Abstract
Nine years after Lehman, the euro area remains mired in stagnation which stands in stark contrast to the economic recovery in the US or the UK. This chapter takes a look at the macroeconomic policies that have led to this outcome within the particular institutional setup of the euro area and discusses feasible ways forward. It argues that procyclical fiscal tightening has exacerbated the crisis and, given constraints to monetary policy and limits to what structural reforms can deliver, increased the likelihood of becoming stuck in an equilibrium characterized by low growth and low inflation which has contributed to rising anti-European sentiment. Since the required change of direction does not seem imminent, the outright creation of broad money would provide an effective tool to salvage stable prices, growth, and employment. If done diligently, such a monetary policy operation would be squarely within the ECB’s remit without compromising its independence or credibility.
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Notes
- 1.
Due to faster population growth in the US and the UK, the picture looks a bit more benign in per capita terms although the cumulative difference in population growth only amounts to 3.5 p.p. over the same time period.
- 2.
Jarocinski and Lenza (2016) try to address the uncertainty surrounding different output gap estimation techniques by ranking various approaches according to their predictive qualities. For the best performing model they find an average output gap of around −6% in 2014 and 2015 which is much wider than institutional estimates for this period of between −2% and −3%.
- 3.
Therefore, the often used label sovereign debt crisis appears misleading and may even obscure the necessary remedial policy responses (see Sect. 4).
- 4.
See Caballero et al. (2015) for theoretical underpinnings and further implications.
- 5.
Borio and Disyatat (2009) point out that “a reserve requirement, depending on its remuneration, affects the cost of intermediation and that of loans, but does not constrain credit expansion quantitatively. (…) By the same token, (…) an expansion of reserves in excess of any requirement does not give banks more resources to expand lending. It only changes the composition of liquid assets of the banking system. Given the very high substitutability between bank reserves and other government assets held for liquidity purposes, the impact can be marginal at best” (p. 19).
- 6.
That is not to say that the counterfactual, i.e. inactivity, would have been preferable.
- 7.
- 8.
Buiter (2014) formally shows that generally “there always exists a combined monetary and fiscal policy action that boosts private demand - in principle without limit. Deflation, inflation below target, (…) and secular stagnation are therefore unnecessary. They are policy choices” (p. 2).
- 9.
The aggregate fiscal contraction in the EA masks considerable cross-country differences. Consolidation efforts have been most pronounced in the countries which displayed the largest output gaps and therefore also exhibited the highest fiscal multipliers (see Sect. 4.2).
- 10.
For instance, Krebs and Scheffel (2016) evaluate the return on investment from implementing structural reforms that involve expansionary fiscal policy in Germany and find that “the reform package [comprising a reduction in the social security tax in the low-wage sector and a publicly financed expansion of full-day school/child care] generates a balanced budget after 7 years and produces a fiscal surplus of 0.11 percent of GDP after 10 years. For any real interest rate (…) lower than 9.37 percent, the proposed reform package is fiscally efficient in the sense that the present value of fiscal deficits and fiscal surpluses is positive.”
- 11.
As Draghi (2016) has pointed out, low interest rates are the “symptom of an underlying problem, which is insufficient investment demand” and that “those advocating a lesser role for monetary policy or a shorter period of monetary expansion necessarily imply a larger role for fiscal policy to raise demand and close the output gap faster”. This notwithstanding, there is no convincing reason why savers should be entitled to non-negative risk-free real interest rates or why the government should supply such an asset in the form of cash (see Sect. 3.2).
- 12.
Cournéde et al. (2014) provide a comprehensive quantitative assessment of the impact of various fiscal consolidation measures on growth and public finances which enables them to deduct a hierarchy of consolidation instruments.
- 13.
Helgadottir (2016) argues that this school of thought has played a significant role in shaping the European policy response to the crisis.
- 14.
Holland and Portes (2012) describe the dynamics as a “death spiral” where falling output leads to rising debt which raises risk premia and, in turn, aggravates the situation even further.
- 15.
For an operationalisation and visualisation of fiscal space across countries see for instance Ghosh et al. (2013) who show that while some EA countries are severely constrained (absent fiscal transfers) others still have ample leeway to bolster the EA’s economy through fiscal support.
- 16.
In addition, public debt plays a pivotal role in providing a safe and liquid asset which should appropriately be taken into account (Holmstrom and Tirole 1998; Caballero et al. 2016). Needless to say, there is broad agreement over the perils of excessive, unsustainable credit growth, both in the public and the private sector.
- 17.
- 18.
Rocholl and Stahmer (2016) calculate that “only €9.7 billion or less than 5% of the total amount of €215.9 billion being distributed in the 1st and 2nd programme were not used for debt-related payments and bank recapitalizations and thus directly contributed to the Greek fiscal budget” (p. 4).
- 19.
- 20.
Dullien and Guerot (2012) ascribe the phenomenon of rigid rules and righteousness reigning supreme over discretionary pragmatism to ordoliberalism as a guiding principle among leading German policymakers, even when it goes against the country’s own very interests as Wolf (2012b), Evans-Pritchard (2014), and Fratzscher (2014) note.
- 21.
