Mario Draghi: The role of monetary policy in addressing the crisis in the euro area

This speech by Mario Draghi is generating some interest in comments.   It usefully puts the ECB’s approach to monetary policy during the crisis in a comparative perspective. 

Some complementary reading: Paul Krugman on euro area macro policy; Simon Wren-Lewis and Antonio Fatas on the dual mandate; Janet Yellen on communication/expectations management at the Fed; and Gavyn Davies on inflation targeting.   On the subject of inflation targeting, this new Vox ebook contains a number of interesting perspectives, including chapters by Stefan Gerlach and Karl Whelan (pdf here). 

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27 thoughts on “Mario Draghi: The role of monetary policy in addressing the crisis in the euro area”

  1. Draghi:
    ‘Although we see a decrease in fragmentation on the funding side, our very accommodative monetary policy stance is only partly passed on to the financing conditions faced by firms and households in some euro area countries. Companies headquartered in stressed countries face worse borrowing conditions than equally risky competitors in non-stressed countries. And, within the same stressed economy, Small and Medium-sized Enterprises (SMEs) suffer relatively more than large companies that have easier access to capital markets and are less dependent on the banking system. This is especially disconcerting given that SMEs account for about three quarters of euro area employment’

    ‘The way out is to restore competitiveness. And the way to do this in the context of a monetary union is to pursue with determination an ambitious structural reform agenda. Such an agenda comprises a number of national measures to make sure that the functioning of product and labour markets is fully compatible with participation in monetary union. One specific aspect is to fight vested interests that hamper competition, structural weaknesses of productivity and to allow, where needed, the nominal adjustments to play out.’
    ‘Monetary policy can support the reform progress by safeguarding price stability and anchoring inflation expectations. But it cannot substitute for actions that other actors, including the private sector itself, must take.’

    ‘When considering the challenges that euro area economies are still facing, it is important to remember the economic hardship that many of our fellow citizens in parts of the euro area are experiencing, and in particular the massive unemployment, especially among the youth’

    The consequences of the above are clear.

    1 Widening margin of credit costs between domestic and overseas enterprises. Aldi 5 Dunnes 0. Redundancies.
    2 Increasing use of receivership to divest domestic enterprises of legacy contracts and associated worker protections. Irish Examiner model. Redundancies.
    3 Restructuring of domestic enterprise debt and management in association with overseas investors. Outsourcing, casualization,redundancies.
    4 Replacement of domestic oligopoly by transnational oligopoly. Administered prices. Redundancies.
    5 Replacement of domestic public tendering with transnational tendering. Redundancies.
    6 Enterprises offering insecure minjobs, McJobs, internships. Opportunities for youth.
    7 Credit flow to 6 only.

  2. “There is another parallel between our early liquidity operations with banks and OMTs. In providing liquidity to our banking counterparties, we cannot and do not want to subsidise banks that are failing. Our liquidity support is not and should not be equity support. Likewise, in pricing out break-up risk in sovereign debt securities, we cannot and do not want to subsidise governments.”

    One has to question the bona fides of that statement.
    The ECB did subsidise large creditor banks, continually, through its policy of providing an umbrella for bank bondholders. Would the creditor banks have ‘failed’ if they took the hits they should have taken? We will never know now, will we!

    While the ECB may not want to ‘subsidise’ governments, the continuation of freedom of movement of capital to core, does facilitate the subsidization of core governments through lower interest rates.
    Why not have capital controls for all peripheries?
    Cyprus now has them.
    So why continue to protect the flight of capital to the core.

    “The heavy task of implementing the important decisions already taken lies ahead. All parties involved in this comprehensive reform agenda must persevere. And we must all work with conviction and determination towards our shared vision”

    The heavy task bears far more heavily on the victims of the ‘important decisions’ than it does on the those implementing the ‘important decisions’.

    As for the phrase ‘our shared vision’, so far the ECB serves neither government nor people, merely price stability and the protection of large bondholders. In Cyprus Mark 1, Asmussen agreed plans to rob grannies of their savings, while billionaires were still transferring money out of the banks.
    Shared vision?

