The continued embarrassment that is European monetary policy … economists?

In the summer 2008, when concerns were growing that a weaker economy was approaching, the ECB raised its rates – a step that had to be reversed pretty quickly as we know. Quite embarrassing.

And what happened this time? Another commodity boom “tricked” the ECB into raising rates at the worst possible time, even though there were no signs of a pass-through of the currently higher headline inflation to core inflation, and thus, to medium term headline inflation. Now, this step will probably be reversed quickly, too. Why? Because even Germany might be heading for a recession.

As Henry Kaspar has pointed out repeatedly on my (other) blog, I shouldn’t criticise the ECB for following its mandate. Even though we all know that the ECB broke its own rules in the past when there was a need to do so, there certainly is some truth to that. (Update: Karl Whelan points out in an email that the mandate of the ECB is “price stability”, so the ECB might actually have more discretion than is commonly assumed). So let me instead address those European economists that keep missing that monetary policy is a huge part of the problem, and potentially a big part of a shorter and longer term fix for the Eurozone.

First of all, what is monetary policy supposed to accomplish? Very broadly speaking: macroeconomic stability. An important aspect is to keep aggregate demand (AD) on a stable and predictable path. The reason is simple: prices and wages don’t adjust quickly enough to accommodate nominal changes that are caused by changes in the demand for the medium of exchange (aka money). So better keep the nominal values on a predictable and stable path, so that there is no need for across-the-board adjustments.

Usually, an inflation-based approach is sufficient, and it has stabilized inflation throughout a large part of the world, which is historically a big achievement. Whether it has contributed to the build-up of the current crisis is still an open question. In times of a severe crisis, however, this approach has clearly proved inadequate, as the focus on inflation has allowed AD to plummet 10% (!) below trend:

Such a drop in AD would be devastating for any economy, not only a currency union. It is time to realize that the policy of the ECB has been extremely tight since 2008, measured by the concept of macroeconomic stability and is therefore an important cause of the current mess.

Second, countries in a currency union experience asynchronous business cycles. This is a problem because monetary policy cannot be tailored to all different cycles. So even though there is some differentiation that the central bank can impose, a large part of the adjustment has to come through changes in prices and wages – a painful process as Germany learned during the first decade of the Euro. And as for anything else that is painful, there is one rule: get it over with quickly.

How can you overcome nominal rigidities quickly? Wages rarely decline nominally (see this Krugman post for some nice graphs), which means there is a(nother) zero lower bound. When some countries need to adjust wages and prices downwards, it is best to be further away from this threshold. The reason is simple: if the best you can do is to keep wages constant, the higher the general price increase, the more the decline in real wages. A higher nominal growth during normal times increases your room for manoeuvre during adjustment periods.

The essence of this: choose a higher inflation, or even better, nominal spending target the more diverse (read: suboptimal) your currency union is. For the Euro area, an inflation target of below 2% is inadequate. This seems so painstakingly obvious, and yet you will have a hard time finding European, let alone German!, economists who share this view – even though the evidence from the Gold standard era supports this argument, too.

Finally, economic historians like Kenneth Rogoff point out that we are currently in a situation of high debt and over-leverage that happens only rarely. When it does, the decline and adjustment usually takes many years – unless the central bank takes decisive action to prevent a severe drop in AD. This may entail temporarily higher inflation, as a period of deleveraging may hurt growth. But it is worth it, as Kenneth writes:

[In 2008] I argued that the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years. Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But, at the end of the day, such a transfer is the most direct approach to faster recovery. Eventually, it will take place one way or another, anyway, as Europe is painfully learning. … Some observers regard any suggestion of even modestly elevated inflation as a form of heresy. But Great Contractions, as opposed to recessions, are very infrequent events, occurring perhaps once every 70 or 80 years. These are times when central banks need to spend some of the credibility that they accumulate in normal times.

Higher nominal spending growth (or inflation) is therefore an important building block to solve the current, short term European crisis – even if you disagree with my argument above that monetary policy since 2008 is one of the major culprits for leading us into this mess. The ECB’s achievement to keep inflation at 2% is a Pyrrhic victory, as Ryan Avent ironically describes:

If the euro zone does fall apart, a fitting epitaph might read, “The ECB feared 3% inflation”.

I sincerely do hope that I read the wrong newspapers and missed all those European economists and commentators screaming all these things (or even better: that I am wrong). But whenever I try to hear something, there is just silence – or Axel Weber lashing out at Olivier Blanchard. Meanwhile, European policy makers and central bankers are wrecking one of the most fascinating projects in human history, the unity and friendship among the countries of Europe. This is beyond depressing. Way beyond.

Germany is not turning on itself

I’ve recently read some interesting but somewhat shocking article, recommended by FT alphaville, in The Globe and Mail (Canada): “Germany’s season of angst: why a prosperous nation is turning on itself”. Fortunately, the author Doug Saunders is wrong.

Describing Germany’s booming economy, he writes:

These are, by several measures, the most successful people in the world. Yet it is very hard to find anyone here who is happy about this state of affairs.

