Eichengreen and Temin on systems failures

Barry Eichengreen and Peter Temin have written classic accounts of the Great Depression. If you haven’t read Golden Fetters, and Lessons from the Great Depression, you should.

But if you don’t have time for that, they have a piece on Vox which reprises the main conclusion of their work:

an international monetary system is .. a system in which countries on both sides of the exchange rate contribute to its smooth operation. Actions by surplus countries, and not just their deficit counterparts, have systemic implications. They cannot realistically assign all responsibility for adjustment to their deficit counterparts.

This is as true for EMU and “Bretton Woods II” as it was for Bretton Woods, or the Gold Standard, but it is a lesson that at times seems to have been completely forgotten.

33 replies on “Eichengreen and Temin on systems failures”

This is a timely and profound contribution to the international debate. Irrespective of any policy lunacy and regulatory failures that were super-imposed during the credit bubble, it is important to get back to these underlying imbalances that still exist both globally and in the EZ.

However, it appears that China is adjusting slowly to rebalance its economy away from export-led growth, but, like the huge tanker it is, the pace of turning is almost imperceptible – and is being slowed by the CCP’s desire to keep a firm grip on the helm. And the adjustment is taking place in the context of significant investment in this and the previous two 5 Year Plans to spread the east coast prosperity into the western provinces.

It is impossible to assess with any confidence the extent to which this adjustment will be either sufficiently timely or large enough to benefit deficit countries, but it appears that, in the EZ, Germany is determined not to deviate from its export-led growth model. It seems to be a case of either you behave like us or we don’t want to know. This doesn’t augur well for the PIGS.

The main claim of the article is that the Euro currency reflects a narrow-minded ideology essentially the same as the Gold Standard ideology of the 1930s and, like the Gold Standard, the Euro experiment is destined to fail, with possibly disastrous consequences.

Their claim seems a bit extreme to me but they might be correct. Kevin do you agree with them?

I don’t think the article says anything about the reasons behind the Euro experiment Greg. What it points out is that once the experiment has been embarked upon, the Eurozone, like the current China-US exchange rate arrangement, has to be understood as a system, and that analyses that just look at policies in one country at a time miss this. So do analyses that just look at the required adjustments in deficit countries — if only deficit countries adjust, this imparts a deflationary bias to the system, and eventually something has to give.

I coming to the end of “Lords of Finance” which deals with the same topic. It is scary how long it can take people to take the necessary actions to break deflation. It is also scary to note the risks involved in any such action.

If our fate is lashed to the ship of the Euro then it is important that we focus on the proper management of the currency. We cannot let German and British-Conservative fetishes destroy our welfare. The ECB must take the bold actions needed as their independence permits them and in the absence of a coherent political process. Unlike the USA, there will be no president of the EU granted sufficient powers to take radical steps to turn the ship around.


Agree, but I fear “[t]he ECB must take the bold actions needed ..” is a vain hope. The ECB sprang fully formed from the loins of the Bundesbank – and in the same location. Unlike the Fed, which must take inflation, economic growth and employment into account, the ECB just has an inflation target – and that’s the way the Germans want it. Yes, it may have been required to do things it wasn’t designed to do, or was comfortable doing, during the current crisis, but it will want to, and Germany will require it to, retreat to its previous role as quickly as possible.

The southern PIGS will survive, in Germany’s eyes, if they achieve some fiscal continence, produce cheap food for export and some lower grade inputs to the German industrial process, supply sunny vacations for the masses and keep buying German output. I’m not sure where that leaves Ireland.

“Golden Fetters” should be mandatory reading for national policy makers and for economic commentators.

There is a shocking failure in public life to comprehend the importance of monetary policy and systems.

By joining EMU we reduced the volatility of our currency movements but we imported massive additional volatility into our domestic economy via an interest-rate regime which is always more likely to be inappropriate to our need than appropriate.

We seem now to be condemned to a prolonged period of debt-deflation. I’m not sure, Kevin, that your recent model on housing recoveries factored in broader macroeconomic factors. I would suggest that the current thrust of our EMU membership is likely to prolong our pain beyond that suggested by a pure housing model.

