Economy « Euro

Artikel getagged mit ‘Economy’

Pushing on a String: LTRO, Endogenous Money and the Eurozone Crisis

24. October 2013, von Alexandre Abreu, Comments (1)

(slightly wonkish, as Paul Krugman would put it)

At a press conference about a month ago, the President of the ECB, Mr Mario Draghi, raised the possibility of a new round of LTRO (Long Term Refinancing Operation), which, for those less familiar with the topic, consist of large-scale, long-term, low-interest loans to commercial banks across the eurozone, which serve to increase what’s called the ‘monetary base’. While many people think and use the analogy of ‘printing more money’ as the equivalent of undertaking expansionary monetary policy, the reality is that the vast majority of money consists of deposits and is created by the banking sector through credit provision. By extending loans to customers and crediting those loans to their accounts, banks effectively create money (i.e. generally accepted means of payment); and by extending loans to commercial banks, the ECB enables the former to increase the amount of credit, hence money, made available to the economy. The relationship between the monetary base and the total money supply is called the ‘money multiplier’ and the standard view, widely taught to economics undergraduates around the world, is that central banks are largely able to control the total money supply, namely by expanding or contracting the monetary base.
However, this ‘standard’ account of how monetary policy works is shattered to pieces by the abundant evidence provided by developments in the eurozone since the onset of the crisis. As shown in the Figure below (taken from here), between 2008 and 2012 the ECB more than doubled the eurozone’s monetary base (through such programmes as the LTRO), and, lo and behold… there was neither runaway inflation (as most delusional neoclassical economists might have expected) nor anything vaguely resembling a solution to the crisis (as some crude Keynesians might have expected). Quite simply, the enormous expansion of the monetary base did not translate into an increase in the total money supply, i.e. into more credit extended to the economy (M3 in the Figure).

Source: European Central Bank, Statistical Warehouse.

Source: European Central Bank, Statistical Warehouse.

The reason for this, as explained by the largely-ignored Post-Keynesian school, is that banks aren’t actually constrained by the monetary base or fractional reserve requirements when it comes to extending credit: as even bankers themselves will tell you, banks neither function as mere intermediaries between depositors and borrowers, nor do they give out loans to the extent allowed for by the amount of reserve deposits that they hold with the central bank: rather, they extend loans first, credit them into their customers’ accounts and only subsequently do they deposit a fraction of that new credit with the central bank. So in the real world, banks are virtually unconstrained in their ability to create money. Unconstrained by reserve requirements and the monetary base, that is, for in reality they are constrained by other things – crucially, by the demand for credit on the part of potential borrowers, with potentially profitable investment projects, who provide sufficiently good guarantees of paying back the loans.

And that’s exactly where the problem lies. In a situation where aggregate demand for goods and services in the eurozone is constrained by both a massive debt overhang and widespread austerity, many firms are unable to take out additional loans due to over-indebtedness, and the vast majority of the remainder are much less willing to undertake productive investments due to the slim prospects of getting a return on those investments. Thus the attempts on the part of the ECB to control the money supply become like pushing on a string: additional narrow money creation doesn’t actually get pumped into the economy, or only does so to a very limited extent, instead causing the banking system (or some parts of it) to accumulate excess liquidity. Indeed, the reason why the monetary base has been decreasing in the last few months (see Figure above) is that many banks across the eurozone have been paying back their own loans to the ECB so as not to hold on to liquidity for which they don’t have any use. There aren’t that many profitable productive investment opportunities around these days, and even the financing of asset-price bubbles – housing, gold, food derivatives – no longer seems as attractive as it used to.

Now, to be accurate, it’s not necessarily the case that monetary policy has been entirely ineffective: it is probably true that the money supply in the eurozone would have collapsed were it not for the unprecedented expansion in the monetary base. However, the complete breakdown in the stability of the money multiplier shows quite clearly that: i) money is created endogenously in the economy by banks and effectively limited by aggregate demand; ii) we’ve reached a point where narrow money creation is neither inflationary nor expansionary – it’s largely ineffective; and iii) the root cause of the problem is stalled aggregate demand across the eurozone as a whole, owing to rising inequality and over-indebtedness built up over the course of the last 2-3 decades and only made worse by austerity. So whether or not a new round of LTRO is indeed implemented won’t really make much of a difference, at least for the purpose of reviving the eurozone economy and overcoming the crisis.
Want some really ‘structural reform’? Reconnect fiscal and monetary policy, so that the latter is backed up by sufficient stimulus to aggregate demand, and actively promote 5%-6% inflation, so that the debt overhang can be gradually overcome. Of course, the chances of this occurring without major political and institutional overhaul are, well, zero – as are the chances of overcoming the eurozone crisis in the next few years.

