Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
The centre-left Parisian daily newspaper Libération recently published (July 8, 2010) an – Interview with Jean-Claude Trichet, President of the ECB. The questions asked were nothing like those you would hear asked on Fox News in the US and essentially probed some of the key issues facing the EMU. The interviewer clearly understood the design flaws in the Eurozone system and pressed Trichet on them. Trichet’s responses were described by my friend Marshall Auerback in an E-mail to me this morning as allowing us to see “inside the mind of a cultist”. Here is a portrait of a neo-liberal cult leader!
Trichet was initially asked whether the “sovereign debt crisis that has rocked the euro area since last January (was) over now?” he responded:.
The concerns of investors and savers over sovereign debt are a global phenomenon and have particularly affected industrialised countries. Indeed, industrialised countries were hit hard by the financial crisis of 2008 and 2009 and, for the most part, their government financial accounts suffered badly. In the particular case of Greece, some investors were convinced that the Greek government would be unable to take the bold decisions that were absolutely necessary, and that neither in Europe nor within the international community would there be the capacity to support its recovery plan.
The sovereign debt crisis inasmuch as there has been one has been confined to the Eurozone nations. No other advanced nation is struggling to place its public debt in bond markets at low and stable yields. Trichet is trying to deflect the specificity of the crisis in the EMU because then he doesn’t have to face up to the design flaws of their monetary system.
Further there has been no particular correlation between the state of government finances and the bond market dynamics. Spain was a solid member of the fiscal austerity brigage before the crisis and was hit hard just like Greece. Japan still issues as much public debt as it desires at very low yields and the bond markets cannot get enough of it.
In general, the bond markets want a lot more public debt than is being issued.
For example, it was reported by AAP today that the Australian Office of Financial Management sold $500 million of 10-year Treasury Bonds wiith a coverage ratio (the ratio of bids received to the value of bonds offered) of 2.70. “There were 38 bids” and only “15 were successful” with “seven of them allocated in full” via the auction process.
Skipping a question, he was then asked and answered:
Q: The markets attacked Europe precisely where it is most vulnerable, in that it has a federal monetary policy without a single economic and fiscal policy.
A: This is not how I would describe matters. Since the severe crisis that erupted in 2007, which we countered by avoiding a recession that could have been as devastating as the one in 1929, all fiscal policies of the industrialised countries have been vulnerable, and not only those in the euro area. The scale of the recession has significantly weakened a number of budgets that were already in difficulty. I do not see what happened – and what is in the process of being gradually resolved – as a targeted attack on the sovereign risks of the euro area, but rather as questioning the fiscal policy of industrialised countries. Some countries have shown themselves to be more vulnerable than others. Certainly, it immediately calls into question the quality of the surveillance of fiscal policies undertaken by the other governments.
Here is the exemplification of the cult leader denying that there is a cult.
Prior to the creation of the EMU, each of the member states were sovereign in their own currencies and had their own central banks. That means they were not revenue-constrained and could conduct fiscal policy and monetary policy in a co-ordinated way to best serve the socio-economic interests of their citizens.
Of-course, in this guise, they succumbed to the growing neo-liberal take-over of macroeconomic policy and typically worried about the size of budget deficits and the public debt. All the usual spurious arguments were used by the conservatives to politically constrain their use of fiscal policy – for example, crowding out arguments (higher deficits cause higher interest rates) and Eurosclerosis that engendered privatisations and deregulation.
Leading up to the unification, the interest rate argument was played to the full. Neo-liberal supporters of the EMU claimed that lower interest rates would emerge throughout Europe. Not only didn’t that happen but it begged the reality – the nations could have unilaterally maintained zero interest rates as sovereign economies by just managing their central bank operations along the lines followed by Japan, for example.
Once again, had they understood MMT and argued the case politically, these nations would now be in much better shape than they are now.
This is why Europe has been sustained very high unemployment rates since the mid-1970s.