Isn’t the fear of deflation being greatly overdone?

Wheat today reached a 22-month high, up 50pc from this time last year?

Oil today is up to $82 a barrel, the highest since Sep 2008.

Other commodity prices are also soaring.

Eurozone inflation rate has risen sharply to 1.7pc in July.

UK inflation rate was 3.2pc in June.

Ireland’s consumer price inflation is still negative, thanks mainly to the fall in sterling and the dollar v the euro in 2009 and early 2010. But, since early 2010, the euro has fallen by almost 10pc against both. This is bound to affect Ireland’s consumer price inflation rate in late 2010. Even as of now, manufacturing output prices in Ireland were up 1.2pc y-o-y in June, while agricultural output prices in Ireland were up 6.6pc y-o-y in May, with milk prices up almost 30pc.

Bye bye deflation!

The ideal scenario for Ireland would be modest inflation of around 2pc in the Eurozone, higher inflation of around 4pc in the UK, and positive but lower inflation of around 1pc in Ireland.

I don’t think that a housing market recovery is a *sufficient* condition for a general recovery Cormac. But, in any event, our study showed that the prospect for a housing recovery in Ireland was essentially zero right now, so I don’t think we can be accused of excess optimism regarding Ireland.

@Kevin O’Rourke

@JtO: re wheat prices, see

Thank you for the link, Kevin. What the FT report says is that wheat prices have risen by 50pc between June and yesterday, but have fallen by 3pc or so today following some soothing noises by the Russians. That still doesn’t exactly lend support to the view that the world economy is entering an era of deflation, which some of the posts above (although not your’s) have claimed, especially when put alongside the other inflation indicators I gave in my post. As for Ireland, more important than the wheat price, is the fact that the euro fell to 82.5p sterling today, nearly 10pc lower than it was in early 2010. If it stays at that rate, it will wipe out deflation and bring back inflation in Ireland in a matter of months. In the words (almost) of the rousing patriotic ballad sung by The Wolfe Tones, it will soon be ‘Inflation Once Again’. The sooner the better. Deflation is clearly a bad thing. It encourages people to postpone spending if prices are falling. A moderate inflation is the oil that keeps economic engines running smoothly. As long as it stays below that of other countries, which seems likely, a moderate positive inflation rate for Ireland is to be greatly welcomed.

You expect salaries to increase to match the increases in commodity prices? (Internal incomes to rise to meet external costs?). I really can’t see it myself. The public sector is stuffed for the moment – it may not have reductions in income, but is unlikely to see increases. The domestically traded economy is likewise at best approaching standstill. The internationally trading one is watching its competitiveness.

Even leaving aside the impact of three more years of budget cuts, I don’t see where income increases are going to come from. Commodity price rises will reduce money in circulation in the domestic economy as more is spent on importing the same amounts. This is deflationary, no?

I don’t see how inflation at 1% will be sufficient in Ireland when the cost of funds for our banks is well above ECB interest rates and those self-same banks are desperate for profits.


Perhaps I am “reading between the lines” too much, but I thought that beneath a diplomatic veneer the article was surprisingly negative and pessimistic about the Euro experiment. They compare it to the “ideology of the Gold Standard” (we know where that led the world economy in the 1930s) only worse. As American economists they are understandably diplomatic but the message is there, in my opinion. Am I misreading them?
See my selective quotes below.

The gold standard is ideology

But the gold standard was not just a monetary arrangement. It was also an ideology. ..[skip ahead]..In the deflationary circumstances of the time, this was precisely the wrong way of thinking about the problem. ..[skip ahead]….The 21st century analogues – the euro and the dollar-renminbi peg – are not identical, but the parallels are there.

Eurozone commitment: Harder than gold

Adopting the euro is, if anything, an even harder commitment than gold. Countries could leave the gold standard during crises without enraging investors, but countries cannot temporarily abandon the euro in times of crisis …

It was many people’s analysis that the only way for Ireland to recover was to deflate wages and costs in order to regain competitiveness.

If the rest of Europe cuts its costs to make itself more competitive then we will have to cut even more to make up ground. We are in fact doing that successfully.

