Why Mario Draghi, president of the European Central Bank, is right about monetary financing and debt
Something which I should have done earlier is to check out some publications of Mario Draghi. And I still have to read them. But the ‘blurb’ accompanying them is a pleasant surprise. No Trichet style incredible, ideological nonsense about ergodic systems, confidence fairies and hyper rationality, but this (anno 2004 but an apt description of the Irish case!):
Discussions of the role of derivatives and their risks, as well as discussions of financial risks in general, often fail to distinguish between risks that are taken consciously and ones that are not. To understand the breeding conditions for financial crises, the prime source of concern is not risk per se, but the unintended, or unanticipated accumulation of risks by individuals, institutions or governments including the concealing of risks from stakeholders and overseers of those entities. This report … analyses specific situations in which significant unanticipated and unintended financial risks can accumulate. The focus is, in particular, on the implicit guarantees that governments extend to banks and other financial institutions, and which may result in the accumulation, often unrecognised from the viewpoint of the government, of unanticipated risks in the balance sheet of the public sector … the report shows that a government’s exposure to risk arising from a guarantee is non-linear. For instance, in the case of a government which guarantees the liabilities of the banking system, the additional liability transferred onto the government’s balance sheet by a 10% shock to the capital of firms is larger the lower that capital is to start with. Recognising this non-linearity in the transmission of risk exposures is essential to the reduction of the accumulation of unanticipated risks on the government’s balance sheet. Analyses of recent international financial crises recognise that the implicit guarantees governments extend to banks and corporations create the potential to greatly weaken their balance sheets.
Small wonder that Weidmann gets so angry at Draghi. Draghi is right.
See also this earlier post about the new disequilibrium thinking at the ECB. But they still have to change their targets and start to track GDP inflation instead of just consumer price inflation as well as national debt related variables instead of just Eurozone ‘M-3 money’.