All posts tagged Mario Draghi

In a deflationary world at the ZLB we need ‘competitive devaluations’

Sunday we got some bad news, which many wrongly will see as good news – this is from Reuters:

China and the United States on Sunday committed anew to refrain from competitive currency devaluations, and China said it would continue an orderly transition to a market-oriented exchange rate for the yuan CNY=CFXS.

…Both countries said they would “refrain from competitive devaluations and not target exchange rates for competitive purposes”, the fact sheet said.

Meanwhile, China would “continue an orderly transition to a market-determined exchange rate, enhancing two-way flexibility. China stresses that there is no basis for a sustained depreciation of the RMB (yuan). Both sides recognize the importance of clear policy communication.”

There is really nothing to celebrate here. The fact is that in a world where the largest and most important central banks in the world – including the Federal Reserve – continue to undershoot their inflation targets and where deflation remains a real threat any attempt – including using the exchange rate channel – to increase inflation expectations should be welcomed.

This of course is particularly important in a world where the ‘natural interest rate’ likely is quite close to zero and where policy rates are stuck very close to the Zero Lower Bound (ZLB). In such a world the exchange rate can be a highly useful instrument to curb deflationary pressures – as forcefully argued by for example Lars E. O. Svensson and Bennett McCallum.

In fact by agreeing not to use the exchange rate as a channel for easing monetary conditions the two most important ‘monetary superpowers’ in the world are sending a signal to the world that they are in fact not fully committed to fight deflationary pressures. That certainly is bad news – particularly because especially the Fed seems bewildered about conducting monetary policy in the present environment.

Furthermore, I am concerned that the Japanese government is in on this deal – at least indirectly – and that is why the Bank of Japan over the last couple of quarters seems to have allowed the yen to get significantly stronger, which effective has undermined BoJ chief Kuroda’s effort to hit BoJ’s 2% inflation target.

A couple of months ago we also got a very strong signal from ECB chief Mario Draghi that “competitive devaluations” should be avoided. Therefore there seems to be a broad consensus among the ‘Global Monetary Superpowers’ that currency fluctuation should be limited and that the exchange rate channel should not be used to fight devaluation pressures.

This in my view is extremely ill-advised and in this regard it should be noted that monetary easing if it leads to a weakening of the currency is not a beggar-thy-neighbour policy as it often wrongly is argued (see my arguments about this here).

Rather it could be a very effective way of increase inflationary expectations and that is exactly what we need now in a situation where central banks are struggling to figure out how to conduct monetary policy when interest rates are close the ZLB.

See some of my earlier posts on ‘currency war’/’competitive devaluations’ here:

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

‘The Myth of Currency War’

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

The New York Times joins the ‘currency war worriers’ – that is a mistake

The exchange rate fallacy: Currency war or a race to save the global economy?

Is monetary easing (devaluation) a hostile act?

Fiscal devaluation – a terrible idea that will never work

Mises was clueless about the effects of devaluation

Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons

The luck of the ‘Scandies’

 

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2 Comments
by Lars Christensen on September 4, 2016  •  Permalink
Posted in Bank of Japan, Bennett McCallum, Currency war, ECB, Federal Reserve, Haruhiko Kuroda, Lars E. O. Svensson, Mario Draghi, PBoC, Uncategorized
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Posted by Lars Christensen on September 4, 2016

https://marketmonetarist.com/2016/09/04/in-a-deflationary-world-at-the-zlb-we-need-competitive-devaluations/

The Euro – Monetary Strangulation continues (one year on)

Exactly one year ago today I was with the family in the Christensen vacation home in Skåne (Southern Sweden) and posted a blog post titled The Euro – A Monetary Strangulation Mechanism. I wrote that post partly out of frustration that the crisis in the euro once again had re-escalated as Greece fell deeply into political crisis.

One year on the euro zone is once again in crisis – this time the focal point it the Italian banking sector.

So it seems like little has changed over the past year. After nearly eight years of crisis the euro zone has still not really recovered.

In my post a year ago I showed a graph with the growth of real GDP from 2007 to 2015 in 31 different European countries – both countries with floating exchange rates and countries within the euro areas and countries pegged to the euro (Bulgaria and Denmark).

I have updated the graph to include 2016 (IMF forecast).

