Gunther Schnabl and Thomas Stratmann
Ten years after the outbreak of the global financial crisis, banks in the euro area have not recovered. The Euro Stoxx Financials is 65% below the pre-crisis peak, whereas the S&P Financials has come close to the pre-crisis level. The different fate of financial institutions is due to different monetary and regulatory crisis therapies of the European Central Bank (ECB) and the Fed. Continue reading
by Karl-Friedrich Israel and Gunther Schnabl
The ECB’s zero and negative interest rate policy continues despite the economic upswing. An interest rate hike is not expected before autumn 2019. The extensive purchases of government and corporate bonds will have reached €2,600 billion by the end of the year. The ECB’s financial market supervision as part of the Single Supervisory Mechanism (SSM), which was created in 2014 in response to the crisis, is proliferating. Most recently, ECB vice president Luis de Guindos has expressed the intention to monitor the investment fund sector.
For a long time, Austrian macro had a unique selling point in what might be called the ‘money matters’ view: referring to the notion that changes in the money supply by their very nature can never be said to be neutral. Yeager (1997) and Horwitz (2000) describe the Austrian stance as a “fluttering veil”. On the one hand, it incorporates the belief that prosperity cannot be generated through an expansion of the money supply in the long-run (long-run neutrality of money). On the other hand, changes in the money supply have real effects (short-run non-neutrality).
This proposition can be traced back to the works of classical economists such as Hume (1970), Mill (1909), Cairnes (1873), and Cantillon (1755).[i] In his essay on economic theory, Cantillon (1755) points out that an expansion of the money supply necessarily entails distributional effects as first receivers of the newly created money benefit compared to those ones further down the line.
by Edward Chancellor*
Interest rates in China may never have turned negative, as they did in neighbouring Japan. Yet China’s economy has also become distorted by the decade of easy money since the 2008 financial crisis. As in the West, low interest rates in China are responsible for inflating asset prices, misallocating capital, aggravating inequality and undermining financial stability.
by Edward Chancellor*
The Greek philosopher Aristotle attacked the charging of interest on grounds that lenders demanded more money in return than they supplied. This ancient prejudice against interest lingers in the French economist Thomas Piketty’s claim that inequality increases when the return on capital, a quantum which includes the rate of interest, is higher than that of economic growth. Yet the overwhelming evidence from the easy money that followed Lehman Brothers’ demise shows that inequality really takes off when interest rates are maintained at artificially low levels.
by Andreas Hoffmann
George Selgin has a much-discussed post over at Alt-M. I agree with most of it. However, I am puzzled by the following statement:
Austrian accounts of the money-creation process often exaggerate the ability of fractional reserve banks to create money “out of thin air,” even while sticking to a fixed reserve ratio, by looking at only one part of the bank money creation process.
[…]
Actually, it isn’t, for the simple reason that, more often than not, a deposit made at one bank involves a corresponding withdrawal of funds from another bank, as when the deposited sum takes the form of a check.
by Andreas Hoffmann
These days many commentators suggest that in Turkey a recession is on the way. But nominal GDP has continued to grow along trend.
Both in Europe and in the US, interest rates have fallen to still very low levels and central banks have used unconventional measures to stimulate the economy. Nevertheless, officially measured inflation rates have remained low. While central bankers are proud of the high degree of price stability, many citizens feel their purchasing power diminishing. How does this fit together?
by Jerry O’Driscoll
Fed Chairman Jerome Powell testified to the Senate Committee on Banking, Housing, and Urban Affairs. It was the semi-annual testimony mandated by the Humphrey–Hawkins Act. Powell’s testimony was anodyne. He repeated and reiterated the Fed’s planned policy moves with respect to interest rates, and added suitable caveats on economic growth, inflation, and tariffs. Trade policy is a new factor for Fed policymakers. Continue reading
by Edward Chancellor*
China’s economy has long defied the doom-mongers. In place of their ominous critique, a more constructive view of economic management in the People’s Republic has surfaced. Beijing, we are told, has found the right balance between state and market forces, and is best positioned to exploit exciting new technologies, such as big data and artificial intelligence. Politically fractured and economically sclerotic Western nations can only look on in envy.
