Home > Uncategorized > Peter Praet, novice at the ECB, tries to rewrite history as well as the present

Peter Praet, novice at the ECB, tries to rewrite history as well as the present

from Merijn Knibbe

Peter Praet, a new member of the board of the ECB, tells us in a recent speech that:

In many societies there was an excessive build-up of debt in recent decades: both sovereign debt and private sector debt (household & corporate). Warnings were voiced repeatedly, also by the ECB. But, the start of serious debt consolidation was continuously postponed, offloading on future generations. There was too much complacency, although many debt sustainability analyses showed that there was a limited period of time to truly address the problem. The crisis has cut the room for manoeuvre.

We can of course agree with most of this, see for instance this article by Mason and Jayadev about ‘debt dynamics’: indebtedness which leads to ever larger indebtedness, not just in remote Indian villages – but also in the USA. ‘Debt peonage’, is the apt phrase.

But is Praet right about the ECB? No, he isn’t. In October 2007, three months after the run up in debt in Ireland started to wind down (July 2007 is the fateful moment) the ECB published a study which analysed their new dataset on consolidated (i.e. total) private debt of the Eurozone. Their analysis clearly showed that the large increase in private debt levels increase could not be explained by economic variables. They however chose to downplay the idea of a ‘irrational bubble’ (ECB 2007):

“assessing the historical pattern of household loan developments purely on the basis of the macroeconomic determinants of loan demand remains to some extent inconclusive, given that loan developments over the past two decades are also likely to reflect a number of structural influences, such as financial innovation and changes in mortgage market regulation, as well as the shift to a low-inflation and credible monetary policy environment in the euro area in the context of EMU.”

And a credible monetary environment is defined, by the same ECB, as a policy aimed at a 4,5% growth of the M-3 money supply, to the well-nigh exclusions of other considerations. ‘We’re credible, so nothing will go wrong’.

They clearly hadn’t read their Minsky, who, about thirty years earlier, stated that

“Theory, which ignores the existence of financial instability, can lead to rules that the authorities should control the growth of the money supply to the well-nigh exclusion of other considerations. Once financial instability is recognized as being at times a significant threat, then such an unconditional posture becomes untenable. Money supply control is at best a conditional desirable policy posture.”

But this aside point: they did have the data, their analysis showed that the build up of debt was unusual large (over 40% of GDP a year in Ireland and over 20% a year in many other countries), the first alarming reports on Ireland (and Spain) must have come in – but they did not become alarmist and they did not warn. To the contrary. Praet’s statement about the ECB is therefore wrong.

But Praet does not only try to rewrite history. He also rewrites the present, by stating that:

A new Macroeconomic Imbalance Procedure (MIP) is now in place. A warning system is helping us in identifying risks arising from large and protracted swings in competitiveness as well as sustained budget deficits at an early stage. How? By monitoring amongst others, domestic prices, costs of production, wages, unit labour costs, export market shares, and productivity.

Indeed, we do have a MIP, nowadays (and other bloggers should write more about this). But the MIP is based upon the MIPS, the Macro-Economic Imbalances Scorecard. And this scorecard looks at completely other variables than those mentioned by Praet. Export market shares and Unit Labor Costs (ULC) are included (not the ‘real ULC’ used by the ECB, but nominal ULC).

But Praet forgets to mention a whole bunch of variables related to debt, asset and land prices and unemployment included in the heart of the MIP, the MIPS. This is highly significant and shows  the ‘myopia neo-classicus’ of the ECB. In the past two hundred years or so, consecutive generations of classical, neo-classical en new-classical economists purged debt, asset and land prices and (most recently) unemployment from their General Equilibrium thinking/models (see Klamer, 1984, about the endeavours of Robert E. Lucas jr. to redefine unemployment away. See for some background the link at the end). And such variables are, therwith, of course absent from the neo-classical New Area Wide Model of the ECB which is central to the economic analysis of the ECB. And it’s not a coincidence that exactly these variables, purged from equilibrium analysis for an obvious reason, are included in the MIPS, which is designed to spot disequilibrium situations.

It’s not a coincidence that Praet does not mention these disequilibrium variables – ‘cognitive dissonance’ and ‘denial’ are the obvious phrases to describe his utterings. It’s ‘the writing on the wall’. But the ECB is not able to read this. The Euro has failed. Neo-classical models have failed. The ECB has failed. And they just don’t want to know.

ECB: ‘Box 1. New Euro area series on MFI loans to households and non-financial corporations’ in: ECB monthly bulletin October 2007 pp. 17-19.

ECB, ‘Long-term developments of MFI loans to households in the Euro area: main patterns and determinants’ in: ECB monthly bulletin October 2007 pp. 67-84.

Klamer, A., ‘Robert E. Lucas jr.’ in Klamer, A., The new classical macroeconomics. Conversations with new classical economists and their opponents. pp. 29-57. Wheatsheaf books LTD, Brighton, 1984.

Minsky, H. P., “An Evaluation of Recent U.S. Monetary Policy – I: Can and Should the Money Supply Be Controlled?” (1972). Hyman P. Minsky Archive. Paper 236. http://digitalcommons.bard.edu/hm_archive/236

A little more background to the ‘purging’ of variables from economics: see my lengthy ‘reply’ on this post.

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