Why Europeans Lost Trust in the ECB

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.

Inflation Is Not Measured Correctly

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.

Unintended Monetary Policy Effects – Tale II: ECB Crisis Policies

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.

Easy Money, Slow Growth

by Jerry O’Driscoll

In today’s Wall Street Journal, John Taylor explains why the U.S. recovery has been tepid while money growth has been very rapid. The recovery has set records for its weak pace, while money growth has set records for its rapidity. Taylor supplies some of the numbers.

Taylor continues an argument he made at the November 2012 Cato Monetary conference. It is the Fed’s policy that is causing the anemic recovery. To quote, “while borrowers like near zero interest rates, there is little incentive for lenders to extend credit at that rate.” He analogizes the Fed’s fixing interest rates to a policy of price ceilings on housing rents. Lenders supply less credit at the lower interest rates, as landlords supply less housing services under rent controls.

Taylor also notes that the Fed’s policy interferes with the signaling of the price system. It distorts capital allocation. Any decently trained micro economist would understand this. Why cannot the backers of the Fed’s policy?

Clarifications of the Austro-Wicksellian Business Cycle Theory

by Mario Rizzo

There has been a lively debate on forecasts of high inflation made by those worried about the Fed’s recent policy of quantitative easing. For details I refer the reader to Daniel Kuehn’s excellent blog. The question to which I address myself is solely “What do these predictions have to do with core Austrian Business Cycle Theory?” This is my answer.

We must start with a few general points. First, I am talking about the Austro-Wicksellian business cycle theory as developed by Friedrich Hayek and Ludwig von Mises and as synthesized by Roger Garrison in his book Time and Money. I cannot take responsibility for versions constructed by others.  It is not that I think the others are necessarily wrong (and I mean no disrespect to them), but I do not know with sufficient precision what all these others are saying in the name of “Austrian theory.”

Secondly, the Austro-Wicksellian theory begins with either an endogenous increase in credit through the banking system or with an “exogenous” increase initiated by a central bank. In the latter case, however, the theory itself has little to say about the extent to which increases in base money will manifest themselves in increases in bank credit to producers.  (This may not be much of an issue during a boom but may be an issue during a recession or in a recovery.)

Third, the theory is fundamentally one about the “upper turning point” in the cycle – it is a theory about why a credit-induced boom must come to an end. It is not a theory, for better or worse, about the “secondary” factors that develop consequent on the break-up of the boom. These include possible recessionary-problems relating to bank runs (there is an Austrian inspired banking literature, but that is not the cycle theory) or what exactly will get investment expectations to turn around.  As to deflation, Lawrence White has argued that the logic of the theory requires the avoidance of deflation in accordance with Hayek’s very early recommendation to keep M V from falling.  (Hayek departed from this in the Depression, and later admitted he was incorrect to do so.)

Now to more specific points:  

Taylor, Krugman and Quantitative Easing

by Chidem Kurdas

In two substantial New York Review of Books articles, Paul Krugman and Robin Wells offer their views on various explanations of the property bubble and ways to get out of the slump.  On the latter front, they advocate aggressive deficit spending by the federal government and  quantitative easing by the Federal Reserve— No surprise to anyone who reads Professor Krugman’s writings.

Regarding the causes of the bubble, they favor the “global savings glut” explanation.  This view absolves the Federal Reserve from having spiked the punch bowl at the intertwined credit and real estate parties—by keeping interest rates exceptionally low from 2002 to 2005. It is remarkable that Krugman and Wells dismiss the case against the Fed without even bothering to mention the work that argues and presents evidence for the Fed’s pivotal role in causing the crisis—namely, Stanford professor John Taylor’s book and articles, including a Wall Street Journal piece.  

Why does this matter?

The European Central Bank Turns into the Fed?

by Andreas Hoffmann*

The European Central Bank (ECB) and the Fed differ in many aspects. First, the ECB is considered to be more hawkish on fighting inflationary tendencies. Its primary goal is price stability and it has continued to watch money growth. Output gaps below full-employment are only considered secondary as instrument to forecast inflation.

Secondly the ECB was constructed to be more independent than the Fed. Thus there has been less interaction with fiscal authorities. Less mobility from governments to the ECB (and vice versa) documents this independence. While in the US it is common to see central bank officials and the secretary of treasury plan the future of the economy, in Europe this is not the case. Central bank independence is considered an important aspect of credibility and stability of the currency (the German central bank model). However, the current crisis has made the ECB more “Anglo-Saxon.”

The Fed’s Coming Indiscretion?

by Mario Rizzo  

There seems to be broad agreement among economists that the current recovery from the recession will be characterized by a slowly falling unemployment rate. This makes a good deal of sense since the problem that created the recession was a misdirection of resources into a number of sectors including housing construction and the financial industry.  

Reallocation of resources takes time. The government is not helping matters in trying to prevent adjustments by various (but not very successful) efforts to slow or reverse the rate of fall in housing prices. It is also difficult for market participants to determine the effect of possible new policies like Obamacare or any further jobs-stimulus legislation.  

