Thursday, April 18, 2013

"The role of monetary policy in addressing the crisis in the euro area": A few ambitious notes.

I would like to point out a few thoughts of mine with respect to a speech by Mario Draghi on April 15, 2013; "The role of monetary policy in addressing the crisis in the euro area".

Firstly, it is the controversial Outright Monetary Transactions (OMT). OMT was announced by Draghi on September 6, 2012. When I first heard the news I couldn't believe my ears and I watched the whole press conference. After that I was kind of emotionally overheated believing that Mario Draghi crossed the Rubicon and Euro area would never be the same again! A few months later my expectations dashed. What happened is that I fooled my own self by playing down the condition of ESM involvement... So far the unlimited bond buying mechanism has never been activated; bank deposits haircut is on its way instead. ECB is not allowed to finance sovereign debt; it is a matter of credibility. Indeed... But the question that needs an answer is how credible our banking system and our hard currency is now. Or this is "neither the responsibility nor the mandate of monetary policy"?

It is not Draghi's fault that the ECB was designed only to target inflation but it was the false perception that the only threats are the debt and the inflation. Briefly, economics is all about debt and inflation, only? No. Economics guide mankind through much more paths. MROs and LTROs are not the only remedy to use until the moment when Eurozone fully recovers and returns to its path of growth. These tools have been effective to maintain a bounded interbank rate but they cannot repair the transmission mechanism of the fragmented Europeans monetary system. The reason is simple, households, SMEs and credit institutions in the stressful regions are operating in an adverse macroeconomic environment and the banking system is unwilling to undertake the great risk posed by providing credit under such a macro- environment. Consequently, this credit risk cannot be reversed for as long as austerity not only preserves but also deteriorates this adverse macroeconomic state of affairs. 

Secondly, it is the enhancement of competitiveness of Greece and the structural reforms declared in Draghi's speech. As a matter fact none of them is true! Despite the legislated fast track procedure for large investment projects and some mitigation in bureaucracy for starting a business no other structural reform has been so far implemented and no emancipation of certain sectors (markets) has been achieved either. No need to mention the strategies for cluster formation, enhancement of human capital, innovation, R&D and the dissemination of ICT to economic activities and public administration; strategies which are nonexistent whatsoever. 

According to Global Competitiveness Report of 2012-2013 by World Economic Forum- although many economists doubt the results of WEF, they can serve as an elementary benchmark in this cases- Greece has fallen six (6) places; being 9oth in 2011-12 to 96th in 2012-13. Nevertheless, competitiveness as measured by the unit labor cost has indeed significantly declined. But competitiveness is not about prices; remember that Apple products are major sources of value added despite being highly priced. I do not mean to compare the Greek economy with Apple Inc., but the point I am trying to make is that other measures are necessary to increase the competitiveness of a nation but the price of labor. Furthermore, with long-term unemployment representing almost half of total unemployment human capital is retrogressing at a faster pace entraining competitiveness.

Competitiveness is definitely "neither the responsibility nor the mandate of monetary policy", but there are facts that must not be neglected when this matter is a subject of a discussion.

Thirdly, it is the role of ECB in times like the post-Lehman era. The credit crunch and the severe liquidity constraints generated by the extensive market collapse of 2008 are challenges that have been successfully- to some extent- met. However, rolling over corporate failure to the state in the form of bail outs is a questionable option. Mario Draghi manifested in his speech that "undertaking structural reforms, budget consolidation and restoring bank balance sheet health is neither the responsibility nor the mandate of monetary policy". Let us take some things from the beginning. Fact No. 1: certain financial institutions are "too big to fail", regardless the point of view of the Austrian School. Fact No. 2: markets had been left completely unregulated and any government involvement was prohibited and sometimes considered a sin (maybe for some, the eighth sin) as a result of Austrian and Chicago School perspectives. Fact No. 3: failure of financial institutions begun.

I would like to note in passing that the dogma of laissez faire is violated since government borrows funds in order to bail out the failing institutions. In other words, it is like claiming that a plus b equals c is true up a point but after that point a plus b equals d or e or @ or & or # or whatever; that is not mathematics, charlatanism it is! In that way, claims that government should not intervene and markets must be free of government reach but when things get ugly it is the government that should take over the correction are somewhere entrapped by a misconception. Government being unwanted when economy thrives, but necessary when system collapses? Keynesians got it right: regulation is necessary to some extent, government intervention is necessary when needed- full stop. That point is implementable in any case and does not lose its sense during boom nor bust.

My opinion is that certain institutions are indeed "too big to fail" and that is why government should be present both when cows are fat and when are lean. But government cannot at the same time boost the aggregate demand and absorb the failing credit institutions, because debt will skyrocket. The balance sheet of the banks is sort of a nominal (monetary) issue and resources are waisted if they are used to restore its soundness. On the contrary, if the ECB takes over these bail outs there is no impact on debt (as far as bail outs are concerned); real resources are not wasted; a Central Bank has the technical knowledge to purge the banking corporations; such an intervention can always be sterilized; share-holders will lose the value (a disincentive for excessive risk taking, remedy for moral hazard) of their equity instead of savers who are not compensated for such risk when they place their deposits. After soundness is achieved, these banks shall be merged by others. 

Correct me if I am wrong but I do not see anything bad about the ECB bailing out. I do not see how credibility will be damaged either. Nor do I see why private sector's misconduct must be paid by the public sector. Do you still believe that "restoring bank balance sheet health should not be the responsibility nor the mandate of" the ECB, under the current extremely adverse economic prospects? ECB must not exclusively focus on monetary policy when economy is not at its best, besides the name is "European Central Bank" not "European Monetary Policy Authority"!

Last but not least, I have already expressed myself about the non presence of deflation and given that oil prices have recorded significant losses over the last few months and are expected not to rise shortly, I would not be that confident over deflation in the EMU. Deflation in the EMU is impending- provided oil prices remain low- and the available monetary tools will be inadequate (even MROs with 100% allotment at 0% will not further increase liquidity) against that scenario while fiscal tools are prohibited. It is more or less a dead end, but we can always turn the blind eye to the imminent threats and focus on austerity.

At the end of the day, European economy must me protected against any threats sometimes at any cost! I sincerely hope that someday our leaders will understand that the cost of their dogmas are much higher than that of other available remedies.