However, if the rest of Europe cuts its costs so as to cause a continent-wide drop in consumption then it will be extremely hard for Ireland and the other countries in difficulty to obtain sufficient benefit from improved competitiveness. If the Euro strengthens against other currencies then it will cause additional difficulties.

We, and other countries in difficulty, are playing our part in the solution by imposing austerity. If those in a strong position in Europe do not play their part by pursuing a more expansionist policy then some in Southern Europe may decide to re-assess their policies.

It is hard to know what the solution might be as printing money is an expensive business when the money printed represents only fills the holes left by losses rather than increasing the supply of money in the system. It also creates a risk of panic.

The solution appears may be an orderly restructuring of sovereign debt
– to a degree that can be tolerated by the banking system
– involving a degree of pain for the defaulting countries to avoid moral hazard and to provide a political sweetener for others
– but allowing markets to treat the defaulters with equanimity so that they can rebuild quickly rather than becoming pariahs.

This course is still open but we are struggling to keep control of the vehicle. The rescue fund and ECB purchase of bonds may throw us off course politically (as default becomes more of a bugbear for voters) and economically (as the burden is put on stretched tax-payers rather than profitable institutions). However, it is giving some breathing space with the banks and may allow a more orderly restructuring.

On the printing of money, it strikes me that there is a threshold that must be crossed before one gets benefits, i.e. one must fill the hole left by losses before the money supply position will be improved.

Stopping short of that threshold appears a dangerous position as one gets an increased sovereign debt without the benefit of increased economic activity and also without the relief of inflation.

Is there a danger that the UK and Germany will make this mistake?

@Greg, the point about the Euro being a harder commitment than the gold standard is just a restatement of this now-classic piece by Barry (who was on balance favourable to the Euro-experiment during the 1990s):


The gold standard did involve a narrow austerian mentality, and that is why it collapsed in flames bringing Europe down wiith it, but there is no technical reason why the Eurozone necessarily has to go down the same road. (Maybe there are political reasons: that is another matter, and I think this vox piece is meant as a contribution towards that particular debate.) The ECB has not been behaving like a gold standard-era central bank, and the Germans have to date been much less irresponsible than the rhetoric of Weber et al would lead you to believe. But the basic point which Barry and Peter make about the dangers of focussing on deficit countries only is spot on IMO.


Yes I see your point, reading the earlier piece in conjunction, perhaps there is a glimmer of hope expressed somewhere in the two articles that the rigid Euro system might survive the recent shocks and future tremors intact. The articles provide an interesting perspective, not unremittantly gloomy but certainly not cheerful!

“On the printing of money, it strikes me that there is a threshold that must be crossed before one gets benefits, i.e. one must fill the hole left by losses before the money supply position will be improved.

Stopping short of that threshold appears a dangerous position as one gets an increased sovereign debt without the benefit of increased economic activity and also without the relief of inflation.

Is there a danger that the UK and Germany will make this mistake?”

Increased sovereign debt is not printing money, nor is it quantative easing. It is fiscal stimulus that must be paid back (borrowing from the future to fund current spending). A Central Bank buying bonds in open market operations – that is QE. It becomes ‘printing’ if, as in the case of the BoE and the Fed, there is no attempt to enforce full repayment (the bought bonds are written off or sold back at lower than they were bought for).

I don’t see that the ECB’s current position is tenable, however; as you point out there is a hole to be filled. The size of the hole in Europe is uncertain, though, as unlimited liquidity has boosted the price of assets that should really be cheapening. Is the ECB storing up trouble? Probably and on both sides of the balance sheet (the prices of assets and the extent of sovereign issue that is going on for fiscal stimulus). There appears to be a proto-keynsian hope that the eurozone can trade its way out of its difficulties – a return to growth = lower debt to GDP = exchequer surplus = lower defaults = asset LTEV success.

There doesn’t seem to be any sense of either the weight of debt in the periphery (and so the unlikelihood of it all being paid back) or that investment opportunities that will make an economic return are few (could it be that peak efficiency under current technology has been reached for the advanced economies?).

Is deflation not a contraction in the supply of money in the ecomony(economic lubricant) rather that a decrease in CPI ( a lagging indicator or deflation).
In a deflationary situation the cost of discretionary goods may decline but the price of essentials may increase (decreased affordability) when cash becomes king… ie no credit facility.