Dinny McMahon, a former financial journalist and mandarin speaker who spent many years reporting on the Middle Kingdom, doesn’t buy this line. In his view, China’s economy has spent years locked in continuous stimulus mode, accumulating bad debts and generating great economic imbalances along the way. This is not an original thesis. But it’s a welcome reality check on the current China hype. Of the many books that have observed the fragility and contradictions of China’s economic model, “China’s Great Wall of Debt” is the best. McMahon writes well, has a fine eye for detail and finds original stories to illustrate his argument.
The European Central Bank will increase the overall volume of its bond purchase program to 2,550,000,000,000 euros by September 2018. The main refinancing rate will remain at zero. Mario Draghi has stressed that this policy shall continue until inflation picks up sustainably (which is unlikely to happen in the foreseeable future). The works of Friedrich August von Hayek (1931, 1944, 1976) help to explain why the tremendous monetary expansion is increasingly causing growing economic and political instability in Europe.
by Sebastian Müller and Gunther Schnabl
Massive losses for Germany’s former catch-all parties (CDU/CSU and SPD) and record gains for the far-right Alternative for Germany (AfD) have caused turmoil in Germany’s political landscape. The tumbling leaders Angela Merkel and Martin Schulz keep affirming that good policies were simply not explained sufficiently. They blame globalization and refugees to be at the roots of growing political discontent. Meanwhile, a rightward shift in Austria and the Czech Republic has occurred, albeit the number of refugees in the Czech Republic is low and growth is high. Everywhere in Europe far-right parties flourish independently from the level of income and the number of welcomed refugees. What is the common driving factor?
by David Herok and Andreas Hoffmann*
Since the financial crisis, trust in the European Central Bank (ECB) has declined substantially among Europeans. We argue that the decline in trust is worrisome and can be both a cause and a consequence of the ECB’s policy failure.
by Jerry O’Driscoll*
The U.S. economy has been growing slowly but steadily since the trough of the Great Recession in June 2009. Deep recessions are typically followed sharp recoveries. Not so this time.
More recently, there is the mystery of low inflation. The Fed’s preferred inflation measure, the core PCE index, has consistently fallen short of its target rate of 2 percent. In July 2017, it came in at a 1.41-percent annual rate. For the Fed, improved growth in employment and the falling unemployment rate should foreshadow a higher inflation rate. The rationale for this is the old Phillips Curve. The reality is that the model is flawed.[1] Continue reading
by Gunther Schnabl*
The European Central Bank (ECB) continues buying securities. By the end of 2017, the balance sheet is expected to have further grown by about 800 billion euros. This corresponds to a growth rate of 20 percent per year, while real growth of the euro area is expected to be only 1.5 percent. Despite this tremendous monetary expansion, euro area inflation remains below the two percent target. This raises the question of whether the quantity equation, which Mark Blaug called “the oldest surviving theory in economics,” is still valid.
by Andreas Hoffmann and Nicolás Cachanosky
The Federal Reserve’s (Fed) and European Central Bank’s (ECB) policy responses to the recent financial disasters offer two tales of unintended consequences. Our previous post outlined undesired effects of the Fed’s policies. In this post, we suggest that the ECB’s stabilization policy did not only fail to achieve its goals. Monetary policy has also hampered the structural adjustment of the European economy and prolonged the crisis.
by Taiki Murai and Gunther Schnabl[*]
In the second half of the 1980s, 13 Japanese city banks climbed into the group of the world’s largest banks, boosted by a domestic speculation boom. With the bursting of the Japanese financial “bubble” in the early 1990s, a gradual decline followed. Since then, the Japanese city banks have been driven by Japanese monetary policy into a concentration process, which has produced new giants without increasing efficiency. Continue reading
by Andreas Hoffmann
The pre-crisis Jackson Hole Consensus view on how to take asset market developments into account in monetary policy can be summarized as follows: Because it is hard to spot bubbles in asset markets with certainty ex-ante, central bankers should not lean against the wind when there seems to be a boom in financial markets (as long as the inflation rate does not pick up). However, as a rapid fall in asset prices can pull the real economy into the maelstrom of crisis, monetary policy should react decisively when a bubble bursts and “clean up the mess” to prevent spillovers to the real economy.