  3. The root cause of the debt crisis!

    I’m sure that Draghi understands the monetary system very well at this stage. I’m sure he knows that every euro is created with a corresponding debt and deleted again as the debt is settled. I’m amazed that he doesn’t see this as the root cause of the crisis.

    Bear in mind growth in the money supply is matched by an even higher growth in debt. Reduction in debt reduces the money supply by the same amount. Can anyone explain to me how the debt crisis can be resolved under this system?

    On a separate note I found Draghi’s point that the ECB’s ”balance sheet has expanded substantially, to almost three times its pre-crisis size” interesting. The type of money that the ECB can create is central bank money and it’s not actually in circulation. Draghi himself noted this:

    ”It is a fallacy to make a mechanical connection between the creation of central bank liquidity and a rise in the money supply. The liquidity we provide to banks is used in the markets where banks lend to each other. It does not automatically increase credit or money in the economy.”

  4. “Also, we have seen reductions in unit labour costs. Ireland has seen an 18 percentage point improvement relative to the euro area average. In Greece, Portugal and Spain the improvement has been about 10 percentage points. As I have recently stressed to the Euro Area Heads of State and Governments, narrowing the gap between wage and productivity growth is absolutely essential for improving competitiveness in euro area countries.

    Apart from the dodgy Irish data, inflation targeting, monetary transmission, Eurozone governance architecture and so on, competitiveness and structural reforms are often spoken of in general terms and Draghi says: “Monetary policy can support the reform progress by safeguarding price stability and anchoring inflation expectations. But it cannot substitute for actions that other actors, including the private sector itself, must take.”
    That is surely true and before the crash for example, politicians kept vested interests in business and trade unions happy by allowing dual markets to develop. It also helped to mask the social costs.

    More than a third of Japan’s workforce are temporary workers or ‘temps’ with few rights working for less than the Irish minimum hourly wage of €8.65 per hour. A quarter of the South Korean workforce are temps according to the OECD and the IMF has said that almost a third of employed youths in advanced economies held such contracts before the crisis. “In boom years, companies relied heavily on temporary workers – – largely to get around regulations that make it difficult to fire permanent workers. As the economy contracted, the temporary workers were among the first let go; moreover, many did not qualify for company-paid severance – – not only was it easier to fire them, it was cheaper. Half of young workers in Spain were on temporary contracts before the crisis and were the first to lose their jobs. Young workers often face a double whammy when they are let go. Not only do they lose the job, they often have less access to social welfare benefits.”

    There are no simple short-term solutions for Italy, for example: In the past decade, traditional sectors such as shoemaking, furniture and textiles have had to deal with competition from both Eastern Europe and emerging markets such as China. Changing course is not easy and it takes a long time to develop new markets.

    Its exports in 2012 were 0.8% below the 2007 level compared with a 17% rise for Spain.

    Italy has a 73rd ranking behind Romania in the World Bank’s ‘Doing Business 2013’ which ranks how easy it is to start and run a business, pay taxes etc. Ireland is at 15, Malaysia 12 and Singapore at no. 1.

    Italy, Spain and Portugal not only had high youth unemployment levels in the past but also high secondary education dropout levels.

    Of the percentage of the population aged 18-24 with at most lower secondary education and who are currently not in further education or training, according to Eurostat, in 2005, was 30.8% in Spain; 38.8% in Portugal; 22.3% in Italy; 11.6% in the UK and 12.5% in Ireland. In 2012, the numbers were: 24.9%; 20.8%, 17.6%; 13.5% and 9.7%.

    Italy experienced a marked economic slowdown in the 1990s, with real GDP growing by an annual average of only 1.2%, down from 2.2% in the 1980s. The decline in Italy’s trend growth rate was much greater than that experienced by EMU (European Monetary System) countries: on average GDP increased at an annual rate of 2.3 % in the euro area, down from 2.4 % in the 1980s. Italy’s GDP increased by less than 3% in 2001-2010 — an annual rate below 0.3% and compared with a euro area average of 1.2%.

