The resident market monetarist at Britain’s Daily Telegraph Ambrose Evans-Pritchard has a comment on European monetary policy under the leadership of the new ECB chief Mario Draghi.
Here is Ambrose:
“Those of a monetarist bent are less alarmed by fiscal contraction (than Keynesians). I have no doubt that monetary stimulus a l’outrance – the classic remedy of Britain’s Ralph Hawtrey, Sweden’s Gustav Cassel and America’s Irving Fisher in the 1930s – can counter the effects of fiscal tightening if conducted in the right way. The debt-to-GDP burden falls faster that way and deflation is averted, a lesson that Japan forgot.
The great question is whether Mario Draghi is embarking on just such a policy, covertly, through his Long-Term Repo Operations (LTRO), starting with €489bn in three-year loans to 523 banks December and to be followed by another blast in February.
The LTRO is not entirely a free lunch. It is replacing funding that has dried up, but to the extent that banks in Italy, Spain, France and Portugal use the cheap money to buy government bonds at rich yields – the Sarkozy “carry trade” – they are not lending to business, as newly bankrupt Spanair can attest…
…Yet, monetarists think Draghi is quietly pulling off a remarkable coup. “This is stealth QE: the impact is dulled because they are not making it clear what they are trying to do, but in the end it may ultimately be as powerful as QE in America and Britain,” said Lars Christensen from Danske Bank.
Tim Congdon from International Monetary Research said Mr Draghi had already boosted total credit to banks from €580bn to €832bn since early November, entirely reversing the Trichet tightening of late 2010.
This may rise to nearer €1.5 trillion this year. While it does not lead to a rise in broad money at first (just the monetary base), it is likely to feed through over coming months in complex secondary effects. “My conclusion is that the Draghi bazooka is such an aggressive example of monetary easing that Eurozone M3 growth will run at 5pc or more [annualized] in mid and late 2012.”
“I (Tim Congdon)remain sceptical about the viability of the European single currency in the long run, but the day of the execution has been postponed once again,” he said.
If Mr Draghi really is the Latin bloc’s monetarist avenger, the Germans will find out soon enough. It is Germany that will overheat, inflate, and suffer a “Latin” credit bubble as EMU’s wheel of fortune turns. Europe’s crisis will take on a whole new political turn. But that is a chapter for tomorrow.”
Needless to say I tend to agree with most things that Ambrose says (and I also find it hard to disagree with Tim). I particularly like that Ambrose mentions Hawtrey, Cassel and Fisher.
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Update: For those interested in my view on fiscal policy see here.
David Pearson
/ January 30, 2012Imagine the EU, and not the ECB, conducted “LTRO”. The EU issues 3-yr liabilities and purchases Italian debt from the banks with the proceeds. The result:
-the private sector holds a 3-yr maturity “safe” asset
-the public sector holds Italian bonds
How is the above different from the ECB operation? Is this fiscal policy, or monetary policy? (Note that any losses from the ECB’s SMP/LTRO will accrue to the fiscal budgets of member states. The ECB’s risk-asset purchases effectively create contingent tax liabilities for EU taxpayers.)
Ah, but the ECB is creating “money”, one might argue. No, it is creating a short term asset that the banking system does not need as a means of payment. This asset and a “Eurobill” are perfect substitutes.
Draghi is the stealth Latin “fiscal avenger”. He can issue liabilities without parliamentary approval. This may be convenient, but it doesn’t make it monetary policy.
David Pearson
/ January 30, 2012A correction to the above: the public sector ends up with a 3-yr asset collateralized by Italian bonds; the private sector with a s.t. safe asset (overnight reserve deposit). Again, this would be the same as the EU buying sovereign debt-backed bonds of the banking system in exchange for Eurobills.
David Beckworth
/ January 31, 2012David Pearson,
To the extent those safe assets serve as medium of exchange for the financial system, then it is addressing a monetary problem. I come to view that fiscal policy’s greatest impact isn’t directly affecting aggregate demand, but providing enough safe assets to keep the stock of monetary asses (broadly defined as both retail and institutional money assets) stable so that nominal spending growth is maintained.
Mike Sax
/ January 31, 2012“Those of a monetarist bent are less alarmed by fiscal contraction (than Keynesians). I have no doubt that monetary stimulus a l’outrance – the classic remedy of Britain’s Ralph Hawtrey, Sweden’s Gustav Cassel and America’s Irving Fisher in the 1930s – can counter the effects of fiscal tightening if conducted in the right way. The debt-to-GDP burden falls faster that way and deflation is averted, a lesson that Japan forgot.
Is it “less alarmed” or “violently in favor of”? You would have to explain how it is that fiscal contraction leads to less deflation-even if there is monetary easing at best it cancels out. The closet anyone is to following this model is Britian and the results are not auspicous.
Once and for all the debt-to-GDP burden is a canard. It only matters for Euro countries, meahwhile yields in the US, Britain, etc. stay low regardless of any “burden.”
David Pearson
/ January 31, 2012David Beckworth,
To the extent QE swaps risk assets for “safe” assets, I see your point. However, the banking system exists in part to provide safe (I prefer the Gorton term “information insensitive”) assets to retail and institutional investors. Its failure to do so results from insolvency fears. This is a fiscal, not monetary, problem. The fiscal authorities could fix a market failure (agency problem) by requiring that weak institutions recapitalize, allowing the system to provide this critical economic function. Why aren’t they doing so? In part, because it is politically easier to push the central bank to provide unlimited — essentially permanent — liquidity to insolvent “lemons”, rather than fixing the lemons problem directly. The LOLR function is not intended to support insolvent firms; it is intended to carry the system through the period where these lemons are identified and either fixed or eliminated. No European government wants to see their own “national champion” banks go down. They would rather see Draghi support them. The result is a banking system that is “turning Japanese” before our eyes. Yes, it may be good at (semi-forced) channeling of savings to support net fiscal spending; it will be exceedingly bad at supporting private credit growth.
Lars Christensen
/ January 31, 2012Mike, the debate about fiscal policy is rather tiring. Frankly speaking, I have no clue why certain New Keynesian who used to think fiscal policy was ineffective suddenly think it is such a great idea. Scott Sumner has been in a very long (too long) debate with Krugman about this. I think Scott has said most of what need to be said in that debate. That said, here is my piece on the debate: http://marketmonetarist.com/2012/01/18/there-is-no-such-thing-as-fiscal-policy/
Lars Christensen
/ January 31, 2012David Pearson, I have two major concerns in regard to LTRO. First, it is unfortunate that the ECB is not much more clear about what it want to achieve with these operations. Fed’s QE suffers from the same problem – as do the recent zero-till-2014 policy. Second, as the Fed the ECB is overly focused on banking problems. If the ECB (and the ECB) would focus on increasing NGDP to the pre-crisis trend then I think most of the banking problems would disappear very fast.
Fiscal policy vs monetary policy? Well, the ECB is increasing its balance sheet quite dramatic so to me that is monetary policy.
David Pearson
/ January 31, 2012Lars,
I detail above how the ECB LTRO operation can be replicated by an EU purchase of 3yr bank debt financed by Eurobills. If something the central bank does can also be done by the fiscal authority, is it monetary policy, or fiscal policy?
At the crux of my argument is that excess reserves are a short term asset of the banking system and, just as Eurobills, not a medium of exchange. Some argue ER’s are “money-like” because they can be converted by banks into reserves. This is irrelevant: in a rate-targeting regime, the supply of reserves is always perfectly elastic. Pre-existing unused reserves are not necessary for the system to increase reserves at will. Thus, it doesn’t matter to potential money creation if ER’s are $1 or $10tr.