Peter Praet, member of the board of the ECB: “ECB monetary policy was perfect”.

from Merijn Knibbe

According to a recent speech of Peter Praet, a new member of the executive board of the European Central Bank (ECB):

“The sovereign debt crisis pointed to an imperfect implementation of economic – but clearly not monetary – governance in the euro area”

Hmmm. In other words: monetary governance was perfect…. But was it?

Since 1999 (the introduction of the Euro), the Eurozone has experienced:

* devastating house price inflation and subsequent deflation in countries like, among others, Spain, Ireland and the Euro-peggers Denmark and the Baltic States
* reckless and out of control pro-cyclical borrowing and lending

* capital flight from Italy, Ireland and Greece: money leaves and debts stay behind
* panicking banks

* debt deflation and deleveraging in times of crisis in Ireland, Greece, Denmark, the UK and by now also the Netherlands
* 21% unemployment in Greece, 23% in Spain and over 10% unemployment in the entire union

But consumer price inflation was, on average, 2% in the medium run which means that monetary governance was perfect.

And Praet himself already points out a basic flow in the worldview of the ECB. The Eurozone was not the ‘General Equilibrium’ perfect markets system assumed by the economic models:

“Originally, it was expected that financial market pressures as well as Treaty obligations would provide strong disciplining devices for Member States to maintain sound public finances and to engage in structural reforms … financial markets were expected to discriminate between sovereign borrowers, leading to differentiated long-term bond yields across issuers with differing degrees of fiscal soundness … However, as we have seen during several years before the crisis, markets did not come up with differentiated pricing, but rather with a fairly complacent pricing of risk across the board. In the wake of the financial crisis, these – one might say, “falsely comforting” – steady states have abruptly turned around”

Indeed: real life capital markets are not inhabited by the all-knowing rational atomicons of economic theory but by real people who really do not know and just look what the other guys and galls are doing. And who were led astray by the very behavior of the ECB which explicitly and implicitly communicated the message that differences between individual countries were not important anymore, which made them forget about risks, behavior which, according to Praet himself, led to folly followed by a ‘Minsky-moment’ and panicking behavior (‘overshooting’, in ECB parlance). This does not stop Praet from being complacent, however. The ECB did just fine. He does not seem to grasp the idea that the models were wrong. According to him, reality was wrong. And monetary policy was perfect.

Even the European Commission (EC) does not accept the ECB view that ‘free’ capital markets will discipline countries and that individual countries and national debts and current accounts do not matter, in the Eurozone, as debts are just rational agreements between rational individual economic agents in a General Equilibrium economy and for instance a current account deficit is just a coincidental aggregation of individual debts. Once governments started to bail about national banks, even ECB economists should have known better. And the EC economists clearly show that many monetary variables like real exchange rates and debts and lending and house prices and current accounts were clearly were out of control, following the introduction of the Euro. Current accounts deficits reached magnitudes of 25% of GDP, private lending was occasionally as high as 40% of GDP a year. But monetary policy was perfect. According to the ECB.