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The Fed and the Crisis on the Eurozone

Yes, he said it. One of the gems found by Erwan Mahé in the minutes of the FOMC meetings. Ben Bernanke: “Here we potentially have a comparison to Keynes’ The Economic Consequences of the Peace and the Versailles treaty, where he pointed out that forcing Germany into extreme austerity, although it might satisfy certain moral, ethical, or political urges, had macroeconomic consequences that might force Germany eventually to rebel. By the same token, if there’s not growth for the South, eventually they’re going to decide that default and leaving the euro are better options than what they have.”

From: Erwan Mahé        27 January 2017
Good morning! I would like to take this opportunity to wish everyone best wishes for 2017. Let us hope it will be less complicated than the one that just ended. 

Unfortunately, I fear that we will remain at the mercy of political events for some time to come. I have come to fear like the plague alternative facts analysis of politics relating to financial markets, with the real economy seemingly more and more directive than before, at least for the time being. But I also use this time of the year to plunge into the reading of the full, declassified minutes of FOMC meetings of the last five years, this time, from 2011,’sans-serif’; font-size: 13pt;”>The several thousand pages of uncensored transcripts are anything but arduous to me. It is just amazing to read the unscripted comments of FOMC members as they debate the events of the day! The year 2011 was particularly rich in events, especially on the domestic front, given the shutdown of the federal budget, which led to the loss of America’s AAA credit rating, and the persistent uncertainties relating to a growth rebound in the United States. 

I also reviewed the lively debates on forward guidance theory, on the effectiveness of quantitative easing and, this will be the object of another paper, on the workings of a reduction in the Fed’s balance sheet, a matter that has resurfaced in the wake of comments by some FOMC members.  

But what I offer readers today (the fruit of a long selection process) is even more interesting because it is the Fed’s reactions, particularly those of its chairman at the time, Ben Bernanke, to the eurozone crisis. For Thaler’s Corner readers at the time of the crisis, the issues raided by members will surely ring a bell, but the frankness of Mr Bernanke’s comments are alone well worth the read. So, without further ado, I present the following excerpts for your own perusal.But don’t forget to check out the many links in the MGC section collected in recent weeks.  

And here’s a little thought from Thomas Jefferson, which seems especially appropriate today: 

The moment a person forms a theory, his imagination sees in every object only the traits which favor that theory.


In chronological order, here are some of the key excerpts from the minutes I have selected. I have highlighted the most interesting comments, but a read of the entirety of these excerpts reveal just how fascinating a year was 2011! Again, Mr Bernanke’s surprising frankness is a pleasure to read. 

Meeting of the Federal Open Market Committee March 15, 2011 

David J. Stockton, Economist 

Even so, several foreign central banks have recently expressed heightened concerns about inflation risks. For example, President Trichet, at his latest press conference, surprised us by signaling that the ECB is likely to hike rates soon. 


President Trichet has been making this argument—and I would just inject that I don’t find it completely plausible—Germany is 2½ percentage points below the pre-crisis level in terms of unemployment. Spain is 12 percentage points above the pre-crisis level. They don’t have a common fiscal authority. They don’t have common unemployment or retirement funds. I think the problems that they face in terms of heterogeneity seem to me to be much deeper than ours, although we certainly do have some.


Two recent developments also give me pause. One is that the ECB looks set to tighten this spring. This took me by surprise. Euro-area harmonized unemployment is 9.9 percent, a full percentage point higher than what we have. Now, to be clear, the low on that measure over the last 10 years was 7.2 percent, and over the last 18 years or so, it’s almost always been above 8 percent. Still, it seems like there’s a lot of slack in Europe. Also, the HICP, the Harmonized Index of Consumer Prices, the ECB’s preferred price measure, is just slightly above 2 percent year on year. With inflation more or less at target and quite a bit of slack in the economy, it did take me by surprise that they’re planning on tightening.


And fourth, the market anticipates the ECB will be beginning a tightening cycle at the April meeting. I think that action is going to underscore the growing gap between the optimal policy for the core countries, such as Germany, which I think is actually pretty close to full employment versus the peripheral countries in which economic activity is contracting and slack is actually growing. At the end of the day, I continue to think that they will muddle through in the end, because I think the commitment of the political leadership in the core countries to Europe is intact. But I think it is going to be very messy. 

Meeting of the Federal Open Market Committee on September 20–21, 2011


Like others, my presumption has been that the European leaders will do whatever is necessary to preserve the euro and, more broadly, the European project. Even for Germany, which has in some sense the most to lose in terms of transfers and bailouts, the benefits of the euro, the single market, and close political cooperation have always seemed to me to significantly outweigh the direct fiscal costs of saving Europe. That has been my view until now. I have been following, though, very closely developments in Europe, and as I mentioned, I had the opportunity to attend two extended meetings last week, one at the G-7 and one in Basel, and I have become more concerned about the ability of Europeans to manage this.

Their political and coordination problems are extraordinarily difficult, and I can only say—and I know this will be in the transcript in five years—but I think there is some lack of imagination in the policymaking that is going on now. There seems to be a very myopic focus now on getting the July 21 agreements ratified, which is in itself a difficult political task, but I think everybody recognizes that the July 21 agreements, particularly the size of the EFSF, will not be sufficient. Meanwhile, time is growing short. The Greek situation is becoming worse.  