Dijsselbloem or DijsselDoom – a Dutch Perspective

9. April 2013, von Adriaan Schout, Comments (0)

I already presented my reservations against the appointment of Dutch Minister of Finance, Jeroen Dijsselbloem (Labour Party) as President of the Eurogroup. The public outrage following the bankruptcy of the banking sector in Cyprus has raised new questions concerning his ‘presidency’ (for which in Dutch the more modest ‘chairmanship’ is used). My initial doubts concerned the question whether this prestigious position would be in the interest of the Netherlands – and I was bold enough to propose Olli Rehn as possible candidate for a permanent chair after his departure from the European Commission in 2014.

The Cypriot turbulence in March immediately tested Dijsselbloem’s ability as a chair. He had become minister of finance in the Netherlands only in November 2012 and his appointment was almost immediately followed by rumours about his candidacy as president of the Eurogroup. In that respect, the criticism of his lack of experience and authority during the Cyprus crisis came as no surprise. For his two rescue proposals for Cyprus the media treated him on nicknames such as “DieselBoom”, “DijsselDoom” and “EuroBaldrick” (borrowed from the series Blackadder) as well as on appeals for his resignation. The fierce debates he provoked centre on the question as to whether the deposit holders are really completely safe. ‘True’ EU believers – and bankers who long for stability – would have preferred a banking resolution including European deposit guarantees in order to prevent bank runs whereas EU sceptics wished for the dismantling of the euro. Moreover, as was to be expected, Dijsselbloem was scorned as a Dutch puppet of Germany and blamed for defending the Dutch position instead of being a neutral chair.

Yet, in view of political realities like the upcoming elections in Germany and the public reservations against saving zombie banks and eurozone countries, the decisions of the Eurogroup to dismantle the Cypriot banks and to bail in seem inevitable. Moreover, given the lack of money in any country, it is highly unlikely that former Eurogroup President Juncker would have been able to orchestrate a different outcome. Approximately € 3 trillion is needed to stabilise banks in the eurozone. It is simply impossible to avoid more haircuts. Still, Dijsselbloem’s presentation of the measures appeared cold and his alleged Dutch bluntness provoked comments like the one by Juncker that you sometimes have to lie as chairman of the Eurogroup – as if financial markets preferred unreliability instead of predictability.

Also, the role of the chairman of the Eurogroup seems to be widely overestimated, if one has a close look at the EU power structure. A lot of criticism on Dijsselbloem is politically naïve in view of the strong resistance against the Cyprus bail-out not only in Germany but also in countries such as France where EU Affairs Minister Moscovici talked about “casino banking” on Cyprus. It seems widely regarded as reasonable to bail-in bondholders and deposit owners – particularly in the absence of an effective European resolution mechanism.

Hence, Dijsselbloem seems to have withstood the criticism well so far. Yet, there are issues for which he could be criticised, which in some cases can be blamed on his lack of experience. First of all, he made himself more important than he really is by ̶ during the hearing before the European Parliament ̶ taking the blame for the bailing-in of savings below €100 000 in the first deal with the Cypriot government. Firstly, the chair (President of the Eurogroup) is not a decision maker but mainly a spokesman: it was the decision of the Eurogroup to bail in those savings. Secondly, he referred to the bail-in of Dutch bondholders. A chair should be as neutral as possible and avoid telling the world how good his native country is in dealing with a crisis. Particularly Dutch politicians should take care not to be too outspoken. Dijsselbloem’s presentation of the Netherlands as a role model fuelled the criticism that he was pursuing a national agenda. Thirdly, he talked in terms of “core” and “periphery countries” as well as “the north” and “the south” whereas a chair should avoid divisions at any cost (as he later seemed to have realised).

Even though these issues are mainly issues of style and nothing serious, the international press once again saw a reason to complain about Dutch bluntness and about pushing through the Northern austerity agenda. Similarly, when Dijsselbloem, as Dutch Minister of Finance, attacked the Commission’s request for an additional € 11.2 billion for the budget for 2013, a question basically unrelated to the euro crisis, this led to head lines such as ”Dijsselbloem, president of the Eurogroup, joining forces with the UK” (EurActiv 3 April 2013). This shows that it seems to be inevitable that the chair of the Eurogroup is not regarded as neutral but as a national politician.

If Cyprus can cause an existential euro crisis overnight, it is very likely that more and more serious crises are to be expected. Against this backdrop, complaints about Dutch bluntness, accusations of Dijsselbloem acting as a German puppet or being part of the British camp, are particularly unhelpful both for the EU and for the Netherlands. What the Eurogroup urgently needs is a professional chair!

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

Why Economists Should not always Ask for Centralisation

25. February 2013, von Adriaan Schout, Comments (0)

Many say that the eurocrisis is not about the euro but about financial markets. Whatever the precise cause: it seems to be a purely economic crisis. Of course, the financial sector was a motor behind the crisis, but there have been other drivers too. National conditions – such as high private debts, corruption and inflexible labour markets – inflated the bubbles and accelerated the economic crisis once these bubbles burst. With this in mind, it is somewhat strange to see that the bulk of the economic discussions about solutions for the eurocrisis concern deeper integration at EU level.