    Part of the 1990s performance resulted from reforms in advance of the launch of the euro in 1999.

    In 1998, the Italian unemployment rate was 12.2% and 12.6% in February 2013; youth employment (under 25s not in education or formal training) was 32.9% in 1998 and 37.8% in 2013. In Spain in 1998, the unemployment rate was 18.8%; youth employment was 35.7% and 55.7% in 2013.

    In 1998, the employment rate (15-64s) was 60.8% in the then EU15. It was 75% in Denmark; 63% in Germany; 50% in Spain and 51% in Italy.

    Italy does have low household debt and it runs a primary budget surplus (before debt interest costs).

  5. @ Michael

    Will Hutton had a great piece in the observer on Saturday.

    http://www.guardian.co.uk/commentisfree/2013/apr/14/thatcher-economy-talk-based-fraud

    “Trade unions within a proper framework are a vital means of expressing employee voice and protecting worker interests. Labour market flexibility – code for deunionisation and removal of worker entitlements – has become another Thatcherite mantra that again hides the complexity of what is needed in the labour market: employee voice and engagement, skills and adaptability. When she left office, 64% of UK workers had no vocational qualifications.”

    There are structural reasons why Germany and Switzerland have more resilient SMEs and it isn’t all down to the ECB.

  6. Its hard to take either MD or PK seriously, but lets assume that neither is biased in their outlook and pronouncements. Both have significant ‘form’ so I am giving both the benefit of a significant doubt.

    Austerity: Everyone knows what this is not. And make sanctiminous statements about it. Lets pass on.

    Un-employments: A fatal social and economic cancer. Its intractable and untreatable. Anyone who disagrees with me on this is welcome to disagree. But they had better have some real, workable solutions to hand. Lets pass on.

    Competitiveness: As with austerity much confusion and dopey comments. Basically its “Pile e’m high and sell e’m cheap”, and, “Please DO NOT look under the hood!”. If you do look under the hood then you will observe some very nasty labour practices indeed, poor wages, no social benefits, environmental degradation, etc., etc. [cf: MH-ff above and some other contributors for more complete commentary] Lets pass on.

    Productivity: Ah yes! Look, if you do manage to keep your productivity on an upward trend then you produce more of something in the same time? Or maybe the same amount of something in less time? Now explain to me what happens to employments. They increase? They flatline? Or, maybe they decrease. Which is it?

    There is either a logic deficit with this productivity thingy – or some folk are clueless about it – but are not deterred from making solemn pronouncements about it. If you increase productivity – you must increase your sales of whatever it is you are producing and, presumably (but not necessarily), at a lower price. What about your costs? What about your margins? Its Capitalism after all!

    So who are you selling the extra output to? It must be into a non-Euro economy. Or if your output remains the same – what do the workers do with their ‘spare’ time? If productivity is to be truly meaningful (in economic terms) it must result in a decrease in employments in the productivity improving sectors and … … Oh sh*t! Lets skip this.

    Not to worry, the emerging Knowledge Economy will absorb all the out of work folk! And what happens if all the EU countries, and Chindia and BRICS step up their productivities simultaneously? That would be fun!

    There is a predicament folks. Our (Western, Educated, Industrialized, Democratic (societies) economic paradigm is fraying – unraveling. We need a new paradigm. Just do not expect any enlightenment (or leadership) from the usual suspects. The problem is not here under the light folks. Its down the road – in the dark!

  7. The great value of this speech by Draghi, it seems to me, is the range of topics that he deals with and the manner in which he does so which should help anchor the academic debate in the realm of the real rather than the imagined.

    The key statement is that relating to the limitations in the capacity of the ECB to resolve the crisis.

    “And let me be clear: undertaking structural reforms, budget consolidation and restoring bank balance sheet health is neither the responsibility nor the mandate of monetary policy. Monetary policy can only avert an abrupt deleveraging that would have been conducted in an environment of panic and fire sales. And this is what we have done in order to avoid deflationary downward spirals that would have prevented us from delivering on our mandate of preserving price stability in the euro area.

