A slightly off-center perspective on monetary problems.
Luis Arroyo sent me the following graph:
I get frustrated when I read people arguing the Eurozone problem is that the ECB canâ??t come up with a one-size-fits-all policy stance. As if monetary policy is too tight for just a few small stragglers on the edge of Europe, comprising just a few percent of the Eurozone GDP. Actually money is even tighter in Europe than in the US. Itâ??s too tight for every single Eurozone member. Nominal GDP is well below the levels of early 2008. Obviously in that situation many people, businesses and governments will have difficulty repaying their nominal debts. Look at the path of nominal income before the crisis (blue line); thatâ??s the income trajectory that people and governments were expecting when they contracted their nominal debts.
Obviously several small countries made extremely foolish decisions. Greece faked its national accounts and Ireland agreed to bail out bank creditors. So theyâ??d be facing some problems under the best of circumstances. But without the big drop in NGDP the Eurozone debt crisis would be far smaller, indeed would be relatively easily contained with a few bailouts.
How ironic itâ??d be if the ECB destroys the euro it was set up to protect, by obsessively trying to raise its value. They should have consulted King Midas.
Or perhaps Hayek, who warned what would happen if nominal incomes were allowed to decline.
HT: Thanks to Luis, and to Niklas Blanchard who finally taught me how to right-size graphs.
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28 Responses to â??Hayek would have told the ECB to print more moneyâ?
Graph isnâ??t right sized here. Oh well â?? a good post nonetheless.
And I hope and trust that the entire MoneyIllusion community had a wonderful Thanksgiving.
Money isnâ??t everything after all.
And my very best to everyone.
And if anyone wants to know how to invest money â?? read this:
http://www.nytimes.com/2010/11/27/your-money/27money.html?_r=1&ref=business
Some related question(s), Sumner. The Krugman is jabbering on about Ireland as a failed experiment in Austerity. He, as usual, wants more so-called "stimulus"?. He does, however, acknowledge that Ireland went through a genuine economic miracle before the bubble times took over (via easy money I contend).
So, here's the questions.
#1. Didn't Ireland's government institute some serious spending cuts as part of the reforms that sparked this "miracle"? and, if so, doesn't that make Krugman's model a bit, ehem, problematic.
#2. Has Ireland actually done any real "austerity"? yet to warrant claims that it has caused their recession? I don't trust Krugman on the facts or the sequence or the casual claims.
Sorry if this is diverging from NGDP"? but at least it's part of the general topic.
Great article JimP! And Happy Thanksgiving to you and everyone else at MI too!
John Papola:
I think that Krugman, as a good counter-cyclical Keynesian, has always pretty much said that budged cutting is most appropriate in periods of economic growth.
He has also said that it is appropriate even in periods of contraction, *if* it is possible to counterbalance its effects with either currency devaluation or monetary stimulus or both. (see http://krugman.blogs.nytimes.com/2010/06/18/fiscal-fantasies-2/)
He also thinks that whatever the case for austerity in the weakest countries, central banks and national governments in the strongest countries should be turning the stimulus up to 11 at this point.
If the ECB and the Fed were doing their job properly, then Ireland could still have austerity while benefiting both from increased demand in the Euro Zone and the U.S., as well as from relative devaluation against other major currencies.
What is wrong with those claims?
I think the graph dramatically makes the case why things are so bad in precisely those periphery countries that should not shoulder any blame(Ireland and the Baltic States). The reduction in liquidity hit those areas of the EU the hardest that were growing the most rapidly.
You can austeritize until the cows come home. Until NGDP in those countries is where it was before the massive reduction in money supply they will be in perpetual crisis.
JimP, The right margin is covered up, but I donâ??t care about that. Thanks for the article about investing. From jerk to nice guy in one life.
John, I donâ??t see how Ireland can even do stimulus, as the ECB determines AD in Ireland. I donâ??t know enough about Ireland, however, to really comment on their situation. I notice the minimum wage is being â??slashedâ? to $10.35/hour, that doesnâ??t seem like austerity to me. If they are serious about stimulus, they really need to leave the euro. But itâ??s possible that the costs of leaving might be bigger than the benefits. I canâ??t understand why they guaranteed those bank debts. Was it simply corruption?
