Finance Basic To Advance Level Knowledge

Back on the Eurozone crisis front we find find some great lines from Michael Darda and Marshal Auerback on the latest developments.  Here is Darda from his latest newsletter: Although there seems to be some optimism in European equity markets that Thursday’s finance ministers’ powwow will bring a “shock and awe”  announcement, we would not wait to exhale. As we’ve argued before, eurozone nominal GDP is about 10% below trend. This has caused tax revenues to collapse and debt burdens to mushroom. Since the ECB has tightened liquidity and raised rates instead of lowering  them and adding liquidity,  we simply  see  no path to  a  recovery in nominal GDP (and solvency) for the European periphery, whose costs and prices are out of whack with the rest  of the eurozone. Rearranging the deckchairs with  alphabet soup bailout schemes and fiscal austerity measures has failed for 14 months and will continue to fail unless accompanied by  a m...

The ECB today followed through on it plans to tighten monetary policy, the second time it has done so since April.  As I have noted before, tightening monetary policy is the worst thing the ECB could be doing right now if it truly cares about preserving the Eurozone in its current form.  If the ECB does care it should be easing monetary policy to help bring about a real appreciation in the core countries and real depreciation in the periphery.  Even if the ECB is indifferent there is still no justification for tightening monetary policy based on its objectives.  For, as Rebecca Wilder notes , inflation expectations are down and the growth in the ECB's targeted monetary supply is tapering off.  So this tightening cycle is truly bewildering.  Maybe the tightening cycle is to provide cover to the ECB buying up debt from the periphery or maybe the ECB is trying to hasten what seems to many the inevitable downsizing of the Eurozone. Either way, the band Europe...

San Francisco Fed economist Fernanda Nechio shows us in one picture the ECB monetary policy mess: If there were any doubt that the ECB is in practice narrowly setting monetary policy for the core countries (i.e. Germany and France) this figure should remove it.  The figure should also nix any doubts as to whether what is good for the core is good for the periphery.  ECB monetary policy was too loose in the early-to-mid 2000s and now it is too tight.  If the ECB really wants to preserve the Eurozone in its current form it must confront this reality.  So far it hasn't and this is why I say the ECB is fiddling while the Eurozone is burning .

Nouriel Roubini has written a number of good pieces on the Eurozone crisis.  His latest one in the Financial Times is no different.  It provides a summary of how the Eurozone got to this point and the options left for it going foward.  Here are the options according to Roubini: (1) The euro could fall sharply in value towards – say – parity with the US dollar, to restore competitiveness to the periphery; but a sharp fall of the euro is unlikely given the trade strength of Germany and the hawkish policies of the European Central Bank . (2) The German route — reforms to increase productivity growth and keep a lid on wage growth — will not work either. In the short run such reforms actually tend to reduce growth and it took more than a decade for Germany to restore its competitiveness, a horizon that is way too long for periphery economies that need growth soon. (3) Deflation is a third option, but this is also associated with persistent recession. Argentina tried th...

So the European Central Bank (ECB) has decided to follow through on its plans to tighten monetary policy this year. The ECB will begin by raising its benchmark interest rate next month.  This is unbelievable. The Eurozone is under severe pressure that could ultimately lead to its breakup and yet the primary concern at the ECB is tightening monetary policy according to schedule.  If followed through, the consequences of this are not only bad for the Eurozone, but for the rest of the global economy too.  The slow-motion bank run now taking place in the Eurozone could easily turn into another severe global financial crisis.   So why then is the ECB pushing so hard for monetary policy tightening?  From the New York Times we learn the answer: With Germany, the euro zone’s largest economy, growing so quickly that some economists fear overheating, the E.C.B. has been trying to nudge interest rates back to levels that would be normal in an upturn. Silly me, I...

In my previous post I argued the ECB could help the Eurozone not just by refraining from interest rate hikes, but by easing monetary policy.  I said doing so would lead to a real appreciation in the core economies of Germany and France and a much needed real depreciation in the periphery.  This would not solve the periphery's problems, but it would make them more manageable.  This is an argument I fist heard from Ryan Avent and I find it compelling.  Let me explain it in more depth. If the ECB were to ease monetary policy, it would cause inflation to rise more in those parts of the Eurozone where there is less excess capacity.  Currently, there is less economic slack in the core countries, especially Germany.  The price level, therefore, would increase more in Germany than in the troubled periphery.  Good and services from the periphery would then be relatively cheaper.  Thus, even though the exchange rate among them would not change, th...

Kantoos responds to my earlier question as to whether Germans dislike inflation or bailouts more. He says that this is a difficult question since Germans passionately detest both. What is known, though, is that because of these strong views there is a sort of  policy paralysis in Germany that leads to a non-optimal policy outcome: This would be the worst possible deal for the Eurozone that Germany could have made: The bailouts prolong the crisis without putting the burden, where it should be put: on the bondholders. And yes, these are in part German banks and insurances. The contractionary monetary policy on the other hand forces the periphery in an already suboptimal currency union to adjust even more than what would otherwise have been necessary with an adequate monetary policy. Sigh. On a lighter note, Merle Hazard has penned a new song about Germany's problems: And here you can find Merle Hazard's song on Ireland's problems.

The ECB, according to Kantoos and Scott Sumner ,  is effectively targeting a stable nominal GDP path for Germany.  Moreover, it is doing a fine job at it.  Kantoos further shows that nominal wage growth is being stabilized around 2% a year.  I take that to mean the ECB is not just effectively targeting nominal GDP, but nominal GDP per capita for Germany.  This comes close to what I think is an ideal goal for monetary policy for reasons discussed here .  Now while the ECB's monetary policy may be great for Germany it is too tight for the periphery of the Eurozone.  Because this one-size-fits-all monetary policy makes it difficult for the the Eurozone  to solve its current problems, the European countries seemingly face the tough choice of giving up their currency union experiment or giving up their national sovereignties to make the currency union more functional. Ryan Avent notes , though, that there is a third way to solve this problem: have th...