Central banks

On Monday 13th May, I participated in a debate on austerity organised by the New York Review of Books, held in the Sheldonian Theatre, Oxford. The motion was: “Austerity in the Eurozone and the UK: Kill or Cure?”. Those arguing in defence of austerity were Meghnad (Lord) Desai and Sir John Redwood MP. On my side was Lord (Robert) Skidelsky. Here is the speech I presented – a version of which was published in the New York Review of Books, July 11, 2013, Volume 60, Number 12. It can also be found at www.nybooks.com. Read more

What do eurozone leaders want most at the meeting of the World Economic Forum? To cease being viewed as the source of global economic threats and return to being a source of economic solutions. It is far more fun – let alone more dignified – to lecture others on their faults than to be lectured on one’s own. It is even more humiliating when those lectures are thoroughly deserved.

Unfortunately for the eurozone, there is no chance that its policymakers will escape blame in Davos. They will argue that they are on the way to a resolution. Alas, the more percipient of them, as well as their peers from around the world, know they are not. Their visit to the Swiss mountains will be a discomforting experience.

The eurozone is almost universally regarded as the source of the pre-eminent threat of an economic meltdown. The risk is that both banks and sovereigns could default, probably triggering – or triggered by – a partial or complete break-up of the eurozone. Such a wreck may still be regarded as unlikely, but it is no longer inconceivable.

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Capitalism in crisis

Three years ago, when the worst financial and economic crisis since the 1930s gripped the global economy, the Financial Times published a series on “the future of capitalism”. Now, after a feeble recovery in the high-income countries, it has run a series on “capitalism in crisis”. Things seem to be worse. How is this to be explained?

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AP/Bernd Kammerer

AP/Bernd Kammerer

In the most recent post, I discussed the fullest analysis yet by Hans-Werner Sinn (together with Timo Wollmershäuser), president of the Ifo Institute in Munich, of the role of the European System of Central Banks in funding the balance of payments imbalances inside the eurozone.

While this post elicited many interesting comments, none, I believe, invalidated Professor Sinn’s basic thesis, which is that monetary financing of the balance of payments (ie the current account deficit, plus net private capital flows) is large, growing and decisive in sustaining imbalances inside the eurozone.

Prof Sinn’s work has attracted much controversy. But this is not, in my view, because it is fundamentally wrong (although I think he did initially exaggerate the problems created for managing money and credit in Germany itself), but because it reveals what many policymakers and observers would like to conceal. Read more

Mario Draghi

Mario Draghi, December 8, 2011. Image by Getty.

Will the European Central Bank save the eurozone? This is an extremely controversial question. What is clear, however, is that the central bank is the only entity with the capacity and the calling to do so. Without the euro, the ECB ceases to exist. That is true of no other eurozone institution. It gives it the incentive to act. It is also acting on a large scale.

The resistance to funding governments by purchasing bonds on a large scale, even in secondary markets, remains strong, as Mario Draghi, the new president of the ECB made plain in his interview with the FT on December 18.

Nevertheless, he argued, the ECB took important action the week before:

“We cut the main interest rate by 25 basis points. We announced two long-term refinancing operations, which for the first time will last three years. We halved the minimum reserve ratio from 2 per cent to 1 per cent. We broadened collateral eligibility rules. Finally, the ECB governing council agreed that the ECB would act as an agent for the European Financial Stability Facility (EFSF).”

Thus the ECB is determined to fund banks freely, at low rates of interest, thereby subsidising them directly and the governments they lend to, indirectly. Read more

During any period of monetary disorder – the 1970s, for example, or today – a host of people calls for a return to the gold standard. This is not the only free-market response to the current system of fiat (or government-made) money. Other proposals are for privatising the creation of money altogether. (See, on this, Leland Yeager, professor emeritus at the University of Virginia and Auburn University, in the latest issue of the Cato Journal.) But the gold standard is the classic alternative to fiat money. Read more

People with a free-market orientation believe that the economy has a strong tendency towards equilibrium. Over the long term money is “neutral”: a rise in the money supply merely raises the price level. In the short term, however, monetary policy may have a big impact on the economy. A big question, however, is over how to measure the impact of monetary policy in an environment such as the present one, when short-term interest rates are close to zero and the credit system is damaged.

The difficulty arises because of the huge divergence between what is happening to the monetary base (the monetary liabilities of the government, including the central bank) and what is happening to broader measures of money (principally the liabilities of the banking system). The former has exploded. But the growth rate of the latter is extremely low. (Look at the chart that accompanied my column, “Why it is right for central banks to keep printing”)

People worried that governments are “printing money” point to the balance sheets of central banks with horror and insist this is bound to be inflationary. Inside the eurozone, Germans are particularly concerned about the willingness of the European Central Bank to buy the debt of governments. Yet the growth of broad money (M3) in the eurozone over the past twelve months has been close to zero. That would suggest there is no inflationary pressure whatsoever.

So which measure is relevant? My responses would be as follows: Read more

The conventional wisdom in both Japan itself and the west is that the country has an unmanageable public debt problem. I find this quite unpersuasive. All the country needs to do is generate, say, expectations of 3 per cent inflation and the public debt problem should melt away like snow. But the longer it waits the bigger the ultimate adjustment will need to be.

In 2010, according to the Organisation for Economic Co-operation and Development, Japan will pay net interest of 1.1 per cent of gross domestic product on net financial liabilities of 105 per cent of GDP. Since 2000, Japan’s average rate of deflation (on the GDP deflator, the widest measure of inflation) was 1.2 per cent. So let’s treat the expected real rate of interest on Japanese government borrowing at 2 per cent. Read more

First comes financial crisis; then comes sovereign debt crisis; then comes financial repression. This is the view of Carmen Reinhart, co-author of This Time is Different, the masterly study of financial crises through the ages. I recently had a fascinating conversation on this topic with her, here in New York, where I have been living since the beginning of April.

So the question for the exchange is: how likely is financial repression? What forms might it take? Might this even be the end of the era of globalised finance? Read more