Upon entering the EMU, all those previously sovereign states surrendered this capacity and became users of the currency issued under the auspices of the ECB rather than monopoly issuers of their own currency. In effect, they became states of a federation (like an Australian or a US state) but without any explicit federal fiscal capacity to support their sub-federal units.
The EMU tied itself up in a strait-jacket (Stability and Growth Pact) to ensure that individual member state governments who are still accountable politically to their own citizens could not pursue their own fiscal agendas very easily.
The reason the bond market attacks on the EMU nations has occurred relates to the design of the monetary system. It is clear that without ECB intervention, the member nations did face solvency risk. A sovereign government never faces solvency risk.
Further, when talking about a sovereign nation (one that issues its own currency and floats it on international markets) there is no sense in the statement that “fiscal policies of the industrialised countries have been vulnerable”. This presupposes that some non-vulnerable state can be defined.
Trichet would claim that a budget balance or even surplus is a position of fiscal strength. But there is no meaning in that statement. The reality is that the budget balance reflects the state of the economy and the strength of private spending. The point is that budget balances should never be a policy target.
The government should pursue public purpose (high employment and sustainable economic growth) and use its fiscal capacity accordingly. At times when private spending is strong then the deficit will be lower (perhaps even in surplus if there is a strong external position). In times of weak private spending, the deficit will be higher.
While it makes sense to talk about weak or strong private spending, given that the non-government sector are revenue-constrained, there is no meaning to be gained by applying those descriptors to the public balance. I never use terms such as an “improving budget position” or a “deteriorating budget position”. There is no one position that is good and another that is bad.
But in terms of the state of the real economy which the budget balance reflects (via the automatic stabilisers initially) there are clearly good and bad outcomes and improving and deteriorating positions.
While Trichet wants us to believe that the crisis “weakened a number of budgets that were already in difficulty” I would suggest that the EMU member countries were running tighter fiscal positions for too long leading up to the crisis – as evidenced by the fact that they could not get their unemployment rates below (mostly) 8 per cent. The persistent degree of real slack across the Eurozone was testament to this.
The bond market problems that some of the EMU nations have now encountered are also not consistently related to their fiscal positions. Spain, for example, was a Eurozone “model citizen” leading up to the crisis but has been hit by the rising cost of gaining funds from the markets.
The bond crisis is directly attributable to the poor design of the Euro monetary system. Why haven’t we seen this sort of issue in sovereign nation bond markets?
He was then asked and answered:
Q: Wasn’t it the case that Europe responded too late to the sovereign debt crisis, given that all the elements of the crisis were in place as early as January 2009?
A: It was first necessary for the countries that were afflicted by a lack of market confidence to adopt a fiscal policy that would enable them to convince all market participants. That is what Greece failed to do in 2009. This made all the difference for a country like Ireland, which – despite the severity of its situation – drew up in advance and adopted a large-scale recovery programme without waiting to find itself in extremely difficult circumstances vis-à-vis investors …
I would not hold Ireland out as an example of being in “recovery”. Please read my blogs – The sick Celtic Tiger getting sicker and The Celtic Tiger is not a good example – for more discussion on this point.
Further, once again you realise that the EMU system is designed to ensure that financial matters take priority over everything. The democratically elected government have rendered their nations vulnerable because they bullied their citizenry into entering an economic and monetary system that would always deliver hardship the first time a serious negative aggregate demand shock hit that system. It was obvious from day one when the Maastricht Treaty was signed and then the Lisbon rules were consolidated that this would be the case. Please read my blog – What is it really all about? – for more discussion on this point.
The citizens within the EMU have ceded their democratic rights to an amorphous bond trading elite courtesy of the likes of Trichet.
Even though sovereign governments cripple themselves with voluntary constraints that empower bond markets, ultimately the government is always in charge andd does not have to “adopt a fiscal policy that would enable them to convince all market participants”. The only judges of fiscal policy should be the people at election time. Please read my blog – Who is in charge? – for more discussion on this point.power
Trichet was then asked:
Q: Why did you wait until 10 May 2010 to intervene in the secondary market for sovereign debt by purchasing Greek bonds and those of other countries? If you had done so earlier, you would have tripped up the speculators.