Monetary Strangulation Summer 2016.jpg

The picture is little changed. In general the floaters (the ‘green’ countries) have done significantly better than the peggers/euro countries (the ‘red’ countries).

That said, I am happy to admit that it looks like we have had some pick-up in growth in the euro zone in the past year – ECB’s quantitative easing has had some positive effect on growth.

However, the ECB is still not doing enough as new headwinds are facing the European economy. Here I particularly want to highlight the fact that the Federal Reserve – wrongly in my view – has moved to tighten monetary conditions over the past year, which in turn is causing a tightening of global monetary conditions.

Second, if we look at the money-multiplier in the euro zone it is clear that it over the past nearly two years have been declining somewhat due in my view to the draconian liquidity (LCR) and capital rules in Basel III, which the EU has pushed to implement fast.

Furthermore, given the increase in banking sector distress in the euro zone recently the euro zone money-multiplier is likely to drop further, which effective will constitute a tightening of monetary conditions. If the ECB does not offset these shocks the euro zone could fall even deeper into a deflationary crisis.  If you are interested in what I think should be done about it have a look here and here.

Concluding, the monetary strangulation in the euro zone continues. Luckily, again this year at this time it is vacation time for the Christensen family so I will try to enjoy life after all.

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If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com

1 Comment
by Lars Christensen on July 14, 2016  •  Permalink
Posted in Banking crisis, ECB, euro crisis, Mario Draghi, monetary strangulation, Monetary Strangulation Mechanism, Uncategorized
Tagged , , , ,

Posted by Lars Christensen on July 14, 2016

https://marketmonetarist.com/2016/07/14/the-euro-monetary-strangulation-continues-one-year-on/

A gameplan for the ECB – it is not complicated

A very good friend of mine asked me what the ECB should do in the present situation where inflation and inflation expectations continues to run well-below the ECB’s inflation target.

Here is my answer – it is what we could call a gameplan for the ECB (it could easily be used by other central banks as well):

1) Stop communicating in the terms of interest rates. Announce a PERMANENT growth rate for the money base. Announce that the growth rate will be stepped up every month or quarter until inflation expectations are at 2% at all relevant time horizons – for example 2y2y swap inflation expectations. At every ECB meeting the permanent money base rate is announced.

2) Control the money base by buying a basket of global AAA-rated govies.

3) Announce a NGDP LEVEL target consistent with the 2% inflation target and announce that the ECB will not let bygones be bygones – meaning if you undershoot the target one year then you should overshoot the following year.

4) Internal forecasting should be given up. Instead only surveys of professional forecasters and market forecasts should be used for policy input. In the reasoning for the money base growth target there should be given only a reference to these forecasts and the ECB should commit itself to set money base targets based on these forecasts and nothing else.

And what could the of EU do?

1) Suspend the implementation of Basell III and other banking regulation that depress the money multiplier and increase demand for safe assets until nominal GDP has grown for at least 4% for 8 quarters in a row.

And maybe also…

2) Suspend the growth and stability pact for now.

I think it is very easy to create inflation and nominal demand. It is all about commitment. Unfortunately the ECB does not have such commitment.

PS this is essentially what I earlier have called a forward-looking McCallum rule – see also a similar suggestion for the Fed here.

15 Comments
by Lars Christensen on July 8, 2016  •  Permalink
Posted in Chuck Norris Effect, ECB, EU, euro crisis, Mario Draghi
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Posted by Lars Christensen on July 8, 2016

https://marketmonetarist.com/2016/07/08/a-gameplan-for-the-ecb-it-is-not-complicated/

Mario, stay on track and avoid the mistakes of 1937 and 2011

The global stock markets have been facing some headwinds recently, and there may be numerous reasons for this. One obvious one is the recent rebound in oil prices, which I believe is essentially driven by markets’ expectation that the Saudi-led global oil price war is now ending.

If that is indeed the case then we are seeing a (minor) negative supply shock, particularly to the European and U.S. economies. Such supply shocks often get central banks into trouble. Just think of the ECB’s massive policy blunder(s) in 2011, when it reacted to a negative shock (higher oil prices on the back of the Arab spring) by hiking interest rates twice, or the Federal Reserve’s (or rather the Roosevelt Administration’s) premature monetary tightening in 1937 – also on the back of high global commodity prices.

