The talk of Greece leaving the euro area – Grexit – is back. Will Grexit actually happen? I don’t know, but I do know that more and more people worry that it will in fact happen.
This is what Google Trends is telling us about Google searches for “Grexit“:
And guess what? While this is happening euro zone inflation expectations have collapsed. In fact this week 5-year German inflation expectations turned negative! This mean that the fixed income markets now expect German inflation to be negative for the next five years!
It is hard to find any better arguments for massive quantitative easing within a rule-based framework in the euro zone (with or without Greece). And this is how it should be done.
PS it has been argued recently that euro zone bond yields have declined because the markets are pricing in QE from the ECB. Well, if that is the case why is inflation expectations collapsing? After all investors should not expect monetary easing to led to lower inflation (in fact deflation) – should they?
PPS I do realise that the drop in oil prices play a role here, but the markets (forwards) do not forecast a drop in oil prices over the coming five years so oil prices cannot explain the deflationary expectations in Europe.
Chris Mahoney
/ January 5, 2015If QE drives down yields, why have Treasury yields declined sharply since the taper began? Treasury yields reflect expected inflation, and are not influenced by QE manipulation. The end of QE (capitulation to the Austrian Bloc) lowered expected inflation, as evidenced by TIPS spreads:
https://research.stlouisfed.org/fred2/graph/?graph_id=214348
IN EUROPE, The market has written off the likelihood of an effective reflationary policy by the ECB. The ECB is now in the same spot as the Fed in 1931: zero credibility, maximum fear.
Chris Mahoney
/ January 5, 2015Treasury yields from 1929 to 1931: not as awful as Bunds 2012-2014.
https://research.stlouisfed.org/fred2/graph/?graph_id=214353.
Max
/ January 7, 2015Regarding Greece, I think there’s a misconception, even among economists, that leaving the euro allows the leaving country to regain monetary independence and “devalue”. It doesn’t, not in a relevant time frame. That’s kind of the main point of a monetary union, as opposed to a peg. The unit of account in Greece is the euro. Only the ECB can devalue it. Greece can introduce a new currency easily enough, but it won’t do any good in this crisis. It has to be adopted as the unit of account first.
Christopher Mahoney
/ January 7, 2015There needs to be more work on the textbook for exit from a monetary union. But surely it requires a law that redenominates every asset and liability (except external claims) into neodrachma, including comprehensive external default. Then, the central bank can fund the banking system, and the payments system can be reopened in neodrachma. Argentina did this in 2001. Clearly, this will require a balanced current account, but this is possible–especially given the impact on tourism revenue. I see no alternative.
jamesxinxlondon
/ January 13, 2015Slightly off topic, but great to see a WSJE columnist so clearly “getting it”:
http://blogs.wsj.com/moneybeat/2015/01/09/is-the-ecb-sabotaging-itself/