First some background.
On May 7, 2010, the Wall Street Journal (reprinted in the News Limited daily The Australian) wrote – ECB holds back its ‘nuclear option’ for containing the Greek debt crisis. The report followed the ECB Governing Council meeting in Lisbon on May 6, 2010.
The WSJ article said:
THE European Central Bank’s monetary council withheld its strongest weapon for stopping the Greek debt crisis from spreading to weaker euro-zone financial markets, but ECB watchers don’t rule out a later deployment. Called the ECB’s “nuclear option” in the markets, the procedure would involve the purchase of government bonds in the secondary market. Rumours that it could be activated as early as yesterday were flatly dismissed.
The ECB President Jean-Claude Trichet told a press conference that “We did not discuss this option” and CDS costs rose immediately.
Four days later, the ECB started by government bonds.
In its May 10 Statement, the ECB said:
The European Central Bank decided on several measures to address the severe tensions in certain market segments which are hampering the monetary policy transmission mechanism and thereby the effective conduct of monetary policy oriented towards price stability in the medium term … To conduct interventions in the euro area public and private debt securities markets (Securities Markets Programme) to ensure depth and liquidity in those market segments which are dysfunctional.
The dysfunctional elements they are referring to was the increasing spreads on some member government debt issues relative to the benchmark German debt instrument and the increasing insurance costs (credit default swaps).
See also its Monthly Report on the Eurosystem’s Covered Bond Purchase Programme for May 2010 where it touches on the sovereign debt purchases.
The WSJ reference to the “nuclear option” is just an ideological statement. Given all the neo-liberal posturing since the EMU was established such an intervention was considered anathema to the policy bosses in Brussel and Frankfurt. But what they finally realised was that without a fiscal capacity to cope with asymmetric shocks that this individual Eurozone countries they were on a fast-track to widespread sovereign defaults and the failure of their entire banking system.
Ultimately, the ECB became pragmatic and has assumed a fiscal role. But it still has asserted its ideological colours by bullying the nations into introducing damaging fiscal retrenchments.
The decision to buy government bonds in the secondary markets was an obvious intervention and should have been taken months earlier. Under the EU treaty, the ECB is forbidden from buying government bonds in the primary (issuing) market. It can buy them indirectly after they have been issued. In effect, this is a fiscal intervention and entrenches the power that the unelected ECB holds over the citizens of the nation states in the EMU.
The ECB can now bully the member governments into very harsh contractionary fiscal retrenchments while still having the capacity to “fund” any level of net public spending in any member state. So the have the capacity of a sovereign government but without any of the political accountability. It is really an appalling situation.
The intervention immediately eased the tension in bond markets as was expected. On May 11, 2010, the ECB bought 16.5bn euro of long-term Eurozone government bonds. This had the effect of pushing up bond prices and holding down yields (borrowing rates). It ensured that the bond markets maintained liquidity.
The ECB statement also indicated that it would not “affect the stance of monetary policy”. They said:
In order to sterilise the impact of the above interventions, specific operations will be conducted to re-absorb the liquidity injected through the Securities Markets Programme. This will ensure that the monetary policy stance will not be affected.
What they did was to offer interest-earning deposit facilities to the commercial banks as a vehicle to drain the added bank reserves as a result of the open market purchase of the government debt. So they added liquidity to ensure the bond prices would be supported and then drained it via the payment of a competitive return (at the main refinancing rate) to the commercial banks. This allowed them to maintain their target policy rate.
The critics of the strategy (including some members of the ECB Governing Council) raise various spurious and ideological arguments against this policy shift.