Because there is empirical evidence that countries with greater credit and asset market booms in the 2000s experienced more severe financial crises in 2007-9, the pre-crisis consensus view has lost popularity. Policymakers and academics have started to think of ways to curb financial booms and lower the probability of crisis using macroprudential regulation or leaning-against-the-wind monetary policy. Continue reading
by Nicolás Cachanosky and Andreas Hoffmann
Even when a policy is successful in achieving its desired ends, we have to consider its unintended and unforeseen consequences, resulting from cumulative market adjustments to policy changes that make it hard to judge the overall outcome of a policy in our complex economy. The Federal Reserve and European Central Bank’s monetary policy responses to the 2008 financial crisis offer two tales of major unintended consequences. This post discusses unintended outcomes of the U.S. Federal Reserve’s crisis policies. In our next post, we address ECB policies.
by Gunther Schnabl*
The Brexit and the election of U.S. President Donald Trump were unexpected and were followed by a search for explanations. Subsequently, the common view spread that globalization is at the root of the frustrations of more and more people who are susceptible to strong nationalist statements from populists. This is surprising because for a long time, the reduction of trade barriers was acknowledged to be a basis for global prosperity. Why should the accepted view suddenly be so different?
by Andreas Hoffmann
Government debt levels in many advanced economies, especially in Southern Europe, in the US and in Japan, have reached peacetime records. People are worried and rightly so: C. Reinhart and K. Rogoff have provided evidence that elevated debt-to-GDP ratios may contribute to stagnation or even debt crises. As austerity policies are unpopular with voters and growth remains rather sluggish, Reinhart and Rogoff suggest that governments might have to consider other options to reduce debt-to-GDP ratios. Debt should be liquidated via financial repression. It’s how governments typically dealt with high levels of debt in history, they say. This time is not different.
by Gerald P. O’Driscoll, Jr.[1]
I have been reading Central Bank Governance & Oversight Reform, edited by John H. Cochrane and John B. Taylor. It is a conference volume of unusually high quality with all the discussions of presentations included.
I plan to write more about the book later, but to highlight one chapter here. It goes beyond the usual topics, covered well in the book, on rules versus discretion, credible commitments, policy legislation, and the historical record.
by Roger Koppl
Oliver Blanchard tells us “Where Danger Lurks” in the macro-finance world.
The big theme is nonlinearity, which is a profoundly conservative move: DSGE modeling is just fine and we don’t need to rethink it at all. We just need to add in some nonlinearities. Blanchard does not tell how to calibrate a model with extreme sensitivity to initial conditions. But if the system is chaotic, it is also unpredictable, so how can you pretend to merely add nonlinearities to DSGE models? It seems like a pretty direct contradiction to me. I mean, you can have the model in a trivial sense, of course. But calibration is an empty exercise that will not let you look around corners.
Blanchard’s second main message is alarming: We do need theoretical innovation, however, in measuring systemic risk. In the modern network literature on financial markets and cascades, one key point is risk externality. My portfolio choice makes your portfolio riskier. We need two things to fix this market failure. First, we need Pigou taxes, which cannot be calculated unless everyone tells the regulator his portfolio so that it can measure systemic risk and calculate a separate Pigou tax for each financial institution. Second, we need to reduce systemic risk. (“[S]teps must be taken to reduce risk and increase distance” from the “dark corners” of the macro-finance system.) In the network literature I suspect Blanchard is alluding to, this is to be done (at least in some of the articles) by having the regulator directly control the portfolios of financial institutions. (Names include: Acharya 2009; Beale et al. 2011; Caccioli et al. 2011; Gai, Haldane,and Kapadia 2011; Haldane and May 2011; and Yellen 2009, 2011)
I take a rather different view of both economic theory and the crisis in my recent IEA Hobart paper From Crisis to Confidence: Macroeconomics after the Crash.