Thanks for the clarification. However, if the EC buys sovereign bonds then doesn’t that increase sovereign debt? Can you clarify how the Fed and BoE have done this in such away as to not increase the deficit of the country issuing the bonds?

Is it the case that the Central Banks have no creditors and therefore their collateral can never be lost? I am not clear how this works.

If the ECB buys bonds other than sovereign bonds or quasi-sovereign bonds then isn’t that a subsidy to debtholders which is not targetted? Presumably that doesn’t happen.

Well, you could argue that by being a willing buyer and creating a market, this does increase the debt of a country.

All three CBs are operating in secondary markets, that is, they are buying from market participants who have bought from governments. The market participants used ‘money’ to pay the governments, the Central Bank uses ‘money’ to pay the market participants, so there is no net addition of ‘money’ to the system.

There are really two operations going on:
1. Fiscal deficits of countries ‘causing’ issue of treasuries.
2. Depreciating assets in markets ‘causing’ interest rate rises.

Interest rate rises (i.e. the increase in riskiness of holding particular assets = a drop in the perceived value of the asset = an increase in price) would be unwelcome at this juncture. So what’s the best way to keep interest rates down? Well, start at the top of the tree and make sure the safest asset (from which all others derive a comparative riskiness) is trading at a high price (and so a low interest rate). The top of the tree is sovereigns.

In all three central banks, there’s also ‘quasi-sovereigns’ – at least they are quasi in the US – mortgage debt, whether securitised from the GSEs in the US or covered bonds in the UK and Europe. All three CBs have also bought mortgage debt (as the next best thing) to try and get that market moving again and keep interest rate spreads (to treasuries) down. As far as I can see, all they’ve done is become the greater fool, but then, thankfully, I’m no expert.

So, do you see the logic in the madness? If you accept the initial premise that there is no relationship between the CBs’ purchases and government’s issuance, then the CBs are really only look at asset prices in the market… it’s a mad, mad, mad, mad, mad world…

A quibble I have with applying lessons of the gold standard to the current monetary arraignment is that one problem with the gold standard in the US was the ‘gold clause’. If the government ‘printed money’ ordinary long term contracts denominated in gold required the debtor to make increased payments due to increases in the price of gold. In other words there was a kind of inflation adjustment.

Under current circumstances a similar situation exists with inflation adjustments built into government spending programs, for example government pension schemes in the US, including social security. Perhaps those that are in favor of increased government “money printing” need to first eliminate modern day ‘gold clauses’ by removing them or making them unenforceable, as was done with the elimination of the gold standard in the US.

One effect of ‘injecting’ money into the private sector economy via Quantitative Easing schemes is to create inflation and therefore increase the payout of all manner of government entitlement programs. As individual states cannot print money they are forced to increase taxes to pay for improved benefits packages, which sucks money out of the private sector economy. In effect any money printing just ends up back in the government, without changing much in the private sector economy.

Evidence of the stress these automatic inflation adjustments are having can be seen in the bankrupt US communities of Vallejo Ca, Prichard Al., and Central Falls RI. The state of New Jersey pensions scheme seems to be teetering.

In short learned people seem to be selective in their understanding of the gold standard forgetting about the gold clause, which might be the most important part.


You (JtO) expect salaries to increase to match the increases in commodity prices? (Internal incomes to rise to meet external costs?). I really can’t see it myself. The public sector is stuffed for the moment – it may not have reductions in income, but is unlikely to see increases. The domestically traded economy is likewise at best approaching standstill. The internationally trading one is watching its competitiveness.

As always, you ask very good questions. Trying to disentangle the various aspects, I’d break my answers down as follows. First, I’ll separate price inflation and income inflation. Second, I’ll separate Ireland from the rest of the world.

First, global price inflation. The original suggestions from some posters, and forecast by some economists, and even more so by some hysterical commentators like Ambrose-Evans Pritchard, is that we are entering a period of global price defaltion. This fits in with their theory that we are stuck in a global depression (the evidence for which getsless almost daily). As the figures I gave above showed, there is no sign of global price deflation. Commodity prices are rising quite rapidly. Overall consumer price inflation in the Eurozone has risen sharply to 1.7pc. In non-Eurozone countries, it is much higher still (3.2pc in UK). So, no signs at all of global price deflation on the horizon.