It may be that the ECB will not repeat the mistakes of 2011, but you can’t blame investors for thinking that there is a risk that this could happen – particularly because the ECB continues to communicate primarily in terms of headline inflation.

Therefore, even if the ECB isn’t contemplating a tightening of monetary conditions in response to a negative supply, the markets will effectively tighten monetary conditions if there is uncertainty about the ECB’s policy rule. I believe that is part of the reason for the market action we have seen lately.

The ECB needs to spell out the policy rule clearly

What the ECB therefore needs to do right now is to remind market participants that it is not reacting to a negative supply shock, and that it will ignore any rise in inflation caused by higher oil prices. There are numerous ways of doing this.

1) Spell out an NGDP target

In my view the best thing would essentially be for the ECB to make it clear that it is focusing on the development of expected nominal GDP growth. This does not necessarily have to be in conflict with the overall target of hitting 2% over the medium term. All the ECB needs to do is to say that it is targeting, for example, 4% NGDP growth on average over the coming 5 years, reflecting a 2% inflation target and 2% growth in potential real GDP in the euro zone. That would ensure that markets also ignore short-term fluctuations in headline inflation.

2) Target 2y/2y and 5y/5y inflation

Alternatively, the ECB should only communicate about inflation developments in terms of what is happening to market inflation expectations – for example 2y/2y and 5y/5y inflation expectations. Again, this would seriously reduce the risk of sending the signal that the bank is about to react to negative supply shocks.

3) Re-introduce the focus on M3

There are numerous reasons not to rely on money supply data as the only indicator of monetary conditions. However, I strongly believe that it is useful to still keep an eye on monetary aggregates such as M1 and M3. Both M1 and M3 show that monetary conditions have indeed gotten easier since the ECB introduced its QE programme. That said, the money supply data is also telling us that monetary conditions overall can hardly be described as excessively easy. Yes, money supply growth is still picking up, but M3 growth is still below the 6.5% y/y that it reached in 2000-2008, and significantly below the 10% “target” I earlier suggested would be needed to bring us back to 2% inflation over the medium term.

If the ECB re-introduces more focus on the money supply numbers – and monetary analysis in general – then it would also send a pretty clear signal that the bank is not about to change course on QE just because oil prices are rising.

4) Change the price index to the GDP deflator or core inflation

Another pretty straightforward way of trying to convince the markets that the ECB will not react to negative supply shocks is by changing the focus in terms of the inflation target. Today, the ECB is officially targeting HICP (headline) inflation. This measure is highly sensitive to swings in oil and food prices as well as changes in indirect taxes. These factors obviously are completely outside the direct control of the ECB, and it therefore makes very little sense that the ECB is focusing on this measure.

Recently, ECB chief Mario Draghi hinted that the ECB could start focusing on a core measure of inflation that excludes energy, food and taxes, and I certainly think that would be a step in the right direction if the bank does not want to introduce NGDP targeting. This would effectively mean that the ECB had a target similar to the Fed’s core PCE inflation measure. It would not be perfect, but certainly a lot better than the present headline inflation measure.

An alternative to a core inflation measure, which I believe is even better, would be to focus on the GDP deflator. The good thing about the GDP deflator (other than being the P in MV=PY) is that it measures the price of what is produced in the euro zone, and hence excludes imported inflation and indirect taxes.

Conclusion: It is still all about credibility – so more needs to be done

One can always discuss what is in fact going on in the markets at the moment – and I will deliberately avoid trying to explain why German government bond yields have spiked recently (it tells us very little about monetary conditions) – but I would focus instead on the markets’ serious nervousness about whether the ECB will prematurely end its QE programme.

There would be no reason for such nervousness if the ECB clearly spelled out that it does not intend to let a negative supply shock change its plans for quantitative easing, and that it is intent on ensuring nominal stability. I have given some suggestions on how the ECB could do that, and I fundamentally think that Mario Draghi understands that the ECB needs to move in this direction. Now he just needs to make it completely clear to the markets (and the Bundesbank?)

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If you want to hear me speak about this topic or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: daniel@specialistspeakers.com or roz@specialistspeakers.com.