Overall, Blanchard’s message is meant to be reassuring: We the smart macro-finance experts have now got the message on nonlinearities. So no further need to worry, we’ve got the situation in hand. To keep the system out of the “dark corners,” however, we will need more discretionary authority. You don’t mind trading off a bit of financial freedom for greater financial safety do you?
by Alexander Czombera*
If there is one single law in economics then it is that markets tend to equilibrium. Or, to align this with Grove’s law (“Technology will always win. You can delay technology by legal interference, but technology will flow around legal barriers”), the free market will find its ways, whether in white, grey or black market. Despite of initially strong resistance of the Zimbabwean government it was market forces and not political consent that abolished central banking and legal tender laws in the South African country. Paper money of its original currency was replaced with notes from other countries, the shortage of coins was addressed by “efficient rounding”, condoms and sweets.
While inflation was mostly in double digits ever since its independence in 1980 it began to climb when the government faced high deficits and deep recessions in the early 2000s. In late 2008 it eventually reached a peak of 8.97 x 10 (to the 22nd power) percent. Prices doubled almost every day.
Because of the limited supply of foreign currencies and fixed exchange rates some people used this time to exploit arbitrage opportunities. The term burning money was coined when well-connected people in Harare exchanged their Zimbabwe Dollars into the limited supply of South African Rand at the fixed exchange rate and sold the Rand in the parallel market at a fair price.
The continuing devaluation of its own currency moved Zimbabwean citizens into other currencies, most notably Rand, Pula, US Dollar, Euro and Pound. In spite of legal tender laws these currencies became established in the regions which traded frequently with the countries issuing these currencies or having previously adopted them. Continue reading
by Jerry O’Driscoll
For the month of November, Cato Unbound features an essay by me on “The Fed at 100.” Over the course of a week, there will be comments by Larry White, Scott Sumner and Jerry Jordan. I will respond to these as appropriate.
“End the Fed” has become a political slogan. Long before that, however, there was a serious academic literature on the prospects for competitive banking. I examine that literature in my posting. One interesting aspect of that literature is that important papers on free banking came out of Federal Reserve banks in the 1980s.
I argue that “the literature on free banking demonstrates the viability of private, competitive banking without a central bank.” But we now have a system of central banking almost everywhere. The fact that the road not taken would have been a viable path does not mean that we can retrace our steps and take that path now.
I devote roughly half the posting to consideration of what it would take to end the Fed. It would be a formidable but not impossible task. It is generally acknowledged that to be viable, a system of competing currencies would need convertibility into something that is in inelastic supply. Historically that has been a commodity, and I suggest gold is as good as any (though many disagree about that). What are the prospects for a return to a commodity standard?
Central banking is historically linked to governments running deficits and needing them to be financed. That is equally true today. Central banks cannot be abolished until permanent deficits are abolished, and governments are shrunk down in size. What are the prospects for that?
I have just returned from a very important conference at the Mercatus Institute at George Mason University on “Instead of the Fed: Past and Present Alternatives to the Federal Reserve System.” As the title suggests, alternatives to central banking in the past and the future were discussed. All three discussants of my posting also participated in important roles at that conference. I was a discussant of three papers, including one by Scott Sumner. So I imagine we will be continuing our dialog at Cato Unbound.
One of the most interesting discussions was among advocates of Fed abolishment and of Fed reform. All agreed that we need better monetary policy now and into the future, regardless of our differences on the issue of free banking versus central banking. I will observe that it was encouraging that people as diverse as George Selgin, Scott Sumner, Ben McCallum and I were able to arrive at a consensus.
I invite everyone to visit Cato Unbound this month and follow the conversation.
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