Next, price inflation in Ireland. Ireland often diverges from the global trend, because of our uniquely open economy and unique extent to which our price level is determined by imports, especially imports from outside the Eurozone. So, if the euro goes up sharply against sterling and the dollar, Ireland’s price inflation is lower than global price inflation. But, if the euro goes down sharply against sterling and the dollar, Ireland’s price inflation is higher than global price inflation. The euro rose 20pc against sterling and the dollar in 2008 and 2009, so Ireland had much lower inflation than global inflation, in fact Ireland had deflation. Since early 2010, the euro has fallen 10pc against sterling and the dollar. If it stays at that level, Ireland’s inflation rate will rise to roughly the level of global inflation, maybe above it. But, obviously, if the euro goes back up again, this won’t happen.

Turning now to income inflation.

Income inflation is far more often than not higher than price inflation. That would be true of nearly every country in nearly every decade since World War 2. It is because of productivity increases. It is why the real wages of most employees have risen in most countries over periods of time. If income inflation is 4pc, and productivity increases are 2pc, it is likely that price inflation will be about 2pc, over the long run. During the trough of recession, this link may not hold, as the balance of power swings towards employers and they may refuse employees the wage increases that have been earned by their productivity increases (meaning unit wage costs fall). But, over the long run, wage inflation nearly always is considerably greater than price inflation. This is clear from the historical record. If you doubt it, comapre the average wage in 2010 with that in 1950, and see by how much more it has increased than prices have in that time.

Regarding commodity price increases, as far as Ireland is concerned, it depends entirely on the commodity. If it is oil, or other imported commodities, you are quite correct in suggesting that price inflation in these commodities does not increase incomes in Ireland. But, if it is commodities that Ireland exports, like meat and dairy products, it most certainly does. The best example is dairy products. As a result of the commodities price boom, prices paid to dairy farmers in Ireland for dairy are currently up by 43pc since this time last year. So, their incomes will certainly rise massively in 2010 and, while this won’t increase my income or your’s (unless you are a dairy farmer), it will increase Ireland’s national income.


I can understand how overvaluing assets bought by central banks might be considered QE. However, that is relatively untargetted. Also, it may not be legally possible. Is there no other avenue of QE open to the Central Bank other than buying dodgy assets? Perhaps the best bet is for the ECB to buy dodgy sovereign bonds and then agree to a massive restructuring.

“Perhaps the best bet is for the ECB to buy dodgy sovereign bonds and then agree to a massive restructuring.”
Indeed and I have been betting on such an outcome for some three years…

If the creditor countries (Germany and France) are not to suffer as a result of their profligate lending and the debtor countries cannot make good on their profligate borrowing, someone is going to have to stand in the middle and share the pain out. Unpalateable? Ja. Bien sur.

As the key point is income inflation (everything else is random price movements), I’ll take issue with this one:
“Income inflation is far more often than not higher than price inflation. ”

Well, it depends on what you measure in your basket of prices. Add in housing costs, health costs, legal costs…

But even taking standard CPI, I’m interested that you make the generalisation. It is not my experience:
US – no rises in real wages for 40 years
Germany – no rises in 20 years
Japan – down 11% in ten years

Did I miss any of the big economies? Oh yeah, China. Until recently, real wages had been flat for some 50 years. There’s some evidence of push with labour shortages likely in the future and with understatement of inflation by the state, but it remains to be seen how effective this will be.

Some countries have clearly increased their wages beyond inflation – Ireland, your own UK, France, but it is pretty clear that they are going to have to slide for a while – as Mervyn King has said: (to paraphrase) when you have borrowed your way to bust, you are going to have to accept a lower standard of living as a result.


How do you bet that will happen?

In any event, that still increases aggregate sovereign debt in the Eurozone up until the restructuring causing severe damage on the way. Therefore, whil restructuring may take place it is probably not a valid recovery policy.