4 Comments
by Lars Christensen on May 14, 2015  •  Permalink
Posted in ECB, Mario Draghi, NGDP Targeting, Oil price, OPEC, Saudi Arabia
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Posted by Lars Christensen on May 14, 2015

https://marketmonetarist.com/2015/05/14/mario-stay-on-track-and-avoid-the-mistakes-of-1937-and-2012/

Draghi’s golden oppurtunity – building the perfect firewall

The ECB’s large scale quantitative easing programme already has had some success – initially inflation expectations increased, European stock markets performed nicely and the euro has continued to weaken. This overall means that this effectively is monetary easing and that we should expect it to help nominal spending growth in the euro zone accelerate and thereby also should be expected to curb deflationary pressures.

However, ECB Mario Draghi should certainly not declare victory already. Hence, inflation expectations on all relevant time horizons remains way below the ECB’s official 2% inflation target. In fact we are now again seeing inflation expectations declining on the back of renewed concerns over possible “Grexit” and renewed geopolitical tensions in Ukraine.

Draghi has – I believe rightly – been completely frank recently that the ECB has failed to ensure nominal stability and that policy action therefore is needed. However, Draghi needs to become even clearer on his and the ECB’s commitment to stabilise inflation expectations near 2%.

A golden opportunity

Obviously Mario Draghi cannot be happy that inflation expectations once again are on the decline, but he could and should also see this as an opportunity to tell the markets about his clear commitment to ensuring nominal stability.

I think the most straightforward way of doing this is directly targeting market inflation expectations. That would imply that the ECB would implement a Robert Hetzel style strategy (see here) where the ECB simply would buy inflation linked government bonds (linkers) until markets expectations are exactly 2% on all relevant time horizons.

The ECB has already announced that its new QE programme will include purchases of linkers so why not become even more clear how this actually will be done.

A simple strategy would simply be to announce that in the first month of QE the ECB would buy linkers worth EUR 5bn out of the total EUR 60bn monthly asset purchase, but also that this amount will be doubled every month as long as market inflation expectations are below 2% – to 10bn in month 2, to 20bn in month 3 and 40bn in month 4 and then thereafter every month the ECB would buy linkers worth EUR 60bn.

Given the European linkers market is fairly small I have no doubt that inflation expectations very fast would hit 2% – maybe already before the ECB would buy any linkers. In that regard it should be noted that in the same way as a central bank always weaken its currency it can also always hit a given inflation expectations target through purchases of linkers. Draghi needs to remind the markets about that by actually buying linkers.

That I believe would be a very effective way to demonstrate the ECB’s commitment to hitting its inflation target, but it would also be a very effective ‘firewall’ against potential shocks from shocks from for example the Russian crisis or a Grexit.

An very effective firewall   

I have in an earlier blog post suggested that the ECB should “build” such a firewall. Here is what I had to say on the issue back in May 2012:

A number of European countries issue inflation-linked bonds. From these bonds we can extract market expectations for inflation. These bonds provide the ECB with a potential very strong instrument to fight deflationary risks. My suggestion is simply that the ECB announces a minimum price for these bonds so the implicit inflation expectation extracted from the bonds would never drop below 1.95% (“close to 2%”) on all maturities. This would effectively be a put on inflation.

How would the inflation put work?

Imagine that we are in a situation where the implicit inflation expectation is exactly 1.95%. Now disaster strikes. Greece leaves the euro, a major Southern Europe bank collapses or a euro zone country defaults. As a consequence money demand spikes, people are redrawing money from the banks and are hoarding cash. The effect of course will be a sharp drop in money velocity. As velocity drops (for a given money supply) nominal (and real) GDP and prices will also drop sharply (remember MV=PY).

As velocity drops inflation expectations would drop and as consequence the price of the inflation-linked bond would drop below ECB’s minimum price. However, given the ECB’s commitment to keep inflation expectations above 1.95% it would have either directly to buy inflation linked bonds or by increasing inflation expectations by doing other forms of open market operations. The consequences would be that the ECB would increase the money base to counteract the drop in velocity. Hence, whatever “accident” would hit the euro zone a deflationary shock would be avoided as the money supply automatically would be increased in response to the drop in velocity. QE would be automatic – no reason for discretionary decisions. In fact the ECB would be able completely abandon ad hoc policies to counteract different kinds of financial distress.