The claim that there has not been an alternative to front-loading fiscal consolidation in the early stages of the euro crisis lacks substance. Countries that had lost market access such as Greece certainly did not have the means for less contractionary fiscal policy in their own right (or run any deficit for that matter). Nonetheless, an earlier and more comprehensive debt restructuring and the provision of greater bridge financing by the European partners up front could have enabled them to do so and obviated the need for further rescue packages by reducing the overall costs of fiscal support in net present value terms. Hence, decisions to assume a large part of Greece’s liabilities towards private creditors and to demand large front-loaded fiscal adjustment measures reflected political choices rather than binding economic constraints.
- 22.
- 23.
Legrain (2014), for instance, lines out a blueprint after surveying a number of different reform proposals.
- 24.
See for instance Feldstein (2012), Rogoff (2012), Sinn (2015), DeLong (2015). Schmitt-Grohé and Uribe (2011) estimate the costs of adhering to a fixed currency regime following large negative external shocks. In their baseline scenario, they find that such adherence leads to an increase in unemployment by more than 20 percentage points and median welfare costs of between 4 and 10% of consumption per period.
- 25.
Levy Yeyati and Panizza (2011) study the costs of sovereign defaults and find that default events tend to be associated with the beginning of economic recoveries.
- 26.
- 27.
- 28.
Estimates from the Australian “cash splash” of 2009, in which the government sent households below certain income thresholds lump-sum transfer payments suggest that the MPC has been roughly 0.4 (Leigh 2012). In the case of OBM, the MPC would likely be higher given that the transfer would not add to national debt, alleviating potential Ricardian effects.
- 29.
Naturally, some of the additional demand would go into imports, which would provide a boost to economies outside the currency area. This, in turn, would stimulate exports, albeit to a smaller degree. If net demand for foreign currency increases in response to OBM, the euro would depreciate and prove a boon to the export sector. However, it is also possible that net demand for euros would increase due to confidence effects associated with OBM among foreign investors.
- 30.
The CLAC consists of capital and reserves (€97 billion) as well as revaluation accounts (€346 billion), which constitute unrealized gains on gold, foreign-exchange reserves, and securities (ECB 2016).
- 31.
Using Monte Carlo simulations Bindseil et al. (2004) show that “central bank capital still does not seem to matter for monetary policy implementation, in essence because negative levels of capital do not represent any threat to the central bank being able to pay for whatever costs it has. Although losses may easily accumulate over a long period of time and lead to a huge negative capital, no reason emerges why this could affect the central bank’s ability to control interest rates. (…) One could therefore conclude that the model implies a perfect dichotomy between the central bank balance sheet structure and its ability to fulfill its monetary policy tasks” (p. 23).
- 32.
For a brief discussion of Ricardian effects in the context of OBM see Sect. 7.5.
- 33.
The present value of future seigniorage gains is even likely to increase under OBM as seigniorage grows when economic growth, inflation, and interest rates pick up.
- 34.
There might be psychological ones which should be negligible for all practical purposes (Turner 2015b).
- 35.
Bunea et al. (2016) provide an overview of how various central banks handle profit distribution and the accounting of losses.
- 36.
See for example Carpenter et al. (2013): “When Reserve Bank income is not sufficient to cover interest expense, realized losses, operating and other expenses, a deferred asset is created. (…) [T]here is little guidance as to the whether or not there is a limit to the potential size of the asset. It may be plausible to assume that it would not be allowed to exceed the value of all future earnings, possibly in present discounted terms, given the fact that it is paid down through future earnings” (p. 13).
- 37.
It deserves mentioning that any central bank operation has fiscal consequences. Even the central bank’s most conventional tool, changing the main refinancing rate, will invariably alter refinancing conditions for the government. It is therefore more instructive to distinguish policies according to their intent rather than according to which other policies would have yielded a similar outcome.
- 38.
If one was opposed to OBM on grounds of this argument, then, by analogy, the central bank should never lower interest rates either because that might tempt politicians to call for further rate cuts in due course.
- 39.
Although this does not necessarily have to be the case, see Sect. 5.3.
- 40.
For an empirical investigation of the redistributive consequences of inflation see Doepke and Schneider (2006) who find that moderate rates of inflation tend to benefit young and middle-class households.
- 41.
Contrary to government debt, interest on and repayment of OBM is state-contingent (besides being optional). Therefore, even if OBM would be perceived as a liability of the public sector, its present value is lower than an equivalent amount of government debt by definition. See also Turner (2016) for a discussion of this argument.
- 42.
- 43.
Different to the one-off character of helicopter money, however, the subsequent permanent conversion of wages (and pensions) at an overvalued exchange rate harmed competitiveness and employment.
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Acknowledgements
The author Sascha Bützer thanks Frank Heinemann, Gerhard Illing, Benedikt Kolb, Tobias Krahnke, Chris Sims, Livio Stracca, Steffen Strodthoff, and Robert Unger for useful suggestions and fruitful discussions that helped shape this chapter.
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Bützer, S. (2017). (Monetary) Policy Options for the Euro Area: A Compendium to the Crisis. In: Heinemann, F., Klüh, U., Watzka, S. (eds) Monetary Policy, Financial Crises, and the Macroeconomy. Springer, Cham. https://doi.org/10.1007/978-3-319-56261-2_7
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