They say that it compromises the independence of central bank and makes it a subject of the political authorities. I see that as a good thing – a pro-democratic development. In practice, the central bank is part of the government sector because its transactions with the non-government sector can be vertical. For an explanation of the difference between vertical and horizontal transactions please read the Deficits suite – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3.
For the government sector to work effectively the central bank and the treasury have to coordinate their monetary interventions, the former being passive to the latter, given that the treasury reflects the elected intentions of government. For me, having an unelected and largely unaccountable body able to change policy settings that damage employment is unacceptable in any sophisticated democracy. This trend towards so-called “independent” central banks has been a feature of the neo-liberal erosion of our democratic rights.
The critics also argue that it amounts to monetising the debt which is inflationary. This is based on the discredited but still dominant Quantity Theory of Money which says that an increasing money supply translates directly into inflation. The theory is deeply flawed and has no empirical standing. Please read my blogs – Please read the following blogs – Building bank reserves will not expand credit and Building bank reserves is not inflationary – for further discussion. – for more discussion on this point.
If you think about the current state of the real economy across the EMU you will realise that the inflation risk is minimal. They will end up having to fight deflation. The rate of capacity utilisation is as low as it ever has been. There is currently zero (but probably negative) core inflation and unemployment rates are above 10 per cent (across the zone) and will worsen as the austerity packages bite. So there is zero wage pressure going to emerge in the EMU in the coming period.
The demand for credit is flat and banks are reluctant to lend anyway given the precarious nature of their balance sheets. There is virtuall no inflation risk at all in the EMU and it is highly likely that the bond purchases would just remain sitting as bank reserves anyway.
But this is not stopping the neo-liberal hard-heads from barking loudly. In this Bloomberg story (May 31, 2010) – ECB Must Stop Buying Bonds ‘Quickly,’ Draghi Says – the ECB council member Mario Draghi emphasised that the cure for the EMU crisis was that the EU had to strengthen enforcement of the deficit rules contained in its Stability and Growth Pact.
The commitment to achieve a structural budgetary position in balance or in surplus must be made cogent by introducing sanctions, including political sanctions, for non-compliance.
So expect more pressure on the use of fiscal policy including even harsher fiscal rules and penalties. Governments are going to be further punished when private spending collapses. It is nonsensical and a total denial of the purpose of fiscal policy – to, in part, offset private spending fluctuations.
Anyway, Trichet answered:
A: We acted because we saw a serious and unprecedented malfunctioning of the financial markets of certain euro area countries in the afternoon of 6 May and on Friday 7 May. At that moment in time and not before, we judged that we had a very serious problem with regard to the transmission of our monetary policy in part of the euro area, and that we had to contribute to re-establish a more normal functioning of the markets in question. Our aim was not to change our monetary policy, which is to maintain price stability for our 330 million fellow European citizens. Inflation is a tax on the poor and most vulnerable.
As noted above, the markets had been punishing Greece and other EMU countries for some time. They acted when they did because there would have been defaults and that would have put the banking system in jeopardy (which still might go under) and challenge the logic of their whole monetary system.
The ECB allowed the real economic situation to deteriorate well beyond what it should have before they intervened. This allowed the automatic stabilisers to drive the budgets further into deficit and beyond the SGP rules. And … this allowed them to bully the member governments into more draconian austerity programs – thus retrenching more public activities.
So the ECB created the dream situation for the neo-liberals – wholesale welfare state retrenchment.
Trichet was then asked and answered:
Q: So the ECB isn’t there to mop up the reckless spending of Member States?
A: The central bank is certainly not there to rectify the fiscal mistakes of governments, mistakes it constantly warned them about.
The intervention is fiscal in nature anyway and recognises, even though the ECB won’t express it like this, that the missing element in the EMU is a supranational fiscal authority that can spend like a sovereign government.
Skipping a few questions, Trichet was then asked and answered:
Q: Isn’t there a risk that the next stage of the crisis will occur in the private debt security market, as seen in Spain, where credit institutions are very vulnerable?