This would mean that even if a major European bank where to collapse M*V would basically be kept constant as would inflation expectations and as a consequence this would seriously reduce the risk of spill-over from one “accident” to another. The same would of course be the case if Greece would leave the euro.

When I wrote all this in 2012 it seemed somewhat far-fetted that the ECB could implement such a policy. However, things have luckily changed. The ECB is now actually doing QE, Mario Draghi clearly seems to understand there needs to be a focus on market inflation expectations (rather than present inflation) and the ECB’s QE programme seems to be quasi-open-ended (but still not open-ended enough). Therefore, building a linkers-based ‘firewall’ would only be a natural part of what the ECB officially now has set out to do.

So now I am just waiting forward to the next positive surprise from Mario Draghi…

PS I would have been a lot more happy if the ECB would target 4% NGDP growth (level targeting) rather than 2% or at least make up for the failed policies over the past 6-7 years by overshooting the 2% inflation target for a couple of years, but a strict commitment to build a firewall against velocity-shocks and keeping inflation expectations close to 2% as suggested above would be much better than what we have had until recently.

PPS A firewall as suggested above should make a Grexit much less risky in terms of the risk of contagion and should hence be a good argument to gain the support from the Bundesbank for the idea (ok, that is just totally unrealistic…)

Related blog posts:

Bob Hetzel’s great idea
Kuroda still needs to work on communication
Mr. Kuroda please ‘peg’ inflation expectations to 2% now

3 Comments
by Lars Christensen on January 31, 2015  •  Permalink
Posted in ECB, euro crisis, Mario Draghi, QE, Robert Hetzel
Tagged , , , ,

Posted by Lars Christensen on January 31, 2015

https://marketmonetarist.com/2015/01/31/draghis-golden-oppurtunity-building-the-perfect-firewall/

Bloomberg repeats the bond yield fallacy (Milton Friedman is spinning in his grave)

This is from Bloomberg:

“A series of unprecedented stimulus measures by the ECB to stave off deflation in the 18-nation currency bloc have sent bond yields to record lows and pushed stock valuations higher. “

Unprecedented stimulus measures? Say what? Since ECB chief Mario Draghi promised to save the euro at any cost in 2012 monetary policy has been tightened and not eased.

Take any measure you can think of – the money base have dropped 30-40%, there is basically no growth in M3, the same can be said for nominal GDP growth, we soon will have deflation in most euro zone countries, the euro is 10-15% stronger in effective terms, inflation expectations have dropped to all time lows (in the period of the euro) and real interest rates are significantly higher.

That is not monetary easing – it is significant monetary tightening and this is exactly what the European bond market is telling us. Bond yields are low because monetary policy is tight (and growth and inflation expectations therefore are very low) not because it is easy – Milton Friedman taught us that long ago. Too bad so few economists – and even fewer economic reporters – understand this simple fact.

If you think that bond yields are low because of monetary easing why is it that US bond yields are higher than in the euro zone? Has the Fed done less easing than the ECB?

The bond yield fallacy unfortunately is widespread not only among Bloomberg reporter, but also among European policy makers. But let me say it again – European monetary policy is extremely tight – it is not easy and I would hope that financial reporter would report that rather than continuing to report fallacies.

HT Petar Sisko

PS If you want to use nominal interest rates as a measure of monetary policy tightness then you at least should compare it to a policy rule like the Taylor rule or any other measure of the a neutral nominal interest rate. I am not sure what the Talyor rule would say about level of nominal interest rates we should have in Europe, but -3-4% would probably be a good guess. So interest rates are probably 300-400bp too higher in the euro zone. That is insanely tight monetary policy.

PPS I am writing this without consulting the data so everything is from the top of my head. And now I really need to take care of the kids…sorry for the typos.

9 Comments
by Lars Christensen on November 27, 2014  •  Permalink
Posted in Deflation, ECB, euro crisis, Mario Draghi
Tagged , , , , , ,

Posted by Lars Christensen on November 27, 2014

https://marketmonetarist.com/2014/11/27/bloomberg-repeats-the-bond-yield-fallacy-milton-friedman-is-spinning-in-his-grave/

Mussolini’s great monetary policy failure

Benito Mussolini is known for having been a horrible warmongering fascist dictator. However, he was also responsible for a major failed monetary experiment – the so-called Battle of the Lira.