Meeting of the Federal Open Market Committee on November 1–2, 2011


I will not be referring to charts. Last week, even as millions of children were eagerly anticipating Halloween, Christmas came early for equity investors. Santa left them a package of new measures to address Europe’s fiscal crisis, beautifully wrapped in shiny paper bearing the seals of the 17 euro-area nations.

Once the package was unwrapped, however, it turned out that a lot of additional assembly was required, many parts were missing, and no one was sure whether, once the whole thing was put together and plugged in, it would work at all. In fact, this week’s market movements suggest people are becoming more convinced that it won’t.


My long-standing concerns about the ability and willingness of European policymakers to address their sovereign debt and banking issues effectively were reinforced 10 days ago, when I attended the meetings of the G-20 governors and ministers and their deputies in Paris. I had a chance to see, up close and personal, that the key players were still very far from having nailed down crucial elements of the deal only days before their self-appointed deadline. Glimpsing how the sausage was made was not at all reassuring.

Conference Call of the Federal Open Market Committee on November 28, 2011 


There are very important political constraints. The ECB, in particular, is in a very delicate position. They have been quite frank with me that although they talk about legalities, they view their main constraints as political.

Essentially, what will the Germans allow the ECB to do? 

Their position is quite delicate in that respect, and frankly, I think it’s kind of perverse that their strategy is to actually buy for their balance sheet Greek debt, as opposed to lending to some vehicle or to the European Investment Bank or some other bank to indirectly finance government debt. But that’s where their arguments about monetary policy have led them. So the main inside information I would share with you is that there’s considerable concern and a lot of pessimism among the policymakers in Europe.


I think the Europeans just do not, in some sense, get it, to use the vernacular. I don’t believe they understand quite how dangerous the situation is that they’re involved in. They are, of course, in a situation where politicians are making the decisions, and they have many concerns other than the ideal economic outcome.

Meeting of the Federal Open Market Committee December 13, 2011


In a classic sequence from the comic strip “Peanuts,” Lucy urges Charlie Brown to run and kick the football, promising that this time, she won’t pull it away at the last second.  As we wrote down the Tealbook forecast of the global economy last week, we were faced with our own Charlie Brown moment: Would European leaders finally deliver on their promise to alleviate the region’s fiscal and financial strains or would their efforts once again fall short, dooming the markets so eagerly running up in advance of last Friday’s summit to another unseemly pratfall?  With the experience of the failed summit programs of July and October still fresh in our minds, we assumed that the Friday summit announcement would indeed fall short. We were not disappointed. 


On the growth side, the situation is even worse. In the short run, you have fiscal austerity. Some people have called the European negotiations a mutual suicide pact. To some extent, that’s what’s going on.  Everybody is agreeing to cut in a way that will obviously be negative for growth, at least in the short run. But my concern, and this was a point President Evans made very well, is that in the medium term, there simply is no provision at this point for ensuring growth in the South. From that perspective, in terms of achieving both fiscal stability and feasibility of growth, we’re far from a solution, and given the incentives on both sides to play close to the edge, we should expect to see uncertainty and volatility for some time. Unfortunately, as we know, games of chicken sometimes end up in disaster, and that’s essentially part of the whole strategy.

There have been many comparisons over the past few years to the Great Depression. Here we potentially have a comparison to Keynes’ The Economic Consequences of the Peace and the Versailles treaty, where he pointed out that forcing Germany into extreme austerity, although it might satisfy certain moral, ethical, or political urges, had macroeconomic consequences that might force Germany eventually to rebel. By the same token, if there’s not growth for the South, eventually they’re going to decide that default and leaving the euro are better options than what they have. I think it’s going to continue. I agree that there’s a strong incentive to avoid a collapse, and for that reason the odds are low, but there’s also not very much likelihood that this is going to be put to bed any time soon.

The Macro Geeks’ Corner (MGC) 

The FOMC versus the Staff: Where Can Monetary Policymakers Add Value?

By Christina D. Romer and David H. Romer, 2008 

There’s a big disagreement taking place at the Fed

Pedro da Costa, Peterson Institute for International Economics, Jan. 5, 2017

Macroeconomics and consumption: Why central bank models failed and how to repair them

John Muellbauer, VOX 21 December 2016 

Economists versus the Economy

Robert Skidelsky,  23 December 2016

Monetary Policy Divergence and Global Financial Stability: From the Perspective of Demand and Supply of Safe Assets

Hiroshi Nakaso, Deputy Governor of the Bank of Japan, January 20, 2017

  1. patrick newman
    January 28, 2017 at 1:11 pm

    Yes and the next Greek debt crisis cannot be far away but the other members of the PIGS (not forgetting Cyprus) are struggling, particularly Italy. We could be but an election or two away from a terminal crisis of the EU.

  2. February 1, 2017 at 11:22 am

    This is complex and quite detailed instructions and oversight for actions and decisions that are supposedly (per the god axioms of economics) to be self-regulating and the best of all possible worlds. Per the old aphorism, the best of all possible worlds is always a lie.

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