Economists have pointed to the impossibilities of working with a half-baked EMU. The euro started as a Monetary Union while the Economic (now called: political) Union was lacking. What this political union should have included, according to the economic analyses, are a central bank with more responsibilities, EU bonds to reduce interest rates and solidarity mechanisms. A second focal point in the debates is the question whether austerity is wise. Economists are happy to call for EU growth initiatives and transfers.

Given these profound economic debates, it is no wonder to see far-reaching economic solutions in Barroso’s Blueprint for a genuine EMU: an additional EU budget, steps towards eurobonds, etc.

The consequence of these economic solutions is centralisation (federalisation) including treaty change. Hence, Barroso’s plans are also about transforming the Commission into a European government, European taxes, a larger EU budget and a stronger role for the European Parliament. Many economists de facto want a political union.

Yet, northern countries lack trust in southern governments and are therefore unwilling to accept EU bonds, to pay for a banking resolution mechanism or to accept other moves towards a transfer union. In the end, the EU seems to remain stuck with the Mundell-Fleming ‘impossible triangle’ that states that the combination of fixed exchange rates, free capital movement and independent monetary policy cannot be maintained.

This call for deeper integration seems perverse integration. The eurocrisis originated at national levels. Hence, the national level is the level where solutions have to be found and implemented first of all. Understanding the eurocrisis requires institutional, in addition to economic, analysis. Banking supervision was failing in all countries. National statistics proved unreliable. National political parties suffer from corruption and regional governments have been deeply involved in the housing bubble. The relevance of the national level is also with a view to the fact that the national publics lack enthusiasm for this federalisation process.

National institutions determine the state of the economy and many of these institutions have been ineffective. It is impossible to construct an EMU with (semi) failing states. Politicians need to do what they hate the most: accept independent European (in whatever form) scrutiny of their national administrations. This involves assessing the independence and quality of national statistical systems, national budgetary control authorities, deregulation authorities, tax collection systems, etc. In addition, scrutiny is needed of the quality of social economic councils in Member States, of the size and quality of  regional governments, of the management of political parties, of transparency policies in member states, of labour market and education systems, of anti-corruption policies, etc.

The measures proposed by Barroso to strengthen the EMU will become much less needed if Member States possess institutions with self-cleaning capacities. It is contrary to the subsidiarity principle in the Treaty to centralise decision making in the EU when many of the problems originate at national levels of government and when further measures can be taking at the national level. The food crisis in the 1990s was not solved through a ‘Food Union’ but by building food authorities incorporated in European networks supported by appropriate legislation and independent national controls. Similarly, competition policy in the EU is now based on independent national authorities. If Member States do not trust each other’s administrations, steps towards a closer union will be impossible. Similarly, if Member States have effective national institutions, there will be much less need for centralisation. By the same token: centralisation will fail – and lack public support – if national governments are weak. Evidently, reforming national institutions cannot be done without EU networks and EU legislation, but the bulk of the reforms should be national. This could also prevent that ‘Brussels’ is used as scapegoat, even though the Commission will always be put in the position to criticise Member States, if they lack self-correcting mechanisms. Weak Member States will, therefore, create an automatic dislike of the EU.

This focus on national institutions is also needed to break the stalemates in social policy. A growth agenda is partly blocked due to lack of trust in national institutions. Triple-A countries are afraid of reducing reform incentives elsewhere. Yet, without social support, the euro could fall apart due to the consequences of collective austerity. However, growth will not come from more money (there is no), but has to be based on sound national policies and sustainable national institutions.

National institutions should be targeted first of all in the discussion on deeper integration. Barroso’s agenda towards a genuine EMU seems logical to economist who ignore the importance of national institutions but it will never work or it will require a transfer union that is politically extremely dangerous.

Europe For Citizens

“This project has been funded with support from the European Commission. This publication reflects the views only of the author, and the Commission cannot be held responsible for any use which may be made of the information contained therein.”

Blog Authors

Adriaan SchoutAdriaan Schout

Dr Adriaan Schout is Deputy Director Research/Europe at Clingendael, Netherlands Institute of International relations. (read more...)

Alexandre AbreuAlexandre Abreu

Dr Alexandre Abreu is a 33-year-old Portuguese economist with a PhD from the University of London. Currently he is a lecturer in Development Economics at the Institute of Economics and Business Administration, Technical University of Lisbon, and a Researcher at the Centre for African and Development Studies of the same University.

Almut MöllerAlmut Möller

Almut Möller is a political analyst in European integration and European foreign policy. She is currently the head of the Alfred von Oppenheim Centre for European Policy Studies at the German Council on Foreign Relations (DGAP) in Berlin. (read more...)

Supported by