Barro, the euro and credibility

Robert Barro, the cheerleader of dollarization and common currencies, has finally come out of the closet. No, not in that way; he just came out against the euro in his Wall Street Journal column (subscription required). He says:

"The euro was a noble experiment, but it has failed. Instead of wasting more money on expanding the system's scope and developing ever larger rescue funds, it would be better for the EU and others to think about how best to revert to a system of individual currencies."

The interesting thing is that he wants to discard the euro for all the wrong reasons. In his view, the problem is fiscal, and what the new national currencies would allow is for 'credible' fiscal adjustments. Again, in his own words:

"Worries about values of government bonds are rational because it is unclear whether—even with assistance from the center—Italy and other weak members will be able and willing to meet their long-term euro obligations. A new (or restored) system of national currencies would be more credible, because Italy should be able and willing to meet its obligations denominated in new liras."

Forget that the ECB can actually buy bonds (Italian and others), and reduce the burden of interest payments, allowing for more expansionary fiscal policy, which is what you need in a recession.

The Euro Imbalances and Financial Deregulation

New paper at the Levy Economics Institute. From the abstract:

Conventional wisdom suggests that the European debt crisis, which has thus far led to severe adjustment programs crafted by the European Union and the International Monetary Fund in both Greece and Ireland, was caused by fiscal profligacy on the part of peripheral, or noncore, countries in combination with a welfare state model, and that the role of the common currency—the euro—was at best minimal.This paper aims to show that, contrary to conventional wisdom, the crisis in Europe is the result of an imbalance between core and noncore countries that is inherent in the euro economic model. Underpinned by a process of monetary unification and financial deregulation, core eurozone countries pursued export-led growth policies—or, more specifically, “beggar thy neighbor” policies—at the expense of mounting disequilibria and debt accumulation in the periphery. This imbalance became unsustainable, and this unsustainability was a causal factor in the global financial crisis of 2007–08. The paper also maintains that the eurozone could avoid cumulative imbalances by adopting John Maynard Keynes’s notion of the generalized banking principle (a fundamental principle of his clearing union proposal) as a central element of its monetary integration arrangement.

Read the rest here.

It's the ECB stupid!

So the Fed announced yesterday that they will inject money into European banks if needed. Mark Thoma and Paul Krugman posted about it (here and here). This is not new, since the Fed did lend to European banks after the Lehman collapse. The reason is simple, US banks would be also affected by a collapse of the European banking sector. The point is that this not sufficient to end the euro crisis, for that the ECB must act buying European bonds. No substitute for that. So Bernanke is still asking: what are these guys doing over there?

The full Monti, and Papademos too

Mario Monti in Italy and Lucas Papademos have substituted the fragile and questioned prime ministers in their respective countries. Monti was an European Commissioner with great experience with the EU institutions, while Papademos was the president of the Bank of Greece and vice president of the ECB. Both are economists. The notion is that now with serious and responsible technical men in charge the chances for a solution, which is still in the view of European authorities more austerity, have increased.

The only possible logical diagnosis in which that would be true is if this would have been a crisis of "confidence." As that is not the case the crisis will continue, and become more intractable. Today, after the Eurozone bonds of almost all countries, including France, were forced to pay a higher risk premium the chief economist of JPMorgan Asset Management said that "Germany [is] the only functioning bond market left in the eurozone." A zone of one.

Original Sin And The Euro Crisis

Krugman has now twice argued that Europe faces an original sin problem (here and here). Let me be absolutely clear. Europe does NOT have an original sin problem. The original sin, a term invented by Ricardo Hausmann (see here), is a situation in which the domestic currency cannot be used to borrow in international markets or to borrow long-term in domestic markets. By the way, a new name for an old problem that was well known by Raúl Prebisch and other Latin American structuralists at ECLAC back in the 1950s, who recommended avoiding excessive borrowing in  foreign currency.

It is true that there are no European bonds, and that Greece, as the other countries of the euro, do borrow in a currency they do not control. However, the ECB can buy Greek bonds, and does print euros. That is not the case in a developing country that borrows in foreign currency, and does have an original sin problem. In that sense, the problem in the Eurozone is the unwillingness of the ECB to monetize even small amounts of debt. Misplaced monetarism, not the original sin, is the problem in Europe.

Mario Draghing the feet on monetary policy

Central Banks have been at the epicenter of the current crisis, and have been, for good and for bad, fundamental for the policy response mounted to avoid a new Great Depression. Recently Christina Romer argued that the Fed should start targeting nominal Gross Domestic Product (GDP) instead of inflation. As I noted previously (see here), this is strange since it is far from clear that the Fed actually targets just inflation, or that targeting nominal output would make any significant difference.

Further, the idea that a central bank has the ability to actually hit a targeted level of output, or inflation for that matter, under the current circumstances in particular, is wishful thinking. Central banks can ease the credit conditions by reducing interest rates, a range of rates from the short to the long, to stimulate spending, and pump money into the system, fundamentally to avoid systemic crisis caused by bankruptcies. The ability of Ben Bernanke or Mario Draghi, the newly appointed head of the European Central Bank (ECB) that reduced the rate of interest in Europe as his first measure (see here), to further reduce interest rates and with that help the staggering recovery in the US or the free fall in the periphery of Europe is very limited.

Read the rest here.

The ECB is throwing gas on a fire

Professor Massimo Pivetti has recently commented on the European Central Bank's (ECB) interest rate increases, that add monetary contraction to the brutal fiscal adjustment that several countries in the periphery of Europe have been subjected to. He says:

"The ECB increased the rate of interest – in what is very likely the first one of a series of increases expected in the next months – with the objective of controlling inflation that accelerated to 2.6% in March from 2.4% in February. Given that this inflation bout has external origins, caused by the increase in the international price of energy, raw materials and foodstuff, the reasoning behind the anti-inflation policy based on dear money is not immediately obvious.

First of all, according to the currently dominant versions of the orthodox point of view about monetary policy, an increase of the rate of interest by the central bank would be only justified if the reasons for the greater inflation including also monetary wages rises would be attributable to imbalances in the conditions of domestic aggregate demand and supply. But certainly not even Trichet would think that today, within euro-system, aggregate demand is pressing beyond the limits of potential product.

He goes on to argue that the ECB policy is like trying to put out a fire by throwing gasoline on the flames, since higher rates of interest translate into higher costs, which firms would pass to their prices.  He notes correctly that the anti-inflationary impact of this policy comes from the appreciation of the euro, which reduces the cost of imported goods, and the reduced wage pressures from an even more depressed economy.  The rest can be read here (if you read in Italian).