Mario Draghi, president of the ECB: “cut bonuses!”
from Merijn Knibbe
On this blog, I’ve on occasion been scornful about the European Central Bank (ECB). Being scornful is of course easy – but I had little other choice, considering the content of the speeches of people like Stark and Trichet. And I was surely not the only highly critical voice. In a recent publication of the Dutch Central Bank (!) the authors write (emphasis added and remember: Trichet continued to focus exclusively on a narrow indicator of price stability until the very end!):
With hindsight, it seems that the most recent housing boom could have been identified as a bubble, given the similarities of this crisis to earlier ones. For instance, the sharp increases in credit and household leverage are usually early warning indicators of financial vulnerabilities building up. Nonetheless, policymakers did not react to these signals. This was partly because of the widespread conviction that they should not try to pre-emptively deal with housing bubbles. Moreover, another reason was that the mindset of policymakers was shaped by the experiences of the 1970s and 1980s, when inflation was a big concern and financial imbalances were largely absent – at least in advanced economies. Therefore, policymakers were slow in recognizing major gradual changes in the world economy. First, inflation became low and stable, conceivably due to better monetary policy, benign shocks and globalisation on the real side of the economy. As monetary policy focused on achieving price stability exclusively, this Great Moderation contributed to lower interest rates, which in turn fuelled risk-taking not justified by fundamentals. Second, financial innovation and financial globalisation increased the importance of financial factors and the interconnectedness across countries. Regulation did not always keep up with this innovation and with the risk-taking by financial institutions, partly because markets were seen as efficient and self-correcting. These developments have enhanced excessive credit growth and the build-up of financial imbalances. These imbalances were insufficiently recognized as they did not lead to inflation in goods and services. The consequences of not responding to these signals were severe.
It can even be argued that the ECB lost control over monetary policy during the summer and autumn of 2011. In a recent speech Mario Draghi, president of the ECB, states (emphasis added):
What monetary policy can do for competitiveness is to ensure price stability in the euro area, reducing risk premia and making sure that all the transmission channels of the monetary impulse do work.
This, of course, suggests that the transmission channel of monetary policy didn’t work, or was at risk of not working, therewith making the ECB in fact redundant. And that’s indeed what seems to have happened during the fall of 2011. As there were no Eurobonds at the time, there also was no ‘European’ interest rate on government bonds comparable with the interest rate of USA T-bills. But an average can be calculated. And somebody did: graph 1 shows a credible weighted average of interest rates on two year Eurozone government bonds (2 year maturity) , which shows that this average went out of control (courtesy Erwan Mahe, comment dit on “hat tip” en francais? Ce n’est pas “astuce de chapeau”, je pense) . The average should be somewhere between the red and the green line (it’s no coincidence that these three rates are in the exact middle of your computer screen when you open the ECB home page). This loss of control was, no doubt, one of the backgrounds for the large LRTO injections of liquidity into the financial system, which enabled the bank to regain control of the ‘monetary transmission channel’ – and to lower the average interest rate.
And though I’m still fundamentally critical of the ECB (mentioning ‘unemployment’ still seems a taboo, using the flawed concept of Unit Labor Costs is not professional, the focus on a narrow metric of the price level (unlike the Fed!)), being scornful becomes less easy. Unlike Trichet and Stark, Draghi acknowledges, in his speech, the problem of differences between countries, the multidimensional character of competitiveness, the long-term character of structural change, the fallibility of managers and even the less than perfect track record of monetary policy itself. Sounds all very common sense, of course. But after reading scores of speeches of Trichet and Stark it feels like leaving a tomb full of dusty mummies and entering the fresh air:
Banks too should use this currently more benign environment to strengthen their resilience further, including by retaining earnings, cutting dividends and bonuses … Taking the context of deeply malfunctioning credit markets, our recent decision on medium-term liquidity has been central in banks returning to play their vital role in the real economy … We are continuously alert to the risk of inflation, but this risk is not materialising at the present time. Moreover, inflation expectations remain firmly anchored in line with price stability. All the necessary tools to address potential upside risks to medium-term price stability are fully available … Competitiveness, broadly defined, is firmly grounded in a notion of relative productivity: a competitive economy is one that provides the institutional environment necessary to foster the development of highly productive firms. … But competitiveness is not only international price competitiveness … These include the range and quality of the products a country exports. In this regard, countries in the euro area can take advantage of their high technological advancement and well-educated labour forces. They should be producing higher quality and more sophisticated goods, and redirecting their exports towards strongly growing markets … In this vein, supportive national economic environments – including well-conceived physical and social infrastructures, sound public finances and, I should emphasise, stable financial systems – will all contribute to the competitiveness of the euro area.