A: The calling into question of certain private debt instruments was the source of the international crisis that we are experiencing. It is as a result of this “private” crisis that we have been faced later with the problem of sovereign debt risk. All industrialised countries must strengthen the soundness and credibility of all public policies, and in particular fiscal policy …
The global crisis clearly arose because the private sector had become too indebted and major defaults started to occur. Banks stopped lending and private households and firms began to repair their vulnerable balance sheets.
As I noted in yesterday’s blog – Employment gaps – a failure of political leadership – the pursuit of government surpluses squeezed the private domestic sector of liquidity. This proved to be an non-viable growth strategy because the private sector (which always faces a financing constraint) cannot run on-going deficits.
Ultimately, the fiscal drag coming from the budget surpluses (structural or otherwise) forces the economy into recession (as private sector agents restructure their balance sheets by saving again).
With a spending collapse and the non-government sector desiring to move into solid surpluses, the government deficits had to increase. They did not increase enough given the magnitude and persistence of the recession.
To consider the rising deficts in the context of the private spending collapse and the impacts this has had on the real economy, to be a fiscal problem tells us that Trichet doesn’t consider fiscal policy should be counter-cyclical. If fiscal interventions cannot maintain high levels of employment in the face of private spending fluctuations, what purpose does it serve? Answer: None!
Trichet was then asked and answered:
Q: Is greater fiscal integration necessary to avoid a repeat crisis of this nature?
A: We must, in particular, be able to go as far as possible, without necessarily changing immediately the Treaty, notably with regard to very early surveillance, almost automatic sanctions, and the strengthening and extension of sanctions so that the euro area has the equivalent of what we would have if we were in a fiscal federation.
So the likely response in the EMU will be to further constrain fiscal policy. The glaring design flaw in the monetary system is the lack of a supranational fiscal authority that can spend like a sovereign government and address asymmetric demand shocks.
Trichet’s solution is to worsen this design flaw by penalising nations that encounter deficits outside of the fiscal rules. The reality is that the automatic stabilisers have driven the budgets in many countries beyond the SGP rules given how severe the collapse in economic activity has been following the sharp decline in aggregate demand.
Further constraining the fiscal capacity to respond to these negative spending shocks will entrench higher levels of unemployment and poverty. What a grim place these characters are creating for the people of Europe.
Skipping a few questions, Trichet was finally asked:
Q: Do the austerity plans announced amid monumental disarray by the Member States pose the risk of killing off the first green shoots of growth?
A: It is an error to think that fiscal austerity is a threat to growth and job creation. At present, a major problem is the lack of confidence on the part of households, firms, savers and investors who feel that fiscal policies are not sound and sustainable. In a number of economies, it is this lack of confidence that poses a threat to the consolidation of the recovery. Economies embarking on austerity policies that lend credibility to their fiscal policy strengthen confidence, growth and job creation.
His response here is the new orthodoxy. I covered it in this blog – We have been here before … – for more discussion on this point.
Somehow they believe that by heavily cutting government spending support for aggregate demand and reducing wages that households and investors will suddenly appreciate that they will have lower future tax levels, will stop saving and will go on a spending frenzy. It will just not happen that way.
The fiscal austerity directly threatens growth and job creation.
For all my Eurozone blogs.
So the cult master speaks.
There is nothing new in Trichet’s responses. They are all the utterances of an ideologue who wants to restore a policy framework that allowed the global economy to get into this crisis in the first place.
The worry is that the Europeans will seek to tighten the fiscal straitjacket even further than specified by the SGP and cause further real damage in their economies.
Finally, as I have noted in previous blogs (A total lack of leadership and Ignorance leads to bad policy), the ECB intervention into secondary bond markets really amounts to a massive fiscal intervention but with the barbs attached that the national governments have to toe the ECB line.
This concentration of power within the EMU within an unelected body which can hand out favours at will in return for total compliance is a very dangerous precedent. If anything looks like increasing totalitarianism in the current environment this is it.
That is enough for today!