    Monetary policy can support the reform progress by safeguarding price stability and anchoring inflation expectations. But it cannot substitute for actions that other actors, including the private sector itself, must take.”

  8. This is for Paul Ferguson:

    I got those books you mentioned. Thanks. The Douthwaite briefing was quite informative. Simple and easy to read and understand. The Lietaer text was great until page 20. Then it fell asunder! The Primer and two appendices were very useful.

    Begg? Is that OUR David? Or a dobbleganger?

  9. Regards to David O’Donnell if he’s reading. Hope you are well and be posting again soon.

    The speech by Janet L. Yellen is really interesting and very clear. She charts the development of the FED’s policy from ‘never explain’ to increasing transparency and the thinking behind it. For example:

    “Such information about intentions and expectations for the future, known as forward guidance, became crucial in 2003, when the Committee was faced with a stubbornly weak recovery from the 2001 recession. It had cut the federal funds rate to the very low level of 1 percent, but unemployment remained elevated, and the FOMC [Federal Open Market Committee] sought some further way to stimulate the economy. In this situation, it told the public that it intended to keep the federal funds rate low for longer than might have been expected by adding to its statement that “[i]n these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period.”

    “Let’s pause here and note what this moment represented. For the first time, the Committee was using communication–mere words–as its primary monetary policy tool. Until then, it was probably common to think of communication about future policy as something that supplemented the setting of the federal funds rate. In this case, communication was an independent and effective tool for influencing the economy. The FOMC had journeyed from “never explain” to a point where sometimes the explanation is the policy.”

    This idea: that the ‘explanation is the policy’ I think is present in Draghi’s speech and makes it a form of literature as much as communication. The suspicion has to be (and this is headwrecking), that as he knows that we know what he is saying is meant to create a self-fulfilling prophecy (eg inflation levels), then we know that he his speaking to shape the world as he wishes to make it (major magic at work here) so he has to speak so that it appears plain and uncontroversial to the uninformed reader but the insider can decipher other meanings to suit – but those meanings still have to fall within the net of desired outcomes for the ECB.

    Put another way. This is a highly subjective speech posing as objective.

    That and the fact that the whole is in a bland, soporific tone means one would need a George Orwell on his top game to really get to grips with it.

    Whew. But some points. Draghi says:

    “The way out is to restore competitiveness. And the way to do this in the context of a monetary union is to pursue with determination an ambitious structural reform agenda. Such an agenda comprises a number of national measures to make sure that the functioning of product and labour markets is fully compatible with participation in monetary union. One specific aspect is to fight vested interests that hamper competition, structural weaknesses of productivity and to allow, where needed, the nominal adjustments to play out.”

    No mention here that early 2010 Draghi, Rehn and Alesina for that matter all confidently predicted that the EZ would outperform the US over the next two years because their policy mix was better. I can dig out refs., if necessary. The complete failure of their policies is blandly omitted from the narrative and more of the same proscribed.

    Also, have a think about this for a moment:

    “And in our joint work with the Presidents of the European Council, the European Commission and the Eurogroup, we have set out a vision and a process for building a genuine Economic and Monetary Union. This is designed to cover the other gaps in the institutional architecture that I previously referred to.”

    “The genuine Economic and Monetary Union comprises four pillars: a banking union with a single supervisor; a fiscal union that can effectively prevent and correct unsustainable budgets; an economic union that can guarantee sufficient competitiveness to sustain high employment; and a political union that can deeply engage euro area citizens.”

    This is the full US of Europe. The gap between that and where the majority of Europeans are at right now is astounding. I was thinking of David O’Donnell as the main pro-Europe socialist on the blog and wondering what he made of it.

    Draghi ends:

    “The heavy task of implementing the important decisions already taken lies ahead. All parties involved in this comprehensive reform agenda must persevere. And we must all work with conviction and determination towards our shared vision.”

