In the panel discussion about monetary and fiscal policy at the Lindau Nobel Meeting in Economic Sciences, Prof. Martin Hellwig remarked that he doesn‘t see such a huge difference between quantitative easing (QE) and the open market operations (OMO) that central banks normally use as a main tool of implementing monetary policy, in the case of the ECB these OMOs are by and large the main refinancing operations (MROs). I thought about Hellwig’s remark and my conclusion is this.
On the surface there seems to be in deed very little difference from both implementation and (supposed) effect on the money supply and term structure. The central bank buys securities from banks and credits their accounts with newly created fiat money. Still, rather remarkable differences are in the details.
I have written a little something on the Euro area, its current weaknesses and challenges and some suggestions of how to overcome them or at least improve on the current situation. Read it at the Blog of the Lindau Nobel Laureate Meeting on Economic Sciences: http://www.lindau-nobel.org/blog-on-the-future-of-the-euro-area/
Thanks to the LNLM blog for giving me the opportunity to write it there.
Today, Eurostat published the new flash estimate for Euro Area inflation in July. The inflation rate (i.e. HICP inflation compared to July 2016) is at 1.3%, so not much has happened since June, when the figure was 1.4%. The flatness of the inflation rate may partly be explained by the usual seasonal, where in July and August, price increases tend to remain flat.
But the disaggregated figures provided by Eurostat point to more. Energy prices have increased by 2.2%, while food and services prices increased in line with the overall rate. Falling short, however, are industrial goods prices. This points to two insights. First, energy still seems an important driver of the inflation rate, which makes it difficult for the ECB to use the HICP as a meaningful yardstick for monetary policy, as I have argued before. Second, while services become more expensive and make use of more capacity, i.e create more jobs and/or increase the wages, the industry has still a lot of slack. This wouldn’t be a problem, if services would soak up all the excess labour, but this is unlikely. Further, as prices in the industrial sector increase only sluggishly, firms have little incentive to invest in new machinery, hire new workers and increase wages, all of which would be necessary. Unfortunately, there is only little the ECB could do. Investments should increase along with confidence which tends to come in tandem with political stability, a lesson especially for Italy and Spain.
Update, August 31, 2017:
The new flash estimate by Eurostat for inflation in August ist basically in line with the numbers a month ago, although energy prices stoke inflation by almost 4%, i.e. twice as much as in July. Thus, the main take-away hasn’t changed: Subdued industry inflation and services inflation below target point to excess capacity in the economy. No need for the ECB to tighten.
Now that the French have fortunately elected a sane, reasonable centrist as president, let‘s talk a bit about the future of the Euro area, as Mr Macron envisions it. The new president advocates a Euro area budget, common bonds, a Euro area finance minister and an economy minister, further a common unemployment insurance for the whole of the EU. None of these points are actually crazy, but I think Mr Macron does not quite realise what his ideas actually entail and how some compromises may look like, if Germany is to go with it. Continue reading After the French election
I have found that optimisers (R’s optim to be precise) are sometime unstable. Not in a numerical sense, but in a more practical sense, i.e. choking on certain inputs (I wasn’t able to figure out when exactly) and in the end crashing, without the possibility of recovery or error-processing. Which is quite bad, when you’re in the mid of some long calculations, e.g. a Monte-Carlo experiment. I found that optim’s standard method, Nelder-Mead, was unsusceptible to such crashes (Please, geeks, explain me why!). But with Nelder-Mead, you cannot use parameter constraints, so you have to formulate your optimisation problem in an unconstrained way. Here are some of my tricks.
Some time ago, an op-ed in a German newspaper (Die Zeit, I believe) decried the use of the term „postfact“ and suggested we should call the bullshit uttered by the Trump administration, the Brexit campaign and others as just what it is: lies. Well, certainly, postfacts are lies, but there is a subtle distinction. Post-facts create their own, subjective version of reality – or “truth” – whereas lies contradict the objective truth. This distinction lays bare a fundamental problem of our democratic way to organise government. It does not really matter, whether Donald Trump or Nigel Farage actually believe the nonsense they utter, but it matters that their voters believe it, because it fits their view on the world.
In a recent press statement, ifo’s President Clemens Fuest argues for second-tier “accountability” bonds that would allow debt above the current limits of the Maastricht criteria, but with strings attached. From the statement:
Fuest and Becker propose that states only be allowed to finance 0.5 percent of their annual economic output with normal bonds. Should they run higher deficits, the excess debt should be subordinate i.e. it will only be repaid after other debts, must not be bought by the ECB, and should also only be held by banks with higher equity cover.
In a recent interview with the FT, Peter Navarro, an advisor to Donald Trump claimed the undervalued Euro to be an implicit Deutsche Mark and would benefit only Germany at the expense of our fellow Europeans and, of course, the US.
OK, I know that facts are not a particular strength of the new US government, but still, at least the assessment of the situation is correct: The Euro is probably undervalued vis-a-vis the Dollar, if you believe in The Economist’s Big-Mac-Index and thus in purchasing power parity. Given the more robust labour market and the recent monetary tightening of the Fed as compared to the Eurozone’s mess and still ultra-loose monetary policy by the ECB, the claim that the Euro is undervalued isn’t really a stretch.
But for the sake of the argument, let’s assume for a second that Germany is benefitting unfairly. The obvious remedy for this would be an appreciation of the Euro vis-a-vis the Dollar, and to do this the ECB should stop its ultra-loose monetary policy and start raising interest rates better sooner than later. Wait, what? Yes, this is basically what Jens Weidmann and Wolfgang Schäuble demand for quite some time now. The allegations that Germany would keep the exchange rate towards the Dollar artificially low is nonsense, at best. And even if, there are some compelling arguments of why the ECB has adopted an ultra-loose monetary policy: weak labour markets in the south, under-capitalised banks, over-indebted governments, etc. Better export opportunities for Germany are merely a side-effect. We can talk about whether the ECB’s policy is adequate or what exactly drives Germany’s exports (non-substitutability perhaps?) or whether purchasing power parity holds, but going back to mercantilist thinking of the past fits the US goverment’s economic thinking: they are not thinking at all.
Politics discuss what to do with Germany’s federal budget surplus of a bit over €6bn. Wolfgang Schäuble, the finance minister, wants to repay some of Germany’s outstanding debt, which is generally a good idea. First, Germany violates a Maastricht criterion by having debt of more than 60 per cent of its GDP and as we have seen in the European debt crisis, high public debt can at times be very dangerous.
Now, usually me as a “fiscal hawk” would agree with Mr Schäuble. But given Germany’s robust growth (1.9 per cent in the last quarter), the general improvement of the federal budget and the fact that we fall behind schedule in investment (see slide 5 of the above presentation by the finance ministry), I would rather suggest to keep the €6bn in the coffers and try to focus more investment (e.g. broadband, infrastructure and education) to bring the money where it is actually needed.