There is also an issue as to whether QE is directed towards debt holes or not. Lending to banks in debt without clearing that debt simply benefits their counterparties. We do not know who those counterparties are or where that money will go. However, we do know that it is largely already accounted for on their books as it already has a notional existence. Therefore, channeling the money through existing banks ensures that it is funnelled into the debt hole rather than building a new mound beside it.

On the other hand, if the ECB was to provide funds to new banks / subsidiaries with clean balance sheets purely for the purpose of lending it to small businesses for working capital and expansion then that money would flow directly into the economy. It could be presribed that the businesses should only be limited liability and that NewBank employees wages be linked to loan book performance.

It could be argued that more should be provided to countries less likely to default to rebalance the economies within the Euro, to reward them for their prudence and because they are less likely to default therefore the net “gift” to them will be less.

However, I am still not clear what mechanism the ECB can use to engage in quantative easing without increasing aggregate private and public debt at the same time, although that is what I have tried to do by requiring that new funds would only go to limited liability companies.

Mostly it is bets for n’giggles (as well as for optimism – without some sort of debt restructuring, we are in for a grim time). Also, staying invested in eurozone sovereigns…

It does lead to an increase in credit, but that presupposes that the sovereigns are not issued to fill debt holes elsewhere. As you say, there are debt holes in the banks. But the ECB channelling money directly to the banks would have to be seen as a doomsday moral hazard scenario, short of the european wide bank resolution scheme that I was talking about in earlier posts – the banks get busted, the shareholders get hosed, as does subordinate debt, while the senior debt ends up as new owners (in the event the bank is salvagable) or getting part repayment.

The problem is that countries are already pouring large amounts into their banks. For the most part, this is being counted as ‘investment’ so is not appearing in GGD figures. As we see from Ireland and Anglo, there comes a point where some of these banks are dead ducks and the ‘investment’ becomes a cost. It was clear in Anglo’s case to many here that the money was never going to be returned. Analysts in other countries can probably see the same thing happening there (the undercapitalised spanish cajas for example). So sovereigns are digging a deep hole for themselves in attempting to fill the banking hole and will be in need of assistance.

So we have two holes, a sovereign one and a banking one. The IMF could theoretically fill the sovereign one, but, as you point out, borrowing your way out of debt is not really feasible. The ECB has already reduced the risk rate of sovereigns by providing a ceiling. It is going to have to do more, both for sovereigns and for banks.

@ hoganmahew

Average real incomes have certainly increased in the USA in recent decades (though perhaps not the 2000s). What hasn’t increased significantly is the median income, i.e. rising income inequality has meant big rises for the already rich and not a lot for the rest. Similar story in Germany I think.

Pertinent to this thread is that once again today the ECB announced no change to its main policy rate (1%). Once again nary a hint of significant critical reaction to this, let alone to the refusal to countenace more aggressive Bernanke-style policies (not that Bernanke the central banker is being as aggressive as Bernanke the academic would have counselled).

In thinking about the ECB’s mandate and its “deflationary” bias I think this old Willem Buiter post is helpful:


In particular, and in light of John the Optimist’s points rising commodity prices, it is interesting to note the ECB’s tendency to switch back and forth between core and headline inflation as the true measure of price stability depending on which one supports a more deflationary policy.

Fair enough. By wages I meant salaries rather than income, as you say, a closer measure to the median than the average.

Shame we don’t have any median figures for Ireland…

Yes I presume dividends, capital gains, inheritance etc. make up a good chunk of the increase of average income in the US (since it pretty much all went to the already wealthy) though CEO and professionals’ compensation has also sky rocketed (with the CEO/average firm employee compensation ratio going from something like 25:1 in the sixties to something like 250:1 today).

@kevin o’rouke

Why can’t economists use plain English? Here is an attempt to translate this blog entry:

“It is assumed that international currency speculation is a smooth operation. Rich countries, as well as poor countries, affect this operation. Rich countries cannot really blame poor countries for their (the rich countries’) losses in this currency market.”

However, it seems to me, the U.K. had no difficulty blaming Iceland and Greece for its losses in currency speculation, or, what is the same thing, losses in speculation on government bonds.

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