    If the vision is as paul quigley has sketched, and I think he is right, then vision is not shared or desired.

  10. @ Gavin

    Unfortunately Michel Rocard’s interview with Paris Match is only available in the magazine but there was one point he made particularly well. This crisis is unfolding in line with the logic of capitalism as currently parameterised.

    Every iteration of the crisis wipes out more jobs and destroy the credibility of more “thought leaders”. Ultimately Germany itself will be trashed. The end will feature just the one percenters with all of the money.

  11. @ Brian Wood Snr

    Glad you enjoyed the books. I founds snippets of others which I didn’t agree with too.

    I’d like your thoughts on the conundrum I posed above. i.e. resolving the debt crisis under the present system.

  12. I think a lot of debt will have to be written off.
    And that will be the end of low interest rates.

    Neoliberalism turned out to be very fragile.

  13. @Gavin Kostick

    This idea: that the ‘explanation is the policy’ I think is present in Draghi’s speech and makes it a form of literature as much as communication.

    A lovely analysis of Draghi’s statement of political intent (and collective institutional amnesia). Draghi might be on the less devout side of the neoliberal church but he remains committed to making it the established faith of the European Union.

    The distaste for what the people of Europe might want (if they were asked) out of European economic policy is also well noted – the European Union policy making elite fancy themselves leaders who have done away with the distasteful need for followers though international treaty.

    More generally the whole “debate” on European policy makes much more sense if seen as being between people who are focused on finding the right policy set to achieve the desired economic results (essentially the left and the portion of the right remaining in the reality based community) and those determined to define economic goals which justify the implementation of a set of canned “rule based, German ordoliberal friendly” policies (essentially the latter are simply neoliberals like Marco Buti, Rehn, Draghi, German conservatives and the nameless army of brain washed former stagaires who staff European institutions).

    The ECB’s doomed but energetic assault on fiscal multipliers and the recent comedy piece on European wealth are terrific examples of how having failed to find a rationale for the current failed policy set they have been reduced to disputing the evidence that would justify other policies. (From “There is No Alternative” to “We dispute all the evidence that there are alternatives.” to “Politically this is our accepted alternative”).

    This assault on the facts is actually a positive thing, the resulting consensus that this is a conflict between a deeply embedded reactionary elite with simple minded and failed policies and everyone else can only be helpful.

  14. ‘Besides this difficulty, there is also a particular challenge within conceptual analysis, which can lead to Bourdieu; it is the need to take the linguistic turn seriously and to think of power in terms of performativity and reflexivity. Power belongs to a series of concepts which play a special role in our political discourse. Naming or addressing something in terms of power does something to it. It establishes the borders of the political realm (res publica), where what falls inside becomes an issue of public action and justification. By doing so, it appeals to discourses of responsibility for acts taken or shunned For concepts such as power, conceptual analysis must include a ‘performative’ component.’

    http://pendientedemigracion.ucm.es/info/sdrelint/ficheros_materiales/materiales051.pdf

  15. @ PF. Got that. Thanks. My initial reaction was some form of thermonuclear device! But on mature reflection, as they say.

    We need a Full Monty disclosure of exactly what each Irish financial institution did from 2000 – 2009. – in respect of fiat-credit creation. No ifs, no buts, no exceptions. We need a full disclosure of their respective residential property ‘loan procedures’ (res prop for owner occupation). That is, how on earth did so many get such high levels of mortgage loans?

    I’m not looking for scapegoats, or to attach blame. Just how did it happen? Now, if a full forensic examination of a random sample of res property loans reveals chicanery or fraud, then those involved must explain themselves and any frauds are pursued.

    Our politicians need to ‘come clean’ about their involvements, but this is very wishful thinking on my part.

