Some pleasant monetarist arithmetic

Speech by Benoît Cœuré, Member of the Executive Board of the ECB, at the Institut d’études politiques in Paris yesterday —

… from an institutional design perspective, central bank independence and a clear focus on price stability are necessary but not sufficient to ensure that the central bank can provide a regime of low and stable inflation under all circumstances – in the economic jargon, ensuring “monetary dominance”. Maintaining price stability also requires appropriate fiscal policy. To borrow from Leeper’s terminology, this means that an “active” monetary policy – namely a monetary policy that actively engages in the setting of its policy interest rate instrument independently and in the exclusive pursuit of its objective of price stability – must be accompanied by “passive” fiscal policy. A passive fiscal policy means that the fiscal authority must be ready and willing to adjust its policy stance (revenues and primary spending) in such a way as to stabilise its debt at any level of the interest rate that the central bank may choose. … The creation of the EFSF/ESM in charge of providing support to euro area Member States in difficulties and enforcing appropriate conditionality has filled this gap. It provides the euro area with a means to restore “Ricardianess”, thereby minimising the risk of “fiscal dominance”.

Although this section of the speech is steeped in references to technical literature, it puts at least one major question up for debate: is what ails the Eurozone a need to reassert monetary dominance? The now seemingly widely accepted diagnosis of Professor Paul de Grauwe was that the Eurozone had excessive monetary dominance: precisely because the ECB was not a national central bank, none of the fiscal authorities within it had the ultimate backstop of monetary financing of debt, and therefore some face punishingly high yields or complete lock out from bond markets.

So although what M. Cœuré describes may be pleasing to Bundesbank ears, the underlying interpretation is somewhat different. What’s happening now is not a switch back from fiscal dominance to monetary dominance. It’s a kinder, gentler monetary dominance where the discipline comes not from a binge and purge fiscal cycle, but more active support to keep the would-be fiscal dominators from finding out the hard way what happens at the end of the alternative path. In so doing, it also makes old style Bundesbank monetarism easier: tight money now doesn’t force countries to the point where inflation is eventually the only option.

The Eurozone designs a halfway house

Setting out the framework for the ECB’s Outright Monetary Transactions (OMT) on Thursday, the ECB said

They may also be considered for Member States currently under a macroeconomic adjustment programme when they will be regaining bond market access.

Certainly helpful for Ireland and Portugal to have that backstop. What’s not quite so clear is how the conditionality would be applied. The countries would be selling bonds as a path to exit from their existing Troika programme and the programme would presumably expire as the final disbursements were made and the original programme conditions met. So what is the Post-Program Monitoring (as the IMF might say) for those countries?

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