And from my personal anecdotal evidence, he is right. When I talk to my fellow Germans about the economic situation, I have the same impression. But why is that? Doug’s interpretation, that Germany is afraid of change, involvement with the outside world, immigration or technological progress may be fitting with an earlier image of Germany. But I find other explanation much more plausible.

For starters, Germans fear the consequences of the Euro crisis in part because some politicians, academics and the media deliberately nurture fear. From “defending the Euro” to Prof Sinn’s exaggerated Target-2 arguments, from claims of high inflation to a Lehman-moment, the Germans are being told that the economic risks for them are huge and imminent, which is only partly correct (if at all). Interesting enough, the political risks – that the German taxpayers will become the major creditors of the periphery thanks to fear-induced bailouts (money and friendship…) – is discussed much less often.

But more importantly, Germans have lived through 15 years (!) of near-stagnation or mind-bogglingly high unemployment or both. That shapes your expectations in two important ways.

First, Germany knows how difficult it is to integrate and reform an economically (much more) devastated country of roughly the size of Greece. In fact, they have just been through it. So not only are they jolly well fed up with paying for something like that: after cumulated net public transfers of €1400bn (it’s not a typo), there are still €6bn in net transfers going to Eastern Germany. Per month. (The brain drain from former Eastern Germany was heavy, so how much “Western” Germany really payed is debatable.) At the same time, many Germans feel obliged to help European friends according to a recent poll:

A new survey finds that 60 percent of Germans believe their country has to help Greece in the eurozone debt crisis — like it or not.

Anyone caught in this tension will stray to extremes at times (like the person that Doug interviewed). The trigger may be when the Greek press retaliates with Nazi-jargon to German tabloids’ disgraceful headlines. Or when German politicians – supported by part of the German press – keep talking about “rescuing Greece” instead of being honest about what is actually being rescued: German investors and banks.

Second, after a decade-and-a-half-long economic struggle, Germans simply cannot believe that those times have finally passed for good, which is fully understandable for a country in whose national psyche security comes first. And no, Doug, the German boom is neither built on the birth of the Euro nor on “a deliberate strategy to keep labour costs low and productivity high”. It is built on Germany having re(!)-gained its competitiveness (warning: shameless cross-linking) and an ECB that will have to conduct too loose monetary policy for Germany in the years to come.

Doug’s other examples, immigration and a new protest movement, as well as nuclear power and the Libya war, have multiple roots that are too complex to discuss in a single post. He might have a point here, but there are more sympathetic and equally plausible explanations. For instance, the success of a populist and alarmist book by Thilo Sarrazin about the alleged decline of Germany is a late response of the German public to problems that have been piling up largely unaddressed over the last 30 years. In this context, Doug much too easily dismisses the internationally underappreciated contrast to Italy, Netherlands, France or even Sweden (!), not to mention Austria, that no right-wing populist party has made it into the federal parliament during the last 20 years, despite an unmatched economic malaise and a proportional election system.

Germany is not turning on itself. Germans just have a hard time dealing with and making sense of the current economic situation – and who could blame them? But if you give it some time, you will see that the 2006 & 2010 World Cup euphoria was not just a break from a national state of angst.

Greek voices…

Behind all the raw financial data there are always people. Here are two very human voices talking about the current crisis in Greece.

First up is a passionate call for action on Sturdyblog, called Democracy vs Mythology: The Battle in Syntagma Square. One quote:

I know it is impossible to share in a single post the history, geography and mentality which has brought this most beautiful corner of our Continent to its knees and has turned one of the oldest civilisations in the world from a source of inspiration to the punchline of cheap jokes. I know it is impossible to impart the sense of increasing despair and helplessness that underlies every conversation I have had with friends and family over the last few months. But it is vital that I try, because the dehumanisation and demonisation of my people appears to be in full swing.

And then there is Regarding the Greek situation by Eugenia Loli-Queru. One quote (emphasis mine):

In the 1920s, the bureaucracy had become so big that the public sector grew not only in numbers, but also in power. A law was enacted where from the moment you became a civil worker, you effectively couldn’t get fired.

This quickly created a two-tier citizenship in Greece. The powerful civil workers (who retire early, some of them work few hours, some of them working in offices are indeed lazy etc), and the private sector, which remained very underpaid, very hard working, and who’d retire at the age of 65. When Europeans today complain about the lazy Greeks, they must understand that Greece has a virtual cast system, and that not everyone is equal in it.

I kindly invite our readers to go and read both posts. Hat tip for the first post goes to Sargasso.

Two random videos

This video is a satire — I want to emphasize this: a satire — done by the great American comic newspaper, The Onion. (The first 15 seconds is an ad. Sorry, that’s how they pay for this stuff.)

This video is an actual commercial that played on Greek televsion recently. (Scroll down for the English translation if you don’t speak Greek.) By pure random accident, I just happened to see them both on the same day.

And that’s all.

