What kind of instruments of monetary policy could the ECB adopt in case of need?
Draghi has three constraints – what is the goal, what would help and what the ECB is allowed to do. The European leaders have failed to agree on the goals. Some countries have too much debt that they cannot service. Some countries are stuck with internationally uncompetitive economies that are traditionally cured by devaluations, but of course that is not an option unless the euro zone would be broken up. These countries are known as the periphery, or PIIGS – Portugal, Ireland, Italy, Greece and Spain. The other group, known as the core, mainly consists of countries that are more competitive and can still service their own debt, but are scared that they will not be paid by the PIIGS. The goal currently given to and maintained by the ECB is to keep the show going on – with LTRO financing, SMP purchases and easy collateral rules – the latest being the OMT program.
Of course, all the programs are basically risk and wealth transfers from the core countries to the PIIGS, which are then mostly used to pay back the debts to the core countries. Should the crisis escalate, the main choices would be either to accept that the PIIGS debts are too large and cut them, or let the ECB take on the debts to its books, at least temporarily. There is not much difference between the ECB’s OMT program and the Federal Reserve’s QE-programmes, except that OMT is conditional – the ECB has promised to purchase the bonds if the country to be supported initially agrees to and then continuously abides by the conditions.
Rising inflation is another way for the ECB to meet its goals: it would make the debt easier to service, kick off growth and probably devalue the euro internationally, making it easier for the eurozone economy to grow out of this mess. This has not been tried, since especially Germany of the core countries and the ECB’s current rules are strictly against the inflation targeting. The average durations, or time-to-maturity, of the PIIGS’s debts are quite low, so rising inflation would force them to ‘roll over’ (refinance) their maturing bonds with higher nominal interest rates.
Options for the ECB are thus:
- don’t do anything and let the weak die
- take some of the extra risk on ECB’s books and wait
- spread the pain evenly through higher inflation.
The economic world is surrounded by a large uncertainty in this period, much of which comes from the fiscal threat coming from the United States, the much-discussed Fiscal Cliff. Many are starting to think that it will not happen and they are starting to call it a "non-event". Do you think it will be a non-event at the end? Or is its threat really something we should be worrying about?
Fear of the fiscal cliff is real, but estimates vary, since the cliff will not happen overnight, instead its effects will be felt over time, Thus, it is not a one-off shock event, and how the economy would adjust and what would be the fiscal and monetary policy response is still debated. Secondly, budget cuts always have a larger effect on the economy due to the multiplier effect – a cut of one billion easily removes more than that in economic activity.
United States Congressional Budget Office estimated earlier that the US GDP growth would reach 1.7% in 2013, if things would continue as they have been. But if there is no agreements, and the temporary tax cuts expire, GDP was expected to contract by 0.5%. Clearly this is a huge difference, 2.2% of GDP, and would certainly pull the world into another recession, with the worst part hitting immediately in the first half of 2013. Luckily, Europe already is technically in a recession…
This week and the next are the critical ones to solve the issue. Most probably some sort of compromise is found at the last minute, but it could turn into a game of brinkmanship – for Obama, he is already elected, and instead of fighting the republicans for the remainder of his term, it could make a lot of sense for him and some sense to the economy to let the cliff come now, so that the country would be back up running right around the next elections – instead of having this slow growth until the elections, with probably a small recession.
The Greek economy is still in great pain, despite all the money it received in these past months. Do you think there’s some hope of recovery for this country over the next year?
No. Greece will not be solved. I don’t see any hope for the country inside the euro. Outside the euro, maybe after five years or so, things would become better. Unless the country becomes a continuously fiscally and monetarily supported monument to eurosocialism, the numbers are hopeless – and the European leaders know this. They are just scared to tell the truth to their own voters. I believe the German elections after the summer will be an important point. Besides, roughly 80% of the funds sent to Greece have been immediately used to pay back Greece’s debts – so in effect the European governments are just transferring the European banks potential losses from the loans to Greece to the European taxpayer before the coming default.
I wrote a long ‘sci-fi’-piece on Greece after a ‘Grexit’, default and a large devaluation. Things would turn out for the better in couple of years and it would be painful and chaotic – but isn’t this waiting painful? I see the delaying of the default as completely pointless. Why should the Greek people suffer for couple of years just to ensure Merkel’s re-election, if the default and Grexit are still waiting at the end of those years? Or is the whole point that the Europe’s federalization and powergrab needs to be completed before Greece is let go?
Do you think the introduction of euro has been the only cause of the crisis we are experiencing? Or are there other important factos to take into consideration? What is your perspective even as a Finnish citizen?
The euro acted as an accelerator of the mess – it allowed many of the negative things to go on much longer than usually would have been the case, and it turned usually normal events that have been dealt quickly in the past to ongoing catastrophes for purely political reasons. If something, the euro crisis has been helpful in revealing the dark side of the federalization – the bribes, the lies, the forgeries, the complicit banks and so forth. The crisis would have happened without the euro – but it would have been much less severe and it would have lasted for a year or two instead of a decade – and for someone in their twenties, this is a long time to be away from the job market. I find the Nobel peace price given to the EU appalling.
There have been many factors at play here. Easy monetary policy and bad regulation of finance, absolutely no international regulation of national budgeting, bad capital requirement and risk measurement systems relying on historical data instead of what might happen – and everyone in the same boat. While globalization is clearly beneficial in many ways, it also makes things more prone to accidents. When everyone looks and feels the same, when the same banks travel everywhere with the same products, when everyone reads the same business books and magazines, when MBA programs in India and US are almost identical, things happen. When all the countries are the same, they get sick at the same time. There’s the lesson of this crisis.