Hence, in 1926 Mussolini announced a major revaluation of the Italian Lira as part of his general plan to revive the greatness of Italy.

This is how the Battle of the Lira was described in the New York Times in August 1927:

“It is just one year since Premier Mussolini, speaking at Pesaro, delivered that oration, destined to remain famous in the annals of modern Italian history, in which he announced his intention to revalue the lira.

‘We shall never inflict upon our wonderful Italian people, which for four years has been working with ascetic discipline and is ready for even greater sacrifieces, the moral shame and economic catastrophe of failure of the lira,’ he declared.

Looking back upon the last year, one must admit that Primier Mussolini has more than kept his word. In August 1926, the average exchange rate was 30 1/2 lira to the dollar. By October it had already dropped to 27 …the lira steadily continued its descent till in May (1927) it reached 18 to the the dollar, where it has remained ever since”

Hence, Mussolini engineered a nearly 70% revaluation of the lira in less than one year. Not surprisingly the economic impact was not positive. This how that is described in the same New York Times article:

“But the result has not been obtained without servere…jolts affecting all classes of citizens.

…Revaluation has led to a period of general stagnation and lack of enterprise in industry, for the gold value of money has increased automatically while the revaluation process was in progress and people preferred to leave their money in banks to rising it in ventures of any kind.

Unemployment is twice as high as it was in this month last year and greater than it has been at any time since 1924. Average quotations on stock exchanges have fallen 40 per cent. Wholesale prices have fallen about 30 per cent, but retail prices lag far behind and show a decrease of less than 15 per cent…

…Despite these somewhat depressing indications, the Government is convinced that the benefits of revaluation will ultimately far outweigh the drawbacks. The official opinion, indeed, is that now that the whole country has become adjusted to the new value of the lira, a rapid improvement will be expirienced.”

That of course never happened. Instead the Italian economy was hit by yet another shock in 1929 when the global crisis hit.

Finally in 1934 Mussolini decided to give up the gold standard and in October 1936 the lira was devalued by 41%.

What role Mussolini’s failed monetary policy played in his domestic policies and particularly in the foreign policy “adventures” – his war against Abyssinia in 1935-36 and his decision to ally himself with Hitler and Nazi-Germany in WWII – I don’t know, but there is nothing like war to take away the attention from failed economic policies.

Or as it was expressed in an article in New York Times in April 1935 at the start on Mussolini war against Abyssinia (but before the 1936 devaluation):

Behind each new political move in Europe, which expresses itself in the mobilization of larger armies, may generally be found an economic cause.

The article also touches on another key issue – the fact that (über) tight monetary policy historically has led to protectionist measures and that the logical consequence of such protectionist measures often is war:

The foreign trade of Italy is, figuratively, “shot to pieces.” The decrees against imports , the unwillingness to do business except where equal valued are exchanged by a foreign nation and the high rate of the lira have produced an alarming situation for a country that today under unobstructed movements of goods, would have an unfavorable trade balance.

One of the major efforts of Mussolini has been to place Italy on a self-supporting basis. Much has been done in this direction. As Italy is poor in natural resources that enter into processes of manufacture, the handicaps to attaining self-sufficiency are not easy to surmount.”

It is too bad today’s European policy makers didn’t study any economic history.

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Related blog posts:

“If goods don’t cross borders, armies will” – the case of Russia
Denmark and Norway were the PIIGS of the Scandinavian Currency Union

And posts on the early 1930s:

1931:
The Tragic year: 1931
Germany 1931, Argentina 2001 – Greece 2011?
Brüning (1931) and Papandreou (2011)
Lorenzo on Tooze – and a bit on 1931
“Meantime people wrangle about fiscal remedies”
“Incredible Europeans” have learned nothing from history
The Hoover (Merkel/Sarkozy) Moratorium
80 years on – here we go again…
“Our Monetary ills Laid to Puritanism”
Monetary policy and banking crisis – lessons from the Great Depression

1932:
“The gold standard remains the best available monetary mechanism”
Hjalmar Schacht’s echo – it all feels a lot more like 1932 than 1923
Greek and French political news slipped into the financial section
Political news kept slipping into the financial section – European style
November 1932: Hitler, FDR and European central bankers
Please listen to Nicholas Craft!
Needed: Rooseveltian Resolve
Gold, France and book recommendations
“…political news kept slipping into the financial section”
Gideon Gono, a time machine and the liquidity trap
France caused the Great Depression – who caused the Great Recession?