Shane, Yes, Krugman is completely correct that the Fed and ECB should be doing much more. Ditto for the BOJ.
Mark, I agree. And the Baltic states show that even with their own currency Ireland wouldnâ??t have any easy choices. But their debt crisis was self-inflicted, not caused by the ECB. They actually donâ??t have that big a deficit, other than the massive bank bailout.
Scott wrote: â??And the Baltic states show that even with their own currency Ireland wouldn't have any easy choices. But their debt crisis was self-inflicted, not caused by the ECB.â?
Sure, they pegged, and they could have chosen not to. But what would the Austerians said if they had depreciated?
And donâ??t underestimate the pain (especially in Latvia).
Yglesias has a post up about the PIIGS adopting dual currencies: issuing new national forms of legal tender that are pegged against the Euro for intranational purchases, but that float against other currencies, including the Euro, on international markets (http://yglesias.thinkprogress.org/2010/11/de-euroizing-spain/). So pace Yglesisas, those within the borders of Spain get to spend Euros and â??Espanolasâ? (why not just call it the Peseta again?) in an interchangeable fashion, but anyone with Euros could exchange them for Espanolas (URGH!) at market rate.
Iâ??ve heard similar things proposed for depressed regions of the U.S. (meet the â??Michigander,â? the local Michigan currency). Any thoughts out there on this idea? I guess it might be appropriate to ask a lawyerâ??s opinion as well as an economistâ??s opinion.
Well the ECB can come up with a one-size-fits-all policy stance. However, they canâ??t come up with one that is appropriate for the hugely diverse economies of the EZ. Taking into account the language barriers preventing labour mobility, different levels of labour market flexibility, no standard banking regulation and widely different inflation it is difficult to see how they could ever have an appropriate one-size-fits-all policy.
In Ireland real interest rates averaged minus 1 per cent 1998-2007. With the removal of currency risk the imbalances were not going to lead to interest rate rises. Absent EMU the overborrowing would have led to interest rate rises. Better regulation of their banks could obviously have helped prevent the worst excesses. However, during this period policy was too loose for Ireland but appropriate for Germany. The main problem now for Ireland and the rest of the periphery is they have lost wage competitiveness.
The ECB policy stance is always going to be determined by the euro core and Germany in particular. The main raison dâ??être for the euro was a convergence of borrowing costs and that is now effectively defunct. The ECB has really lost control of the situation and absolutely no one is saying â?? donâ??t fight the ECB â??. The only way I can see the euro project survive in anything like its current form is if they adopt a common debt euro-bond. The EFSF instrument could be the beginning of pooled debt. However, it will require the periphery to surrender sovereignty over their budgets to a central authority. Otherwise why would the core want to pool borrowing costs when they can already refinance cheaply. I suppose you could call it a one-size-fits-all fiscal stance.
Scott, could you point me to the source of Hayek's nominal income targeting recommendations?
John Papola, Check out this by David Beckworth: http://macromarketmusings.blogspot.com/2010/02/hayek-and-stabilization-of-nominal.html
It is an odd time of ultra-low inflation, even deflation, and yet some economic commentators calling for austerity and tight money. Some seem to have conflated a tight fiscal policy with a tight monetary policy. Keep banging the drum that money is oxygen for a growing economy. Remember, the anti-QE2 crowd are the â??Nipponists.â?
This looks like my country circa 2001. Things wonâ??t end well if policy isnâ??t changed.
@Shane, â??Yglesias has a post up about the PIIGS adopting dual currencies:â? Yglesias should read on the Argentine crisis and the experiments with complementary currencies and barter [1]
1- http://en.wikipedia.org/wiki/Patac%C3%B3n_(bond)
Thanks, Scott, I´ve translated and published it in http://cuadernodearenacom.blogspot.com/2010/11/de-money-illusion-de-scott-sumner-quien.html Mi blog Ilusión Monetaria (inspired on your´s as you remember). When I saw the graph I can´t believe it. But don´t worry, that is a question which don´t worry in the ECB. ECB manage an unknow model that always say: chit chit, too much inflation Mr Trichet, you must rise interest rate. BTW, Madame Merkel is watching you.
Scott â?? I have to disagree.
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