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Grexit, Germany and Googlenomics

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“:

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.

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Great, Greater, Greatest – Three Finnish Depressions

Brad DeLong has suggested that we rename the Great Recession the GreatER Depression in Europe as the crisis in terms of real GDP lose now is bigger in Europe than it was it during the Great Depression.

Surely it is a very simplified measure just to look at the development in the level of real GDP and surely the present socio-economic situation in Europe cannot be compared directly to the economic hardship during the 1930s. That said, I do believe that there are important lessons to be learned by comparing the two periods.

In my post from Friday – Italy’s Greater Depression – Eerie memories of the 1930s – I inspired by the recent political unrest in Italy compared the development in real GDP in Italy during the recent crisis with the development in the 1920s and 1930s.

The graph in that blog post showed two things. First, Italy’s real GDP lose in the recent crisis has been bigger than during 1930s and second that monetary easing (a 41% devaluation) brought Italy out of the crisis in 1936.

I have been asked if I could do a similar graph on Finland. I have done so – but I have also added the a third Finnish “Depression” and that is the crisis in the early 1990s related to the collapse of the Soviet Union and the Nordic banking crisis. The graph below shows the three periods.

Three Finnish Depressions

(Sources: Angus Maddison’s “Dynamic Forces in Capitalist Development” and IMF, 2014 is IMF forecast)

The difference between monetary tightening and monetary easing

The most interesting story in the graph undoubtedly is the difference in the monetary response during the 1930s and during the present crisis.

In October 1931 the Finnish government decided to follow the example of the other Nordic countries and the UK and give up (or officially suspend) the gold standard.

The economic impact was significant and is very clearly illustrate in the graph (look at the blue line from year 2-3).

We have nearly imitate take off. I am not claiming the devaluation was the only driver of this economic recovery, but it surely looks like monetary easing played a very significant part in the Finnish economic recovery from 1931-32.

Contrary to this during the recent crisis we obviously saw a monetary policy response in 2009 from the ECB – remember Finland is now a euro zone country – which helped start a moderate recovery. However, that recovery really never took off and was ended abruptly in 2011 (year 3 in the graph) when the ECB decided to hike interest rate twice.

So here is the paradox – in 1931 two years into the crisis and with a real GDP lose of around 5% compared to 1929 the Finnish government decided to implement significant monetary easing by devaluing the Markka.

In 2011 three  years into the present crisis and a similar output lose as in 1931 the ECB decided to hike interest rates! Hence, the policy response was exactly the opposite of what the Nordic countries (and Britain) did in 1931.

The difference between monetary easing and monetary tightening is very clear in the graph. After 1931 the Finnish economy recovered nicely, while the Finnish economy has fallen deeper into crisis after the ECB’s rate hikes in 2011 (lately “helped” by the Ukrainian-Russian crisis).

Just to make it clear – I am not claiming that the only thing import here is monetary policy (even though I think it nearly is) and surely structural factors (for example the “disappearance” of Nokia in recent years and serious labour market problems) and maybe also fiscal policy (for example higher defense spending in the late-1930s) played role, but I think it is hard to get around the fact that the devaluation of 1931 did a lot of good for the Finnish economy, while the ECB 2011’s rate hikes have hit the Finnish economy harder than is normally acknowledged (particularly in Finland).

Finland: The present crisis is The Greatest Depression

Concluding, in terms of real GDP lose the present crisis is a GreatER Depression than the Great Depression of the 1930s. However, it is not just greater – in fact it is the GreatEST Depression and the output lose now is bigger than during the otherwise very long and deep crisis of the 1990s.

The policy conclusions should be clear…

PS this is what the New York Times wrote on October 13 1931) about the Finnish decision to suspend the gold standard:

“The decision of taken under dramatic circumstances…foreign rates of exchange immediately soared about 25 per cent”

And the impact on the Finnish economy was correctly “forecasted” in the article:

“In commercial circles it is expected that the suspension (of the gold standard) will greatly stimulate industries and exports.”

HT Vladimir

Related post:
Currency union and asymmetrical supply shocks – the case of Finland

Italy’s Greater Depression – Eerie memories of the 1930s

This is from the Telegraph:

Italy was hit by strikes, violent demonstrations and protests against refugees on Friday as anger and frustration towards soaring unemployment and the enduring economic crisis exploded onto the streets.

Riot police clashed with protesters, students and unionists in Milan and Padua, in the north of the country, while in Rome a group of demonstrators scaled the Colosseum to protest against the labour reforms proposed by the government of Matteo Renzi, the 39-year-old prime minister.

Eggs and fire crackers were hurled at the economy ministry.

On the gritty, long-neglected outskirts of Rome there was continuing tension outside a centre for refugees, which was repeatedly attacked by local residents during the week.

Locals had hurled stones, flares and other missiles at the migrant centre, smashing windows, setting fire to dumpster rubbish bins and fighting running battles with riot police during several nights of violence.

They demanded that the facility be closed down and claimed that the refugees from Africa and Asia were dirty, anti-social and violent.

Some protesters, with suspected links to the extreme Right, yelled “Viva Il Duce” or Long Live Mussolini, calling the migrants “b*******”, “animals” and “filthy Arabs”.

…A group of 36 teenage migrants had to be evacuated from the centre in Tor Sapienza, a working-class suburb, on Thursday night after the authorities said the area was no longer safe for them.

The sense of chaos in the country was heightened by transport strikes, which disrupted buses, trams, trains and even flights at Rome’s Fiumicino airport. Demonstrations also took place in Turin, Naples and Genoa.

Unemployment among young people in Italy is around 42 per cent, prompting tens of thousands to emigrate in search of better opportunities, with Britain the top destination. The overall jobless rate is 12 per cent.

Mr Renzi’s attempts to reform the country’s labour laws, making it easier for firms to dismiss lazy or inefficient employees, are bitterly opposed by the unions.

The ongoing recession has also exacerbated racial tensions, with some Italians blaming refugees and immigrants for their economic woes.

It is hard not to be reminded of the kind of political and social chaos that we saw in Europe in the 1930s and it is hard not to think that the extremely weak Italian economy is the key catalyst for Italy’s political and social unrest.

By many measures the Italian economy of today is worse than the Italian economy of the 1930s. One can say – as Brad DeLong has suggested – that this is a Greater Depression than the Great Depression.

Just take a look at the development in real GDP over the past 10 years and during the 1925-1936-period.

crisis Italy

If you wonder why Italian GDP took a large jump in 1936 (year +6) it should be enough to be reminded that that was the year that the Italian lira was sharply devalued.

Today Italy don’t have the lira and everybody knows who I blame for the deep crisis in the Italian economy.

It is sad that so few European policy makers understand the monetary causes of this crisis and it is tragic that the longer the ECB takes to act the more political and social unrest we will face in Europe.

PS I do not mean to suggest that Italy do not have structural problems. Italy has massive structural problems, but the core reason for the Greater Depression is monetary policy failure. Don’t blame Renzi or the immigrants – blame the Italian in Frankfurt.

 

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