The depressing state of European monetary “thinking”

Somebody today sent me the following quote from the front page of today’s edition of the German business daily Handelsblatt (translated from German):

“The interest rate illusion: Europe’s central bank cuts interest rates to a historic low 0.5 percent. But the hope this will pull the euro zone out of recession will not be fulfilled, economists warn. On the contrary: the cheap money is dangerous.”

I am afraid that this is the general perception – not only in Germany but across Europe. But note how terribly inconsistent the comment is – monetary policy doesn’t work, but at the same time monetary easing is very dangerous (inflationary). If monetary policy does not work why would it be so dangerous to ease monetary policy?

The Handelsblatt also repeats the common fallacy that the level of interest rates tell us anything about whether monetary policy is easy of tight. Interest rates is NOT the price of money. The interest rate is the price of credit.  Whether money is cheap or not is a matter of money demand vs money supply. Money demand still remains extremely elevated in the euro zone and money supply is extremely weak. Hence, monetary conditions are extremely tight – and this is exactly what the market is telling us. When German bond yields are extremely low it is exactly a reflection that monetary policy is TIGHT. As Milton Friedman used to say – interest rates are low when monetary policy has been tight. Besides that monetary conditions should of course be VERY EASY given the massive deflationary pressures, historically high unemployment and a very large negative output in the euro zone.

Europe is not on the verge of hyperinflation as the Handelsblatt seems to think. Europe is on the verge of deflation and anybody who have studied German history should understand the grave political and social dangers of deflation and for those who have a hard time remember here are the facts. In 1923 Germany had hyperinflation. 10 years later Germany was struggling with serious deflation and high unemployment. That brought Hitler to power – not easy monetary policy.

German inflation

PS I did not read the entire Handelsblatt story and my comments should be seen as a general comment on the state of economic and monetary debate in Europe and I readily admit that I am greatly frustrated by the fact the powerfull interests are keeping the ECB from taking appropriate action to end this crisis. It is very easy to do.

PPS I suspect that the German fear of monetary easy really is not about monetary easing, but about bailouts. However, monetary easing is not a bailout.

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