About that Greek public sector

Charlemagne, over at the Economist blog, can be… uneven. But this recent post about Greece’s public sector is IMO top notch. It puts the creation of Greece’s huge, poorly paid, inefficient public sector in historical context:

Take the painful question of the huge public sector, and all those civil servants with jobs for life, and unusually generous retirement packages. The existence of those jobs for life is not a cultural quirk, in which Greek officials simply like coffee and backgammon too much to do any work. It is the end result of a brutal, multi-decade power struggle between the left and the right: a struggle that got people killed within living memory…

The Greek civil war, and the bloody score-settling that followed, is a living memory for many Greeks. Any consideration of Greek nepotism or clientelism needs to be seen in that light. So for example, it is not enough to say that Greek civil servants enjoy jobs for life, and that is a big problem. (Though it is a big problem, not least because many Greek civil servants are paid pitiful wages—partly because there are so many of them. That means they will resist austerity measures all the harder, because they feel like victims in this crisis, not fat cats.) But the bloated public sector is also a function of history… Continue reading

Greece: citizenship for children of immigrants?

In between trying to deal with one of Europe’s worst economic crises and a crippling series of strikes, the Papandreou government in Greece has introduced a new immigration law. It would allow the children of immigrants to apply for Greek citizenship, provided that

(1) their parents have lived legally in Greece for at least 10 years, and
(2) the child has completed at least three years of schooling in Greece.

By one estimate, over 250,000 children and young adults would qualify for citizenship. As many as 100,000 of those may be of voting age.

This is a huge, huge deal. In order to understand why, you have to understand the odd position of immigrants in Greek society. Continue reading

Socialists win big in Greece

This seems to have gotten very little attention, but Greece changed governments last week. The ruling center-right New Democracy (ND) party called elections a couple of months ago, and the result was that — predictably — they got stomped hard.

ND had a wafer-thin majority of 152 seats out of 300; they lost 61 (!) seats, and are left with just 91. The rival Socialists jumped from 102 seats to 160, which will allow them to govern alone.

Two of the three minor parties — the Communists and the Radical Left — stayed about the same. The third minor party, the Popular Orthodox Rally, jumped from 10 seats to 15. That’s kind of depressing, because the Popular Orthodox guys are assholes. They’re your classic Balkan Obnoxious Populist-Nationalist Party; insofar as they have a platform, it’s “Hate Albanians and cut taxes”.

One thing I still don’t understand is why ND called this election. Yeah, narrow majority, economic crisis, blah blah. The ND government was only two years old; they could have clung to power another couple of years. They didn’t expect to lose this badly, of course, but the polls made it clear they were going to get kicked out of government. Can anyone shed light on this?

As for the new government: they say they’ll enact an economic stimulus package. Otherwise, from this distance they look pretty similar to the other guys. Again, more detail is welcome.

That said, it’s noteworthy to see a left/center left party win power in Europe these days. (And in a landslide, too.) That hasn’t been happening much lately.

Trivia: outgoing Prime Minister Karamanlis was the nephew of a previous Prime Minister, while incoming Prime Minister Papandreou was the son and grandson of previous Prime Ministers. I would say Greece needs a whosekidareyou site, but on the other hand probably not — it’s not exactly a secret.

Greek journalist sued for writings on Bosnia

Via Marko Hoare’s blog, here’s an unhappy story about Greek journalist Takis Michas. A few years back, Michas wrote a book about the links between Greece and the Bosnian war — Greek support for Milosevic and Karadzic, Greek volunteers going to fight for the Serb side in Bosnia, and so forth.

Well, now he’s being sued by a Greek veteran of the Bosnian war. The lawsuit seems pretty dubious; the volunteer is claiming that he’s been libelled because Michas described the Greek volunteers as “paramilitaries” who took part in the Srebrenica massacre when (the volunteer says) they were in fact members in good standing of the Serb Bosnian army who just happened to be in Srebrenica around that time. The suit is being funded by something called the “Panhellenic Macedonian Front”, which is an umbrella group for a variety of extreme nationalists. A short interview with Michas, discussing the lawsuit, can be found here: Continue reading

Greece: what if nothing happens?

We’ve seen a lot of hand-wringing over Greece in the last couple of weeks. Various commenters have compared it to 1968 and to 1973, have noted the deep-rooted miseries that this has exposed in Greek society, and have expressed concern that violence may spread to other Mediterranean economies (Italy, Spain) or even to France.

Maybe. Maybe. But let me advance a contrarian suggestion: maybe nothing much is going to happen. Continue reading

The Greeks of Burundi

There’s a Greek deli in central Bujumbura, the capital of Burundi.

It’s hard to overstate how odd this is. Burundi is one of the poorest countries in the world. Bujumbura, on the shores of Lake Tanganyika, is… basic. The roads are mostly unpaved. Much of it has no electricity; the parts that do, are subject to regular blackouts. Armed militia groups still lurk in the hills just a few miles from the city. Malaria and yellow fever are issues.

But, you know, Greek deli. Black and green olives floating in tanks. French wine; Greek wine. Good bread and rolls. Spinakopita. Salami. The feta cheese was pretty horrible, but I think that can be forgiven.

Bujumbura also has a Greek consulate. And right in the middle of town there’s a big, really big Greek Orthodox church.

Why? Continue reading