    At the end of the day a proportion of mortgage loans are ‘lost’. These are written off and the borrowers (if they are still resident in Ireland) may have their credit-ratings trashed for some time. A proportion of the mortgages can be serviced, but there may have to be writedowns to x2 times the nett salary (a min of 3 No. P60s will be needed) of the borrower. All neg equities are written down to a commercial valuation based on an annual rental yield. Borrower has two choices. Pay or vacate. BtL and commercials are on their own.

    All future res property mortgages must be non-recourse. This will apply an iron discipline on the lenders. Max 80% loans – subject to that not being in excess of x2 nett annual salary. Future wages and salaries are unlikely to rise much – one occupier being employed.

    No Irish financial institution can ever again create fiat-credit via fractional lending or borrow without strict CB sanction. Banks are there to serve our community – not loot us!

    Actually, if I had the power to do so, I would unconditionally nationalize all Irish domestic banks – and fire all directors and the top three layers of management. We need to plough them under and start afresh.

  16. @ All

    The redoubtable Helmut Schmidt is worth quoting. “Anyone who has visions should consult his doctor”.

  17. Thanks DOCM.

    @ Brian Woods Snr.

    Did I read that right?

    ”No Irish financial institution can ever again create fiat-credit via fractional lending or borrow without strict CB sanction. Banks are there to serve our community – not loot us!”

    A few weeks ago you felt that the current system of money creation/destruction was a brilliant piece of human ingenuity that was almost perfect?

  18. @ PF: Er? Did I? Might have been my Doppleganger BWII?

    I have opined in the past that the creation of fiat credit is a form of miraculous conception. How can it be explained that if you create something from nothing, you can exercise ownership rights over it? – al la John Locke?

    Money creation is NOT the same as the creation of a work of art or a literary piece. Its a very serious matter. The common good is at stake and the legal privilege to issue fiat money has been right royally abused – to the severe detriment of the common good. And politicians bear the full responsibility for this sad state of affairs.

  19. Not miraculous conception as in out of nothing was conceived ……

    First there was barter, then there were tokens and then there was government with gold and silver. Then lightning struck and in a stroke of pure genius fiat currency was born along with modern banking Medici/Italian style.

    Now according to a documentary film maker a German took his “gold certificate” to the company charged with “storing” his gold and demanded the 20 ozs of echt gold not the ersatz version. They told him that his certificate for 20 ozs was in actual fact a certificate for the cash equivqlent of 20 ozs at current market value. One thing led to another and the FED NY had to sell 500 tons of gold into the market in order to save the large gold depositories (supposed) from collapse. There is also a story out there that the Bundesbank asked to see its gold store in Fort Knox and was refused access. If it is at all true then fact is far more stimulating than fiction.

    Jesse’s Crossroads Cafe is interesting these days.

  20. Not sure if this was posted previously, Blanchflowers new paper argues fairly cogently for a deul mandate to lean against unemployment rather than inflation

    ww.bos.frb.org/employment2013/papers/Blanchflower_Session5%20.pdf

    ‘Higher unemployment and higher inflation correlate with lower levels of reported well-being, the research shows. But the impact of unemployment is much larger. A one percentage point increase in unemployment lowers well-being nearly four times as much as an equivalent rise in inflation, the paper says.’

    ‘unemployment lowers happiness of the unemployed but also the happiness of everyone else.
    • A higher proportion of individuals report that unemployment is the major problem the economy faces than is the case for inflation in most countries. Exceptions are the core Eurozone countries such as Germany and the Netherlands.
    • Europeans don’t appear to expect unemployment to come down any time soon.
    • The majority of respondents in Europe back a deficit financed burst to growth to create jobs.
    • Banking crises lowers happiness over and above their effects on inflation and unemployment and there is evidence these effects are long lasting.
    • We find that the least educated, women and, somewhat surprisingly, the old put the highest weight on unemployment. Conversely, the young, men and the most educated put the greatest weight on inflation.’

    http://economix.blogs.nytimes.com/2013/04/12/inflation-is-miserable-unemployment-is-worse/

    The only surprise for in all this is why the young educated men fear inflaiton more as its a direct transfer to them. I suppose the explanation is they dont have to fear unemployment…

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