with funds in the first place, if the EFSF was then to be used to provide insurance for those buying Italian and Spanish bonds, the EFSF would in effect be a façade behind which the Italian and Spanish treasuries were providing the insurance to those willing to hold their own bonds. The big difference, of course, is the German stamp on the EFSF façade.

The third issue is recapitalization. Disagreements prevail about how much capital is needed to insulate European banks from the consequences of sovereign defaults. The figure favoured by those meeting in Brussels is 108bn Euros: adequate, they say, to tide Europe’s banks over the rough waters of Greek default. For analysts, this is woefully inadequate as it assumes away the problem everyone is thinking about: what if a Greek default is followed by the insolvency in other larger member states, namely Spain or Italy.

Varoufakis’s argument is that the sums simply do not add up. The thin gruel of the EFSF cannot satisfy the demands of creditors. What is surprising is how heavily he relies on the European Central Bank. If the ECB can be made into a lender of last resort and be made to print Euros, then the circle can be squared. Failing that, Varoufakis suggests it can at least borrow in its own name on the international markets and then use that money to pay-off some of the continent’s sovereign debt. As argued before, this reliance on the ECB is a common feature of bourgeois economists. Charles Wyplosz has argued this consistently, as has Paul de Grauwe (see here and here). The problem is that it ignores – in one swift assumption – one of the main features of the current crisis: the way in which political constraints are closing in on governments, limiting their options. The ECB might be transformed into a lender of last resort on the back of a wave of federalist sentiment. But at present, as the isolation of national executives meeting in Brussels chafes against the demands of protestors and national political parties to be more closely involved in Eurozone decision-making, support for the EU is dwindling.

This development should be welcomed: the narrowing of executives’ freedom of manoeuvre internationally is a sign of a more politicized and contested crisis at home. To rely on the ECB is to wish these political developments away. Perhaps Varoufakis thinks European populations do support a leap towards fiscal integration and that what is holding them back are national governments. But there is little evidence of this on the ground. Relying on the ECB might make mathematical sense but it pays scant regard to the politics of the current moment.

“Contagion”, market pessimism and democracy

19 Sep

As European finance ministers last week converged on Wrocław in Poland for a meeting of the economic and finance grouping of EU member states, the so-called ECOFIN meeting, many analysts and commentators were talking more openly about the modalities of a Greek default. This is still vehemently denied by most governments in Europe, not least by the government in Athens, but it is worth considering how exactly it should be done.

The first question is which should come first for Greece: exit from the Euro or default on its debts (thanks to Klaus Giesen for first raising this). Looking at the commentary in the financial press, most assume that a default will come first, either by necessity or simply because defaulting might not automatically mean Greece has to leave the Euro. In its weekend edition, the Financial Times considered the option of a Greek default, followed by a more favourable assessment by private creditors of its growth outlook paving the way for Greece’s return to international loan markets. It seems also clear that default would come first, simply because of the difficulties of preparing to introduce a new currency without anyone finding out. Were it to emerge that Greece was secretly printing a new Drachma somewhere, there would be a run on its banks and any existing loans would dry up.

If a default occurred, and this put a stop to the money currently entering Greece via the European Central Bank and the IMF, the government would be unable to pay its everyday bills. It would not have enough money to pay its civil servants or to meet its welfare obligations to its citizens. At the same time, Greece’s banks are heavily exposed to its own government’s debt: a default would leave the banks high and dry. In this respect, the economy would grind to a halt. Greece would be left with two options: exit the Euro and begin issuing its own currency in order that it can start paying its own bills and recapitalize its banks; or sit in limbo, hoping that some kind of help will come from outside, whilst on the ground in Greece the cash economy gives way to a temporary bartering arrangement and the creation of quasi-currencies in the search for some kind of medium of exchange.

Putting all this into some perspective, and if we remember that Greece’s economy accounts for only a tiny proportion (less than 3%) of the overall Eurozone economy, the most likely scenario would be for Greece to default and – assuming that wasn’t enough to convince private creditors that it could return to growth in the medium term – it would exit the Euro but in a way that saw it tided over by loans from the EU. The difficult period between default and a new currency winning some kind of international credibility could be made easier by help from other European governments.

What makes this orderly default and exit from the Eurozone unlikely? Everything hangs on the problem of what analysts are calling “contagion”. In fact, contagion is the wrong word. The problem is simply that if Greece’s default were to work in Greece’s favour, it would make it seem attractive for other crisis-stricken countries like Spain, Portugal or Italy to follow, raising the prospect of a mass default that would be incredibly expensive for those banks exposed to government debt in those countries. But if Greece’s default were to be a complete mess, that would also spook the markets, making it seem as if there was no alternative to keeping the Eurozone together, putting the spotlight on the political problems faced by Merkel, Sarkozy and others. So for a Greek default, both success and failure would cause problems: damned if you do, damned if you don’t.

Much of the concern about the Eurozone thus rests on the nebulous idea of “contagion”, a term which gains its force from its implication that events can develop randomly and in unexpected ways, a little like the spread of an epidemic. In fact, there are strong reasons to suppose that a Greek default and/or exit from the Eurozone could be contained. Greece is not Italy or Spain. The underlying basis of these economies is quite different, with the fundamentals in Italy in particular being much stronger.

What prevails in contemporary analysis is as much an overwhelming pessimism with the ability of democratically elected representatives to tackle contemporary economic problems as it is a clear-headed assessment of economic fundamentals. It is this lack of faith in democracy that is making the Eurozone crisis so intractable, not the objective and relentless laws of the markets.

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