Europe is in Recession Because ECB Wants It

I am traveling today, so only have time to complain about some themes I keep coming across when reading the press and speaking to people out in the real world. No links.

1. There is no reason at all for the ECB to look around for transmission mechanisms to boost the eurozone economy. Europe is in recession because the ECB WANTS IT TO BE IN RECESSION. Yes, the ECB doesn’t know that it wants a recession, but the NGDP growth it is producing will inevitably produce a recession in the eurozone. OK, they aren’t even targeting NGDP, but the highly flawed CPI including oil and VAT that they are trying to hold well below 2% will inevitably produce the sort of slow NGDP growth that will inevitably produce recession.

2. The ECB is not at the zero bound. Over the past few years they’ve been repeatedly steering eurozone inflation through conventional policies of raising and lowering the short term interest rate. If they had a broken transmission mechanism they would not have been raising rates during 2011.

3. And even if they were out of room to cut rates, they are not out of paper and ink. There is no need to look for wacky UK-style proposals to stimulate bank lending–that’s what got us into this mess in the first place. They need to do monetary stimulus, WHICH HAS NOTHING TO DO WITH BANK LENDING. More currency depreciates the value of a euro note for the same reason that a big apple crop depreciates the value of an apple. Does a big apple harvest only cause apple prices to fall if bank lending is stimulated? Of course unlike apples, currency is durable. Hence the increase needs to be (expected to be) at least partly permanent.

4. Money is very tight in the eurozone, using the Bernanke NGDP/inflation criterion for tightness. They don’t need new ideas, they need to adopt an easy money policy. The bank lending channel was just as broken in 2010, when eurozone GDP was rising.

5. Is there any excuse for the press to still be talking about “easy money” throughout the developed world? (A view that seems to be based on little more than low interest rates.) I mean seriously, after the last 6 months in Japan, how can people still equate easy money with low rates? Just to refresh your memory, Japan’s had near zero rates for 16 years and nothing has changed in the past 6 months. Yet when you talk to finance-types you get the impression the current stock market booms are due to low interest rates caused by easy money. That “easy money” policy of low rates brought the Japanese stock market from 39,000 in the early 1990s to 8675 by mid November 2012.

6. Then Japan really did adopt a slightly easier money policy, and stocks soared 70% in 6 months, even though the dominant paleo-Keynesian narrative says that monetary stimulus has no effects at zero rates. Oh wait, they’ve just invented a new theory! How convenient! At zero rates the liquidity trap applies to output but not stock prices, which are raised though the finance equivalent of “immaculate conception.”

7. For anyone with two eyes, the past few months have decisively confirmed the Bernanke/Friedman/Mishkin/market monetarist view that low rates do not mean easy money. That high rates don’t mean tight money. And yet the other 99.999999% of humanity continues to blather on about “tight money” in 1979 and the Latin American hyperinflations, and “easy money” in the 1930s and the late 1990s Japanese deflation, and the current morass.

8. Again, eurozone tight money is keeping eurozone NGDP flat, and that’s a sufficient condition for a recession. Yes, they may also have supply-side problems, but that’s beside the point. Tight money is a sufficient condition for recession. They can adopt a policy of 4% NGDP growth if they want to; they simply don’t want to. Until that dynamic changes, the eurozone will continue to under-perform.

9. Nothing is gained by disaggregating the eurozone. Yes, some countries are healthier than others, but easier money will boost the overall eurozone NGDP, and that’s likely to help the weak as much as the strong, perhaps more. Recall that the current tight money policy HURT THE WEAK MUCH MORE THAN THE STRONG.

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About Scott Sumner 492 Articles

Affiliation: Bentley University

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.

Visit: TheMoneyIllusion

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