1933:
Who did most for the US stock market? FDR or Bernanke?
“The Bacon Standard” (the PIG PEG) would have saved Denmark from the Great Depression
Remember the mistakes of 1937? A lesson for today’s policy makers
I am blaming Murray Rothbard for my writer’s block
Irving Fisher and the New Normal

 

2 Comments
by Lars Christensen on November 15, 2014  •  Permalink
Posted in Benito Mussolini, ECB, euro crisis, Italy, Mario Draghi
Tagged , , , , , ,

Posted by Lars Christensen on November 15, 2014

https://marketmonetarist.com/2014/11/15/mussolinis-great-monetary-policy-failure/

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.

 

8 Comments
by Lars Christensen on November 15, 2014  •  Permalink
Posted in Brad DeLong, ECB, euro crisis, Greater Depression, Italy, Mario Draghi
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Posted by Lars Christensen on November 15, 2014

https://marketmonetarist.com/2014/11/15/italys-greater-depression-eerie-memories-of-the-1930s/

Three terrible Italian ‘gaps’

Yesterday we got confirmation that Italy feel back to recession in the second quarter of the year (see more here). In this post I will take a look at three terrible ‘gaps’ – the NGDP gap, the output gap and the price gap –  which explains why the Italian economy is so deeply sick.

It is no secret that I believe that we can understand most of what is going on in any economy by looking at the equation of exchange:

(1) M*V=P*Y

Where M is the money supply, V is money-velocity, P is the price level and Y is real GDP.

We can – inspired by David Eagle – of course re-write (1):

(1)’ N=P*Y

Where N is nominal GDP.

From N, P and Y we can construct our gaps. Each gap is the percentage difference between the actual level of the variable – for example nominal GDP – and the ‘pre-crisis trend’ (2000-2007).

The NGDP gap – massive tightening of monetary conditions post-2008 

We start by having a look at nominal GDP.

NGDP gap Italy

We can make numerous observations based on this graph.

First of all, we can see the Italian euro membership provided considerable nominal stability from 2000 to 2008 – nominal GDP basically followed a straight line during this period and at no time from 2000 to 2008 was the NGDP gap more than +/- 2%. During the period 2000-2007 NGDP grew by an average of 3.8% y/y.

Second, there were no signs of excessive NGDP growth in the years just prior to 2008. If anything NGDP growth was fairly slow during 2005-7. Therefore, it is hard to argue that what followed in 2008 and onwards in anyway can be explained as a bubble bursting.

Third, even though Italy obviously has deep structural (supply side) problems there is no getting around that what we have seen is a very significant drop in nominal spending/aggregate demand in the Italian economy since 2008. This is a reflection of the significant tightening of Italian monetary conditions that we have seen since 2008. And this is the reason why the NGDP gap no is nearly -20%!

Given this massive deflationary shock it is in my view actually somewhat of a miracle that the political situation in Italy is not a lot worse than it is!

An ever widening price gap

The scale of the deflationary shock is also visible if we look at the development in the price level – here the GDP deflation – and the price gap.

Price gap Italy

The picture in terms of prices is very much the same as for NGDP. Prior to 2007/8 we had a considerable level of nominal stability. The actual price level (the GDP deflator) more or less grew at a steady pace close to the pre-crisis trend. GDP deflator-inflation averaged 2.5% from 2000 to 2008.

However, we also see that the massive deflationary trends in the Italian economy post-2008. Hence, the price gap has widened significantly and is now close to 7%.

It is also notable that we basically have three sub-periods in terms of the development in the price gap. First, the ‘Lehman shock’ in 2008-9 where the price gap widened from zero to 4-5%. Then a period of stabilisation in 2010 (a similar pattern is visible in the NGDP gap) – and then another shock caused by the ECB’s two catastrophic interest rate hikes in 2011. Since 2011 the price gap has just continued to widen and there are absolutely no signs that the widening of the price gap is coming to an end.