Seizing the Commanding Heights

by Jerry O’Driscoll  On the Opinion page of yesterday’s Wall Street Journal, George Melloan spells out how government stimulus is stifling lending, crowding out private investment and impeding economic recovery.  He writes that “the credit market has been tilted to favor a single borrower with a huge appetite for money, Washington.” It has done so in a number of ways.   First, the Fed announced that it will evaluate bankers’ pay on the basis of how well they manage risk.  How better to be a good risk manger in a bureaucrat’s eyes than to take no risk?  Purchasing Treasury obligations and federal agency paper is the sure way to avoid risk.  The Fed has a second policy to make that strategy profitable: zero interest-rate borrowing to finance Treasury and agency debt yielding 3%.or more.  The Fed continues to signal it will keep rates low, diminishing interest-rate risk.   These policies are choking off the supply of credit to the private sector, espcially small business.

Avoiding Deflation Without Bailouts

by Mario Rizzo  

I have not posted in a while since I have been on vacation. During that time an interesting dispute has arisen among friends Tyler Cowen, David Henderson, Arnold Kling, Peter Boettke, Bob Murphy, Steve Horwitz and others over whether Ben Bernanke was right to bail out specific banks. (Some of this has gotten mixed up with the issue of what Brian Boitano would have done — oops, I should say Milton Friedman.)  

I think the question could be simply stated in two parts. First, is it possible to prevent general deflation and not bail out big banks? Second, if so, what would be the effect on the economy of bringing the banks to bankruptcy court while preventing outright deflation?  

Ben Bernanke: Ipse Dixit

by Mario Rizzo

Today’s Wall Street Journal has an opinion piece by Fed Chairman Ben Bernanke. He assures us that the Fed has the tools and the willingness to restrain inflation when that is appropriate (not now). He recognizes it is all about timing. But everything is under control:

“Overall, the Federal Reserve has many effective tools to tighten monetary policy when the economic outlook requires us to do so. As my colleagues and I have stated, however, economic conditions are not likely to warrant tighter monetary policy for an extended period. We will calibrate the timing and pace of any future tightening, together with the mix of tools to best foster our dual objectives of maximum employment and price stability.”

How good are Bernanke’s abilities as a forecaster? Thanks to YouTube we have evidence (HT: Bob Murphy).

Monetary Policy At War With Itself

by Mario Rizzo  

It is well-known that John Maynard Keynes favored permanently low interest rates in order to foster adequate and stable investment demand. Let us first focus on stability and then we’ll see a connection to adequacy.

 What happens when counter-cyclical policy (aka Lerner’s “functional finance”) is practiced?  

The Wall Street Journal ran an excellent small article by Richard Barley, focused mainly on the UK, that makes interesting general points. Investors must try to figure out when the current policies of quantitative easing will be reversed. Those who are long (or plan to be long) in the securities which central banks have bought are quite interested in timing. 

The Next Bubble

by Jerry O’Driscoll  

Since September, 2008 the Fed has been engaged in policy of unprecedented monetary expansion.  Arthur Laffer provides the numbers in The Wall Street Journal for June 11, 2009.  “The percentage increase in the monetary base is the largest increase in the past 50 years by a factor of 10.”  The stock market is booming, with the Dow Jones Industrials up 34% in three months.    Fed officials are concerned that financial markets have got ahead of themselves, apparently unable to connect their policy with its inevitable consequences. Today’s Wall Street Journal reports on its front page that there is a “bailout bubble” in the stock market.  Businesses cannot spend the trillions of dollars of bailout money fast enough, so it is going into financial markets.

What Ended The Great Recession?

by Mario Rizzo  

Some business forecasters with a not-too-bad record are predicting that the recession will be over by the end of the year.  (NBER dates the beginning to December 2007.)  

Of course, the recovery in terms of real output from the Great Depression began in the 3Q of 1933 and that did not preclude high unemployment rates and a further recession in 1937. Here. Let that pass for the moment. 

If recovery begins, the discussion about why will also begin. Let’s confine ourselves to evaluating policies designed by the government to produce recovery.

OK, it’s “later” now

by Sandy Ikeda

MSNBC reports that “Evidence mounts that recession may be ending”. At the same time, in the Wall Street Journal:

[T]he central bank has been buying mortgage-backed securities and Treasurys. Through programs announced since last fall, it has bought more than $460 billion of mortgage-backed securities and more than $125 billion of Treasury bonds. But the winds turned against the Fed in recent days, as investors worry the government’s approach could lead to inflation.

Time to start crossing that bridge already?

The Fed Against Equilibration

by Mario Rizzo

 

Reality is more complex than our models. Free-market forces are asserting themselves but the Fed is also intervening and trying to affect those forces. Real-world data is the result of both factors.

 

The Commerce Department  has issued some new data showing that house sales are rebounding (but still off their year-ago levels) and that house prices are falling. This is to be expected as supply and demand begin to equilibrate.

Reflating the Housing Bubble?

by Mario Rizzo

 

In an effort to prevent deflation, the Fed has now decided to do more quantitative easing, that is, to buy with newly created high-powered money various assets aside from short-term Treasury securities. Over the next six months it will buy up to $300 billion in long-term Treasury bonds.

 

It will also purchase additional mortgage-backed securities (MBS) in the amount of $750 billion as well as up to $100 billion in additional securities of Fannie and Freddie (to a total of $200 billion). These are the parts of the new policy that concern me most. They are bad ideas.