Monetary policy according to a German lawyer

This is from Bloomberg:

European Central Bank Executive Board member Sabine Lautenschlaeger said quantitative easing isn’t the right policy choice for the euro area currently, hardening a split among officials over the right response to slowing inflation.

“A consideration of the costs and benefits, and the opportunities and risks, of a broad purchase program of government bonds does not give a positive outcome,” Lautenschlaeger, a former Bundesbank vice president, said at an event in Berlin today. “There are very few shared competencies in fiscal policy. As long as this is the case, the ECB’s purchase of government securities is inevitably linked to a serious incentive problem.”

Lautenschlaeger’s comments signal she’s become ECB President Mario Draghi’s highest-ranking opponent in the debate over introducing QE to the euro area. They echo the position of Bundesbank President Jens Weidmann, who has said QE diverts attention from the need for governments to make structural adjustments to their economies.

“Long-term interest rates on Spanish and Italian (GBTPGR10) government bonds, for example, are already lower than those from the U.S. or the U.K.,” Lautenschlaeger said. “It is therefore questionable whether we should ‘depress’ interest rates for the securities class even further.”

First of all, it is very clear that Frau Lautenschlaeger thinks that quantitative easing – an expansion of the money base – is some kind of credit policy. It is not. Let me quote myself:

I have noticed that there generally is a problem for a lot of people to differentiate between monetary easing and bailouts. Often when one argues for monetary easing the reply is “we should stop bailing out banks and countries and if we do it we will just create an even bigger bubble”. The problem here is that Market Monetarists certainly do not favour bailouts – we favour nominal stability.

I think that at the core of the problem is that people have a very hard time figuring out what monetary policy is. Most people – including I believe most central bankers – think that credit policy is monetary policy. Just take the Federal Reserve’s attempt to distort relative prices in the financial markets in connection with QE2 or the ECB’s OMT program where the purpose is to support the price of government bonds in certain South European countries without increasing the euro zone money base. Hence, the primary purpose of these policies is not to increase nominal GDP or stabilise NGDP growth, but rather to change market prices. That is not monetary policy. That is credit policy and worse – it is in fact bailouts.

As the ECB’s OMT and Fed’s QE2 to a large extent have been focused on changing relative prices in the financial markets they can rightly be – and should be – criticized for leading to moral hazard. When the ECB artificially keeps for example Spanish government bond yields from increasing above a certain level then the ECB clearly is encouraging excessive risk taking. Spanish bond yields have been rising during theGreat Recession because investors rightly have been fearing a Spanish government default. This is an entirely rational reaction by investors to a sharp deterioration of the outlook for the Spanish economy. Obviously if the ECB curb the rise in Spanish bond yields the ECB are telling investors to disregard these credit risks. This clearly is moral hazard.

The problem here is that a monetary authority – the ECB – is engaged in something that is not monetary policy, but people will not surprisingly think of what a central bank do as monetary policy, but the ECB’s attempts to distort relative prices in the financial markets have very little to do with monetary policy as it do not lead to a change in the money base or to a change in the expectation for future changes in the money base.

That is not to say that the ECB’s credit policies do not have monetary impact. They likely have. Hence, it is clear that the so-called OMT has reduced financial distress in the euro zone, which likely have increased the money-multiplier and money-velocity in the euro zone, but it has also (significantly?) increased moral hazard problems. So the paradox here is that the ECB really has done very little to ease monetary policy, but a lot to increase moral hazard problems.

I can hence certainly understand if Frau Lautenschlaeger would object to credit policies to bailout nations or banks, but an expansion of the money base to curb deflationary pressures and to stabilise nominal spending growth has nothing to do with bailouts. It is just the proper policy response to a deflationary crisis – by the way caused by the ECB itself.

Second, Frau Lautenschlaeger is clearly making the common bond yield fallacy when you claim monetary policy already is easy because nominal bond yields are low. She of course should know that rates and yields are low in the euro exactly because monetary policy is extremely tight and there market expectations are for continued very low growth and inflation.

Furthermore, I am puzzled why she would make a reference to bond yields in specific countries. Monetary policy certainly is not about targeting bond yields and certainly not about targeting bond yields in individual countries in a monetary union.

Listening to some ECB official brings memories of French central bankers in the 1930s or Japanese central bankers in the 1990s. The outcome unfortunately is the same deflationary mess – and as a consequence rising debt problems.


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  1. Interesting point about her confusion about monetary policy and targeting bond yields in specific countries. Perhaps Draghi added to that confusion with the “whatever it takes” speech, by giving the impression that the ECB was ready to intervene in sovereign debt markets for the sake of bond yields, and not as a means of increasing the monetary base.

    • Ravi, I think that you are completely right. Mario Draghi is to a large extent to blame for the confusion. He – as Bernanke used to – speak the language of credit policy instead of in terms of money demand and money supply. That said the Germans should be able to make the proper analysis on their own.

  2. I think that I understand the German thinking here. As Austrians, they believe in price stability (0% inflation) and free markets. They see all of the massive distortions in Club Med caused by socialism. Their concern is that if the ECB starts buying these countries’ bonds, they will have no incentive to reform. (Plus they don’t want the credit risk.) They are annoyed that Draghi’s “whatever it takes” comment has removed the risk premia for Club Med bonds, and feel that QE would only exacerbate this problem. Plus they don’t think the ECB can buy the bonds of any country running a deficit because that would be fiscal monetization. Hence the ECB’s conundrum: it has no “consensus” policy instrument. Now, we know that a central bank can buy anything: gold, foreign government bonds, toothpicks. But that would be radical and unconventional and “distorting”. And anyway, the Germans see no need for QE in the first place, because the ECB is successfully delivering its mandate of price stability. This is why the outlook for Europe is so dire, and so reminiscent of the US under Hoover and Mellon.

  3. Adam Platt

     /  December 1, 2014

    Well put, Lars. Keynesians tend to speak in terms of “boost” and “kickstart”, while mainstream media tends to describe monetary policy in terms of “easing” and “unconventional”. The entire popular lexicon of monetary policy is really bizarre once you understand the NGDP/Market Monetarist argument. Once you get that, you realize how much all of those terms miss the point. So I really feel for you. Not only do you have to explain the importance of an NGDP target (which is surprisingly hard for many people to grasp), but you also have to get them to move past the entire popular lexicon surrounding monetary policy.

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