What should be noted, however, is that the price gap is considerably smaller than the NGDP gap (7% vs 20% in 2014). This is an indication of considerably downward rigidity in Italian prices. Hence, had there been full price flexibility the NGDP gap and the price gap would have been of a similar size. We can therefore conclude that the Italian Aggregate Supply (AS) curve is fairly flat (the short-run Phillips curve is not vertical).

The Great Recession has caused a massive output loss in Italy

In a world of full price flexibility the AS curve is vertical and as a result a drop in nominal GDP should be translated fully into a drop in prices, while the output should be unaffected. However, as the difference between the NGDP gap and the price indicates the Italian AS curve is far from vertical. Therefore we should expect a major negative demand shock to cause a drop in prices (relative to the pre-crisis trend), but also a a drop in output (real GDP). The graph below shows that certainly also has been the case.

Output gap Italy

 

The graph confirms the story from the two first graphs – from 2000 to 2007 there was considerably nominal stability and that led to real stability as well. Hence, during that period real GDP growth consistently was fairly close to potential growth. However, the development in real GDP since 2008 has been catastrophic. Hence, real GDP today is basically at the same level today as 15 years ago!

The extremely negative development in real GDP means that the output gap (based on this simple method) today is -14%! And worse – there don’t seems to be any sign of stabilisation (yesterday’s GDP numbers confirmed that).

And it should further be noted that even before the crisis Italian RGDP growth was quite weak. Hence, in the period 2000-2007 real GDP grew by an average of only 1.2% y/y – strongly indicating that Italy not only has to struggle with a massive negative demand problem, but also with serious structural problems.

Without monetary easing it could take a decade to close the output gap  

The message from the graphs above is clear – the Italian economy is suffering from a massive demand short-fall due to overly tight monetary conditions (a collapse in nominal GDP).

One can obviously imagine that the Italian output gap can be closed without monetary easing from the ECB. That would, however, necessitate a sharp drop in the Italian price level (basically 14% relative to the pre-crisis trend – the difference between the NGDP gap and the price gap).

A back of an envelop calculation illustrates how long this process would take. Over the last couple of years the GDP deflator has grown by 1-1.5% y/y compared a pre-crisis trend-growth rate around 2.5%. This means that the yearly widening of the price gap at the present pace is 1-1.5%. Hence, at that pace it would take 9-14 years to increase the price gap to 20%.

However, even if this was political and socially possible we should remember that such an “internal devaluation” would lead to a continued rise in both public and private debt ratios as it would means that nominal GDP growth would remain extremely low even if real GDP growth where to pick up a bit.

Concluding, without a monetary easing from the ECB Italy is likely to remain in a debt-deflation spiral within things that follows from that – banking distress, public finances troubles and political and social distress.

PS An Italian – Mario Draghi – told us today that the ECB does not think that there is a need for monetary easing right now. Looking at the “terrible gaps” it is pretty hard for me to agree with Mr. Draghi.

11 Comments
by Lars Christensen on August 7, 2014  •  Permalink
Posted in ECB, euro crisis, Mario Draghi, Uncategorized
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Posted by Lars Christensen on August 7, 2014

https://marketmonetarist.com/2014/08/07/three-terrible-italian-gaps/

“God forbid that our policy should ever work”

This is Mario Draghi at the ECB’s press conference yesterday:

“Meanwhile, inflation expectations for the euro area over the medium to long term continue to be firmly anchored in line with our aim of maintaining inflation rates below, but close to, 2%. Looking ahead, the Governing Council is strongly determined to safeguard this anchoring.”

You got to ask yourself why you would ease monetary policy if you don’t want inflation expectations to increase. And ask yourself if the market will believe this will work if the ECB is so eager to say that the policy will not increase inflation expectations.

It all just feel so Japanese – pre-Kuroda…

HT Nicolas Goetzmann

 

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by Lars Christensen on June 6, 2014  •  Permalink
Posted in ECB, euro crisis, Mario Draghi
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Posted by Lars Christensen on June 6, 2014

https://marketmonetarist.com/2014/06/06/god-forbid-that-our-policy-should-ever-work/

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