Thursday, 31 October 2013

In honour of plumbers

In the days of Ottmar Issing and Juergen Stark, high-powered economists ruled the ECB but times have changed and the current environment requires a new breed of central banker. I'll call them plumbers, but that is not intended in any way to belittle them. They are, led by Mario Draghi, more practical and more adept at coping with a deply flawed monetary system that has been put under stress. Indeed, perhaps the best comparison is between architects, necessary to design a building, set policy targets and understand the way the world works and plumbers, who don't look for perfection but simply try and keep the building from falling apart, finding a way to get the hot water from the boiler to the radiators and the dirty water out into the drains rather than all over the living room.

In term of architecture and economics what does the Euro Zone need? A fiscal union with a common taxation and spending policy; a single risk-free interest rate and instrument; a genuine monetary union that can police the financial system, raise levies to provide the funds for future bailouts and provide guarantees for retail depositors. All of this is as likely as pigs flying over the Eurotower on their way to a rave in Wilhelm-Epsein Stra├če. 

By the same token, what 'should' Europe's central bank do faced with rising uemployment, a rapidly growing current account surplus, shrinking banks' balance sheets, a huge output gap and an inflation rate falling towards zero? They should have, some time ago, worked with government to create a European TARP, to re-capitalise banks and create a 'bad bank' for impaired assets. They should now be injecting money intravenously into the system through large-scale bond purchases, and there would be nothing wrong with an Abenomics-like policy of talking down the currency, front-loading fiscal easing and structural reform of the labour market and pension system.

Some people will disagree with some or all of these policies. But what they have in common is that they, too, won't happen. 'Proper' QE is against self-imposed European rules. Talking down the currency is not in the ECB's mandate. Another set of rules demand austerity with slippage rather than either outright austerity or Keynesian expansion. And as for all getting together to re-capitalise banks, it needed to happen 5 years ago.

So what is left? When Mario Draghi arrived at the ECB he was a breath of fresh air, slicing the growth forecast, announcing the LTRO, getting money moving around the system. Then a series of vague promises and incompletely-defined promises to buy government debt and bank debt if needed were introduced. Purists look at all these policies and question whether there is any substance behind them but the yields on spanish and Italian debt just goes on falling. Others are alarmed by the way the ECB is lending money to banks to buy their own government's sovereign debt. And we all worry about the fact that with little or nominal GDP growth, debt levels are doomed to rise steadily until they are unsustainable (if they aren't already). But the Euro Area house still stands and a bloke with a wrench and some tape is making sure the money flows around the system. That's what the plumber-in-chief has achieved while he waits for his political masters to build a better structure. Hey, it's a lot better than the alternative....

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